The context of my literature review conveys the causes and effects of the 2008 financial crisis. After completing my first draft of the literature review we began to discuss the readings on proposals in class and basically how to present an argument. These class discussions didn’t only help with the literature review but the research essay as well. I say this because it still helps me form an opinion and how to state my evidence throughout this paper. My literature review evolved from being subpar to a lot better due to the critiquing of myself as well as Dr. Wharton and a few of my peers. They told me exactly what I should write and how I should incorporate it into my literature review. They also helped me organize my paper accordingly. Prior to the peer review I wasn’t aware on how to order my information from the first draft because the information I had came from 10+ sources and wasn’t in a good order, but through peer reviews I got my literature review organized and ready to go. The peer review sessions helped me develop my argument into the causes and effects of the financial crisis which then helped have solid structure for my organization and structure for my research essay.

Literature review

I became interested in the financial crisis due to my curiosity of how exactly it happened. I began to wonder how home mortgages and the complexity of loans were linked to Wall street and how billions of dollars were in rotation between commercial banks and investment banks out of sight of the public eye. I began to wonder why this event took such a catastrophic toll on the United States as well as the European financial system and how it impacted an average persons life that had nothing to do with the causes of the financial crisis and was totally oblivious to the fact. I became interested in the complexity the financial crisis and wanted to comprehend exactly what happened and be able to tell my peers exactly how the U.S. financial system folded in 2008 as a result of investment banks, commercial banks and mortgage lending companies using complex financial instruments unethically to receive a hefty profit. I also became interested in the financial crisis because finance intrigues me, whether its derivatives, stocks, bonds, time value money, commodities, hedge funds, mutual funds, Exchange traded funds, corporate finance, etc. Despite what it is finance is what I like to do, its something I would do for free and it’s something i’m passionate about. The fact that a group of guys got together and almost tore our economy apart is extremely surprising, and it was something I seeked to learn more about. I also was influenced to research the topic through my interest in macroeconomics and how it directly relates to financial markets, which also played a part in the financial crisis of 2008.

Causes

According to my research the three root causes of the financial crisis of 2008 was “high risk lending by U.S. financial institutions, inflated credit ratings, and high risk poor quality financial products designed and sold by investment banks” ( Wall Street and the Financial crisis 2). One cause that contributed to the financial crisis was high risk mortgage lending which was when mortgage lenders or commercial banks such as Washington Mutual would provide mortgage loans to borrowers with bad credit ratings. These high risk mortgage loans that were provided by washington mutual are called subprime mortgage loans. At the time of Washington mutual issuing the loans before the 2008 financial meltdown “Wamu was the nation’s sixth largest bank, with $300 billion in assets, $188 billion in deposits, 2,300 branches in 15 states, and over 43,000 employees.” ( Wall street and the financial crisis 2).Also Washington Mutual In 2004 WaMu began to pursue the strategy of high risk mortgage lending. By 2006 the loans that WaMu issued began to have a high default rate by borrowers which caused the bank’s portfolio to dramatically decrease in value. Also in 2007 the bank “found itself incurring losses due to a portfolio that contained poor quality loans” ( Wall street and the financial crisis 2). As an immediate response shareholders in WaMu’s stock began to lose confidence in them which caused their stock price to drop tremendously. Also depositors began withdrawing their money, which eventually caused the demise of WaMu. WaMu’s president stated that Wamu’s home loan business was the “worst managed business” he had ever seen. (Wall street and the financial crisis 3). The collapse of Washington mutual was considered the “ the largest bank failure in history”( Wall Street and financial crisis 2). This goes to show how one banks search for profit fueled by greed led to “ the origination and securitization of hundreds of billions of dollars in high risk poor quality mortgages that ultimately plummeted in value, hurting investors, the bank, and the U.S. financial system”( Wall Street and the financial crisis 3).
Another tremendous contribution to the financial meltdown of 2008 was inflated credit ratings. Credit rating agencies such as Moody’s and the S&P 500. Rating agencies are basically agencies that assess the risk of financial investments closely and then reveal information to investors that is suppose to be accurate because it is vital information that a great deal of investors follow. By taking in a huge amount of “revenue from wall street firms Moody’s and S&P issued AAA and other investment grade credit ratings for the vast majority of the subprime mortgages.” ( Wall Street and the financial crisis 6). This means that it was basically okay to invest into a subprime mortgages and the credit rating agencies knew it was bad business the entire time, but they shut their mouths and took the money from Wall Street and continued to basically make dirt look like gold. Moody’s and the S&P deemed securities that depended on high risk mortgage loans safe.
The credit rating agencies before the financial crisis defrauded investors in a way that has never happened before. Essentially they were making terrible investments look like top of the line investments and these investments were seen as so great that even pension funds had a stake in them. Originally investments with a AAA rating were suppose to have had a less than 1% probability of failing. Although in 2007 a year before the financial crisis of 2008 the vast majority of securities such as subprime loans with AAA ratings incurred substantial losses ( Wall street and the financial crisis 6). A few years after issuing the AAA ratings, in 2007 credit rating agencies were basically forced to put the real rating on the securities that were based on the subprime mortgage loans. Once they did the securities became almost instantly worthless and since a plethora of commercial banks , investors, hedge funds, and investment banks had a stake in these securities it hit the financial market like a tsunami which was the start of the financial crisis.
Lastly the most important cause of the financial crisis was the poor quality financial products designed by investment banks. For example a financial product designed as a result of the high risk mortgage lending is a MBS or a mortgage backed security. A mortgage backed security is a financial security that derived from a mortgage loan. For instance say a mortgage lender such as countrywide lends $1M to 1,000 borrowers which is $1B total and each of the borrowers have to pay back a 10% interest rate on the $1M per year. Which means each borrower pays $100,000 per year for 10 years to pay off their mortgage and in year 10 they pay $1M. Guys on wall street in investment banks such a Jp morgan for instance come along and have an idea. JP morgan wants to buy the whole set from countrywide for slightly more than $1B and countrywide agrees to it. So now all the borrowers of the mortgage loans are paying off these loans to JP morgan instead of countrywide , and the investment banks then repackaged the loans and sold them to investors as MBS’ or mortgage backed securities. So here is how JP morgan would do it this they would receive the money from the loans which is about $100M per year in total. They would put these loans into a loan pool or pool of debt called a CDO or collateralized debt obligation. The guys from JP morgan would then take this pool of loans and split it up into 1 million shares and sell each share for $1,100 and the investor would receive $100 per year for 9 years and on the tenth year the investor would receive $1,000 making the investor gain a profit of $900 per share which is very profitable. The investment bank would make $100M because if each share of the CDO is sold that means 1M shares were sold at $1,100 making the investment bank have a revenue of $1.1B. Although after calculating how much they initially bought the package of loans for from countrywide for $1.1B they profited about $100M ( Khan academy).
Although this example is in a perfect situation. Lets think about a situation in the wake of the financial crisis what if only a few loan borrowers only paid their $100,000 one year because there was an abundance of subprime loans issued by countrywide? But the worst part is that these loans were not only subprime but rating agencies were paid by investment banks to give them AAA investment grade ratings. Therefore this abundance of subprime loans looked extremely enticing to investors because they have no idea that they are subprime loans and some have no clue what a subprime loan is, they just see that its promising and it has a great investment grade. The grade AAA’ is the best investment grade an investment can have. Again, the AAA investment grade traditionally meant that there was suppose to be a default rate of under 1%. ( Wall street financial crisis). The investment banks that engineered and sold these complex financial products were the major cause of the financial crisis.

Effects

The impact of the financial crisis according to my research was substantially severe to the U.S. economy, as well as europe. According to author Kristin Seefeldt in America’s Poor and the great recession, the number of U.S. citizens in 2008 rose from 39.8 million to 46.3 million in 2009. The book also states that the amount of poor people from 2006 to 2010 grew by 27 percent while the total U.S. population only grew by 3.3 percent. This shows that the amount of people living in poverty before the financial crisis skyrocketed after it hit. Another direct impact of the financial crisis was the loss of jobs in the financial and banking sector of the economy. In the wake of the financial crisis Lehman brothers a very well known investment bank had to file for largest bankruptcy filing in history. When Lehman brothers filed they were $619B in debt, and was the fourth largest investment bank during their collapse. ( Investopedia).
The financial crisis also affected peoples everyday lives around the world. The financial crisis not only affected Americans but Europeans as well. For instance, in the wake of the financial crisis in spain a homeowner by the name of Manolo Marban was evicted from his home and owed the bank $140,000 he stated “ I will be working for the bank for the rest of my life, I will never own anything not even a car” as the tears rolled down his face ( House of Debt 119). It is shameful because Manolo had nothing to do with the unethical use of the financial products that caused him to be out of a home. Manolo most likely didn’t know what he was getting himself into because his mortgage was probably too complex to understand. The problem today is that the typical hard working middle to low class individual doesn’t delve deep into things like their mortgage they just pay it every month. That is exactly what they should do, that’s how it’s supposed to be although it wasn’t. It makes you question the ethics of some of those mortgage lenders and the guys at the various investment banks that participated in this heinous act of putting the economy in a downward spiral that was incentivized by greed. Some of these guys are millionaires today and will never have to lift a finger again in their lives.