2008 Financial Crisis

A crisis of historic proportions struck financial institutions in the U.S. and globally in September, 2008. Major financial markets went into a free-fall after The U.S. government took over mortgage lenders Fannie Mae and Freddie Mac. As a result, several banks and investment firms were went bankrupt or were bought by other companies at well below their value.¹

The crisis came to a head in late September 2008 as the world financial markets, including the New York Stock Exchange and the NASDAQ. The Dow Jones Industrial Average is down about 20 percent since July of 2008.² The financial crisis has spread across the entire world, including markets in Europe and Asia.³

Causes

An increase in high-risk mortgages caused numerous homeowners to default on their loans in record numbers. The default numbers caused a subprime mortgage crisis in which mortgage-backed securities rapidly lost value. Several mortgage lenders and banks had invested heavily in these mortgage-backed securities and could not absorb those losses. Extending of credit was sharply reduced and the global stock markets fell sharply.⁵

Bailout Plans

The United States and the European Union have proposed ambitious plans to further stabilize the world economy. The US Congress passed a 700 billion dollar mortgage bailout plan. The plan allows the U.S. Treasury Secretary to buy mortgage-backed securities, also known as toxic debt, and hold them until market conditions become more favorable.⁶ Meanwhile, the European Union has promised guaranteed bank refinancing for any country in the union that uses the Euro as currency but has not fully endorsed a large-scale bailout plan. As of October 13, 2008, The EU deal is pending final approval from 27 member states.⁷ ⁸

Predictions

On August 28, 2006, and again on August 18, 2007on Fox News Channel, economist Peter Schiff predicted that the economy was in real trouble, and that the U.S. was headed for a serious recession in either 2007 or 2008. The problem, he said, was there too much consumption and borrowing and not enough production and savings. He said that when home equity evaporated, Americans would stop consuming and the economy would collapse. He also said he thought that was a good thing, because the system would be righting itself. He was scorned by fellow panelists, including Arthur Laffer and Ben Stein.⁹

In April 2007, economist Nassim Nicholas Taleb argued in a book called The Black Swan that the consolidation of banks created a dangerous situation such that the costs of one bank failure is enormous. In a PBS interview dated October 22, 2008, Taleb and his mentor chaos theorist Benoit Mandelbrot argue that the complexity of the global community is leading toward a recession worse than it's been since the American Revolution.¹⁰