Crisis of 2008: What was it and why is it different from now – 03/15/2023 – Market

The bankruptcy of Silicon Valley Bank, on March 10, and the 30% depreciation of Credit Suisse this Wednesday (15), bring to mind the economic crisis of 2008, the worst the world has gone through since the 1930s.

But the current turmoil is not related to what happened in 2008. That was a crisis generated by the real estate sector, and this one has other factors.

In the case of Silicon Valley Bank, customers withdrew their money out of concern that the company’s cash reserves were low. Regarding Credit Suisse, there is a crisis in investor confidence in the bank, after a report released by the institution points out distortions in its financial statements.

The 2008 crisis, however, has its roots in the US mortgage market. Banks spent years lending money at very low interest rates to customers to buy their properties. In 2003, for example, interest at the Fed, the central bank of the United States, fell to 1% per year, the lowest rate since the end of the 1950s.

The plentiful and cheap credit generated an increase in interest in home ownership, and, with greater demand, prices also increased. In 2005, the “boom” in the real estate market was advanced: buying a house (or more than one) became a good deal, not only for those who wanted to acquire their own property, but also for those looking to invest.

At that time, banks discovered a niche that had yet to be explored in the market: that of customers in the “subprime” segment, characterized by low income, sometimes with a history of default, such as the unemployed and people with no proven income.

This segment represents a greater risk of default than other credit categories, but, precisely because it is more risky, the rates of return are much higher. In other words, the market lived a fantasy, lending money to those who probably couldn’t pay.

One of the attractions of financial institutions was to offer customers lower interest rates in the first few months, which increased the risk of default when rates increased over the course of the loan. The vast majority of these loans were secured by the negotiated property itself, the well-known mortgage.

After reaching a peak in 2006, property prices, however, began to fall. Fed interest rates, which had been rising since 2004, made credit more expensive and drove away buyers; As a result, supply began to outstrip demand and what we saw was a downward spiral in property values.

With high interest rates, the risk became a reality. Defaults increased and the fear of new defaults caused credit to suffer a significant slowdown in the country as a whole.

Without sufficient credit supply, the US economy slowed down. With less liquidity (cash available), less is bought, less companies profit and fewer people are hired.

Companies and families affected by the crisis effectively lost the conditions to invest and consume, like property owners who lost value. Thus, you avoid borrowing money and try to save for difficult days. But, with the retraction of investment and consumption, companies sell less; with falling profits, there are more layoffs; with less income, families cut consumption, and the cycle starts again.

The 2008 crisis was marked by the bankruptcy of the traditional bank Lehman Brothers, on September 15th. With widespread default, dozens of other financial institutions also went bankrupt in the country, running out of money to lend to customers and for basic operations, such as paying their employees and bills.

The end of Lehman was followed by the sale of Merrill Lynch to Bank of America; the aid of US$ 85 billion to the insurer AIG, also at risk of going bankrupt due to lack of sources of borrowing; the bankruptcy of the Washington Mutual (WaMu) savings loan segment —in what, according to analysts, was the largest bank failure in the United States—; and the sale of Wachovia, the fourth largest in the US, which announced a merger with Wells Fargo, in an operation worth US$ 15.1 billion in exchange of shares.

To combat the wave of bankruptcy among financial institutions and calm the market, the US Congress approved a US$ 700 billion bailout plan. The money was used to buy “rotten” securities, or papers whose redemption is very unlikely, that is, with a high risk of default. Most of these assets were linked precisely to “subprime” mortgages.