Saturday, July 09, 2011

A Summary of the Financial Crisis 2008

It has been 3 years since the financial crisis happened. I want to summarize my understanding the the causes so that I can reference back and remember this lesson.

Financial institutions relaxed lending standard in pursuit of market share and fee revenue.

The saving glut from China's industrialization means liquidity everywhere.

Borrowers used the easy credit on housing: "flip that house" in pursuit of quick riches.

Securitization and derivatives murky the water for risk assessment in the investment process.

Non-performing loans forced financial institutions to write down their assets. Investors start to withdraw their credit. Fire sale in order to raise liquidity. Other institutions marked down their assets to the market. Fear contagion spread.

Government response: Federal Reserve open discount window and purchase asset backed securities; Lower the fed funds rate to zero. Fiscal response - Congress passed 800+ billion of stimulus. About one third in tax rebate/reduction, one third in construction/projects, and one third in extension of unemployment benefit.

Consequences: 7.8 million people lost their job due to recession. More than 2 million homes foreclosed. Federal deficit runs at $1.4 trillion a year. The shock wave rippled through every corner of the world. The economic loss is greater than any natural disaster in history.