Perhaps the single most catastrophic event in the last 90 years, apart from COVID-19 and WW2, was the 2008 Market Crash. We’ve all probably heard terms like ‘mortgage’, ‘subprime’ and ‘default’ when watching films and shows, such as the 2015 biographical drama, The Big Short, which chronicled how the markets fell, why they fell and the levels of greed and stupidity on Wall Street. To understand why greed and blindness reigned supreme during the worst period in the history of the global economy, it is imperative to understand why markets fall in general, and why the housing market’s collapse happened and the ripple effect it had globally. After all, we know that if the market crashes in the US, it would also crash in India, UK, China and everywhere else too. But why is it so? And most importantly, who is to blame for this crisis?

Let’s start with the first question: why does a market fall? Markets fall because something extraordinarily bad has happened, or is going to happen soon. This leads to groups of investors selling their stocks and builds a bandwagon that essentially leads to panic selling.

Another reason for markets to crash is due to a bubble. A bubble is an economic cycle characterized by a sharp increase in market value, particularly in asset prices. This rapid inflation is followed by a rapid decline in value, or contraction, which is occasionally referred to as a “crash” or “bubble burst.” A bubble typically develops as a result of an increase in asset prices that is fueled by irrational market behavior. Assets often trade at a price during a bubble, or within a price range, that is significantly higher than the asset’s intrinsic worth (the price is not in line with the asset’s fundamentals). A famous example of a bubble burst is the Dot-Com bubble during the late 90s and early 2000s, when investors speculated a great sudden rise in the tech industry, leading to massive investments in new tech companies. When these companies underperformed or even collapsed, most of this investor confidence was lost and people soon realized that they greatly overvalued tech stocks at the time.

Now, back to the topic – the 2008 Financial Crisis. But markets don’t fall so sharply overnight and the crisis was years in the making. During the early and mid 2000s, most banks internationally figured out that they could lend more and more to customers with low credit scores, even if it were against most regulatory government policy. Banks believed that most homeowners would not default and even if a few would, most borrowers would still be able to pay back loans on time. Many huge banks, who were believed to be “too big to fail” created CDOs (Collateralized Debt Obligations) that pooled together a bunch of loans together – often a lot of the bad ones – in order to make them seem like ‘risk free’ investments. Some banks were bailed out by the government, such as Bear Stearns, whereas others simply collapsed and couldn’t be saved, such as the Lehmann Brothers.

But, it was not all with bad intentions. Initially, to recover from the Dotcom Bubble, a series of accounting scandals and the 9/11 Attacks meant that the Feds lowered interest rates to a mere 1% in order to boost the economy. Most poor and middle class people were now able to take mortgages (home loans) at low interest rates and realize their dream of buying a home. But soon, when these borrowers defaulted (didn’t pay back) due to their financial inability to do so.

Who is to blame?
Numerous economists attribute the majority of the blame to loose mortgage lending regulations that allowed many individuals to borrow amounts far beyond their means. However, there are many people to hold accountable, including:

• unscrupulous lenders who promoted homeownership to people who would never be able to repay their mortgages.
• the investment gurus who purchased those subpar mortgages and packaged them for sale to investors. They appeared to be safe investments thanks to the top investment ratings that mortgage bundles received from rating organizations.
• investors who either neglected to look at the ratings or just took care to sell the bundles to other investors before they went bust.

Like very few others in history, the 2008 financial crisis got to a size that, when it burst, it hurt millions of people, many of whom weren’t investing in mortgage-backed securities, and devastated entire economies. Luckily, banks will never carry out such terrible mortgage lending practices and government regulations have become stricter in their approach to overseeing the banking industry.