Global Financial Crisis
The current recession encompasses the worst economic conditions seen in the United States since the Great Depression. According to the National Bureau of Economic Research this economic downturn began in December 2007, however some of its roots lay in the remedies for the previous official recession, which happened during 2001. The links in this guide take you through recent interest rate cuts, subprime mortgage issuance and asset-backed securities and how they led to the current state of the economy.
Expand All Guide SectionsThe Role of Subprime Mortgages in the Recession
During 2001, the U.S. economy saw a roughly eight-month long recession spurred on by the dot-com ... read more »
Collateralized Debt Obligations, or “Toxic Debt”
Some banks repackaged their mortgage debt and sold it to investment banks as financial instruments that would garner their return on investment from the interest paid on the home loans. The sale of the debt gave mortgage lenders more money to make more loans, which in turn brought them to repackage and sell more debt. But when mortgage borrowers began to default on their loans, these debt securities, called collateralized debt obligations, or CDOs, began to fail.
Top Sites for Toxic Debt
The Consumerist
explains that CDOs were categorized into tranches according to their risk. The tranches deemed less risky, issued a AAA rating by credit rating agencies, were the first to get paid, then came the others, in order of increasing risk. When funds stopped coming in due to defaulted mortgages, the lower-rated debt tranches dried up. Financial blog Consumerist posted a video that explains how CDOs functioned—and ceased to function—by likening the investment vehicle to a champagne glass tower and mortgages to a bottle of bubbly.
The New York Times
has a step-by-step guide that traces how risky mortgage-backed securities were repackaged to eventually reemerge as bonds rated “safe” by bonds-rating agencies.
Seeking Alpha
has an article from June 2007—while the financial markets were still generally on the rise—that examines hedge funds and how they were keen to buy CDOs. It also mentions investment banks at risk of exposure to “toxic debt” from CDOs. Among them were long-standing investment houses that would either fail or be acquired by other banks, including Bear Stearns and Merrill Lynch and Lehman Brothers, as well as banks that weathered the crisis that would roil Wall Street 14 months later, including Morgan Stanley, Goldman Sachs and Barclays.
Fortune
wrote in a November 2007 report that the subprime crash is shocking in that it hit some well-established, respectable players, yet it was hardly unpredictable. The norm on Wall Street, according to Fortune’s Shawn Tully, is that it “always rides a wave until it crashes. As the fees roll in, one firm after another abandons itself to the lure of easy money.” Tully quotes Tiger Williams, CEO of Williams Trading, who said, “The fee engine becomes so huge that these products take on a life of their own. Everyone rationalizes that it’s safe because they’re making so much money. But it’s far from safe.”
The New York Times
has an August 2007 article explaining how the CDO market roiled Wall Street and other world financial markets, including how inaccurate credit ratings were apparently issued on the packaged debt securities. As investors became aware that the securities were riskier than originally thought, they began to sell them off out of panic. The New York Times article also has a graph showing the rise and fall of CDO issuance.
The Subprime Mortgage Crisis’s Effect on the Markets
Mortgage companies had already begun to go by the wayside, and margin calls were made on hedge ... read more »
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