A bubble is referred to as a period of time when prices of assets inflate rapidly. The prices look unrealistic and out of proportion from reality. One of the most prized assets of people all around the world is real estate. Thus, the 2008 housing bubble and the global financial crisis that followed crushed the economy.
One of the seeds of the financial crisis in the US was Mortgage-Backed Security. A mortgage is a form of a loan that citizens of the United States buy real estate that has interest applied to it. In order to get mortgages, a person has to show that they are capable of repaying and are required to deposit 20% of the real estate’s price. Mortgage-Backed Securities are groups of thousands of mortgages. Once a MBS is in place, it is sold to someone who has the funds to pay them and in return, they make profits from the interests paid by the homeowners. Ideally, this is a win-win situation. However, banks failed to carry out accurate credit checks and handed out mortgages to people who had low chances of being able to pay them back. This is where the financial crisis began.
The housing bubble in the United States began with a sudden rise among citizens of the country who want to own a home. Because of the initial increase in demand, prices of real estate shot up after years of being dormant. Banks relaxed their standards of lending because they only wanted to make commissions on the houses they sold. Since all the mortgages were being backed into Mortgage-Backed Securities and were sold to big investors, these lenders did not need to keep in check the ability of the people to pay back their mortgages. The ratings of Mortgage-Backed Securities had been contaminated. A picture of the miserable situation is painted when Mark Baum meets a CDO Manager and learns that big banks had been paying him commissions and incentives to encourage his clients to invest in subprime bonds. t Michael Burry was the first to realize that the Mortgage-Backed Securities sold by the banks were very risky. If interest rates increased, then a lot of borrowers would default on their loan and if too many people did so, the real estate market would crash. Thus, he decided to buy $1.3 billion of Credit Default Swaps.
Predatory lending standards meant that mortgage rates would spike. The low quality of mortgage takers reflected that many would not be able to pay them back. The real estate bubble began to burst in 2007. People began to default their mortgage payments in large numbers and lost their homes because they had to give them up as collateral.
John Galbraith, in his book ‘A short History of Financial Euphoria’ explains financial bubbles and crashes. Through the book, Galbraith brings to the reader’s notice how difficult and important it has been, through history, to avoid the danger of financial bubbles. A bubble can only get as big and will eventually burst. The inflated prices do not just come back to reality. They dip below what it was prior to the bubble. These bubbles are repeated every year and have become a part of the way market’s function.
In 1999, the tech bubble saw the stocks of tech companies like amazon and yahoo rise by hundred times within years. However, the crash in 2000 had its effects worldwide. What happened in the 2007 financial crisis fell along the same lines. People were bidding extremely high prices for real estate. The stock prices of real estate companies had gone through the roof. However, within less than a year, the bubble burst and the economy came crumbling down. More recently, a similar bubble was formed around bitcoin. 2017 saw the price of one bit coin shoot up to 18,000 dollars. However, in 2018, its value fell by 83%. The financial memory of a person is poor. A person acknowledges an event of 20 years at its oldest. Hence why, Galbraith asks his readers to be cautious of when people tell them that this time around, things would be different.
Bubbles are an inherent part of the market. With time, businesses at the top of the game change, along with technology. The only aspect that is consistent in a market is humans. Unfortunately, although bubbles arise due to higher ups making bids on a business, the most affected are the common people. The movie, ‘The Big Short’ aids as an eye-opener in the scene where Mark Baum and his team investigate in Florida, only to enter a ghost town. Homes give off an eerie aura without any people living in them. It was the common man who was left homeless. This is the truth of what greed can do to markets and the lives of the common people.
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Hello! I am Sudrisha. I am a daughter, a friend, a student or a mere passer-by on the street. My mind is a cauldron of ideas, imaginations, dreams and values imbibed in me through everything I have been in the past twenty years. Fictional and non-fictional characters from the glossy pages of Vogue to Austen’s exquisite Pride and Prejudice are my travel guides through life. There is nothing more thrilling to me than a warm cup of cocoa (with extra marshmallows) paired with a book that makes me explore beyond the four walls of a room.