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What Caused the Financial Market's Meltdown?

Updated on February 17, 2017

Back to 1929

In order to understand the root cause of the financial meltdown, you have to get in the way back machine and go all the way back to the Wall Street Crash of 1929. It is now known that one of the major factors that created the crash and the ensuing Great Depression was that commercial banks could act as investment companies and investment companies could act as commercial banks. What does this mean? It means that commercial banks could invest in the stock and bond markets and investment companies could loan money to people for house mortgages.

Glass-Stegal Act

The Glass-Stegal Act was passed in 1933 and it put a stop to the commercial bank and investment company rulings. All was well until 1980 when Reagan removed the limit on saving and loan companies as to how much they could loan for mortgages. There was a 100K, limit, but thanks to Reagan that was removed and the sky was the limit. Everybody was leveraging houses and finally, the whole thing came crashing down, like a house of cards. It was known as the savings and loan debacle of the 80’s.

Gramm-Leach-Bliley

In 1999, Clinton, under duress from congress and bank lobbyists, passed the Grahm-Leach-Bliley Act, which allowed banks to be investment companies and investment companies to be banks. This was done so that everybody could buy a house. The banks and investment companies developed all kinds of exotic instruments that would allow people to buy houses and mitigate the risk for the lenders.

Enter FNMA and Freddie Mac

FNMA (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) were allowed to develop sub-prime mortgage which allowed people to get a very low interest rate mortgage initially, but after a certain period, it would increase tremendously. You did not have to even qualify for the loan or show that you had any income at all. They would fake the documents for qualification.These loans were then pooled together and sold to investors as mortgage backed securities.

Credit Default Swap

Derivatives and Credit Default Swaps

Derivatives were the next step. If I bet on the point spread of a football game that is a derivative, it is derived from the game, itself. If an investor wanted to bet on a security going up in value or down in value, they would take out a derivative.

To further mitigate the risk, there are rating agencies that rate the investments as high risk, medium risk, and low risk. A credit default swap is an insurance that insures the investor in case the investment goes bad and is based on the amount of risk in it. The rating agencies were rating toxic assets as AAA ratings, when they were really junk bonds. By the way, last year, this was a 60 billion dollar market world wide. This is one of the causes of the European Financel Market Meltdown. Iceland was the first to go and then Greece. Be sure to view the video full size by double clicking on it.

The Crisis of Credit

House of Cards

So now we have everybody in the market, home buyers are buying houses, the investment companies are making great gains and everybody is happy. What happens next? The loans reset to the next interest rate. Now people can’t afford those homes, so they walk away from them. The insurance companies like AIG can’t cover their loses and everything comes tumbling down like a house of cards. The loans that are not covered become toxic assets. Here is an animated video that shows how the crisis unfolded. Be sure to double click on it to view it at full screen

Enter TARP

Under the Bush Administration, the TARP (Toxic Assets Recovery Program) is announced. It’s a 700 billion dollar program to bail out the financial markets. Hank Paulson, Secretary of the Treasury, wants the money without any conditions. But the people who made great money for banks and savings and loans have to get their bonuses. So they get paid. Paul Krugman, Nobel Prize winner in economics, said: "Wall Street has socialized its risk and privatized its gains." In the mean time the economy is going down the tubes. Companies that used to get short term loans from the banks to run their business can no longer get them. So they close their doors. Other companies have to layoff people.

Where are we Today?

Obama has pushed for regulation of the markets, to bring back the Glass-Stegal act. The banks don’t want it and pay lobbyists big money to block it. Nothing has been done to regulate them. They are still playing in the unregulated derivative market and will not loan money to anybody, because they can make more money playing in these markets.

How would you like to drive on a street where there were no lanes, no stop signs no signals and no police? It would be chaotic, dangerous, and risky. That’s where we are today in the financial markets. That's why I wanted to share this with everybody, so that we can understand what really happened and what needs to be done to prevent it from happening again.

For additional reading, you may want to read my hub on What does the Federal Reserve do?

New Flash 7/26/12

Sandy Weill, former CEO of CitiGroup, who was instrumental in having Glass-Stegal repealed wants to go back to the way things were when Glass-Stegal was law. Here is the link.

http://www.huffingtonpost.com/2012/07/25/sandy-weill-cnbc-break-up-big-banks_n_1701274.html

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    • peoplepower73 profile image
      Author

      Mike Russo 3 years ago from Placentia California

      Marie: Thank you so much for your kind comments. I think it's really about the money changers. All you have to do is follow the money.

    • Marie Flint profile image

      Marie Flint 3 years ago from Jacksonville, Florida USA

      Peoplepower, thank you for writing this article. I intuitively have a distrust of money, so I don't have any. My elder daughter (a Scorpio), though, had about five planets in her "House of Finances" in her natal chart. Today she works for Fidelity Investments her in Jacksonville, Florida, and is fairly savvy about financing. She is well aware of the lending banks handing out loans to those who didn't qualify for them. While I site "greed," as the cause of our problems, she specifically sites banking loan practices. I suppose it's all a matter of perspective. I can't help remember Shakespeare's line, "Neither a borrower nor a lender be, and it shall follow as the night the day, thou canst not be false to any man." (Hopefully I got that right!) Thank you, and blessings!

    • Hackslap profile image

      Harry 4 years ago from Sydney, Australia

      Lack of engagement??? .. u've gotta be kiddin! lol .. I have limited my Amazon listings to two items only..? ..Cheers for the tip though I'll take a look ...

      And yes 'Margin Call' did remind me of what happened at Lehman although its probably more like a mix of Lehman (ie they named the charecter of the CEO John Tuld .... for Dick Fuld?? hah) .. and Deutsche and Goldman Sachs (who did go on a mass sell-off of their MBS holdings..

    • peoplepower73 profile image
      Author

      Mike Russo 4 years ago from Placentia California

      Hackslap: It reminds me of the Lehman Brothers meltdown. A film was made of that as well. I will have to watch Margin Call. It seems you can talk to people about this, but their eyes glaze over when you try to explain the intricacies. They can gain more understanding from a film like this. I gave your review a five star rating. Thanks for sharing.

      On another note, I see you have several Amazon books listed. Hub Pages and Google don't like that anymore. You will get a Lack of Engagement rating, unless you limit your book selection to no more than two books...go figure! I changed several of my hubs to limit the book selection and they went from pending to being featured.

    • Hackslap profile image

      Harry 4 years ago from Sydney, Australia

      Hey you might be interested in this ..(my latest work)

      https://hubpages.com/entertainment/Margin-Call-201

    • Hackslap profile image

      Harry 4 years ago from Sydney, Australia

      haha ..its Friday night (actually early Sat morning now) hence Im awake .... yup god bless broadband! .

    • peoplepower73 profile image
      Author

      Mike Russo 4 years ago from Placentia California

      Wow, that's the fastest reply I have ever received and from Sydney Australia as well. You got to love the internet!

    • peoplepower73 profile image
      Author

      Mike Russo 4 years ago from Placentia California

      forlanda: In part that's true. However, the bankers and investment companies had been trying to remove the fire wall between investment banks and deposit banks for years. That allowed the merger to of those two institutions to loan the money to people who had no qualifications. Thanks for your comments and thanks for stopping by.

    • Hackslap profile image

      Harry 4 years ago from Sydney, Australia

      No worries :)

    • peoplepower73 profile image
      Author

      Mike Russo 4 years ago from Placentia California

      Hackslap: That's true, here in the U.S., the federal reserve is injecting 80 billion a month into the economy by buying treasury bonds. Federal Chairman Bernanke said he will continue to do this until the housing market and jobs start to show signs of significant recovery. Thanks for the comments and stopping by.

    • forlanda profile image

      Juancho Forlanda 4 years ago from US of A

      This whole mess is rooted in the fact that people who really couldn't afford to buy a house were allowed to buy them. You explained it well in the FNMA and Freddie Mac section.

    • Hackslap profile image

      Harry 4 years ago from Sydney, Australia

      Excellent article .. although this cycle of bubbles and bursts will keep cotinuing until the banks (or as such nations) survive under the notion that cemtral banks can inject capital when needed ..ie taking the example of what's happening in the EU..

    • peoplepower73 profile image
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      Mike Russo 4 years ago from Placentia California

      I'm complying with Hub Pages Style guides and removed all but one Amazon book and ebay book.

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      I've updated this hub to include breaking news on how a former CitiGroup executive used a billion dollar Collateralized Debt Obligation (CDO) and bet agains his client, knowing the CDO was loaded with toxic assets.

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      Patty Kenyon: Thank you so much. Did you see the update that I added today? It's about the former CEO of CitiGroup who was instrumental in the repeal of Glass-Stegal. He has taken his gazillion dollars and now he wants the banks returned to the way they were before he lobbied for the repeal 10 years ago. Thanks for dropping by.

    • Patty Kenyon profile image

      Patty Kenyon 5 years ago from Ledyard, Connecticut

      Awesome, Useful, and Very Interesting!!! I love how you wrote this so that everyone can understand what happened without having a huge financial minded background!! Awesome Job!!!

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      Neil: Thanks for dropping by. I apprecieate the comments.

    • Neil Sperling profile image

      Neil Sperling 5 years ago from Port Dover Ontario Canada

      Well done and accurate - one thing missing in my opinion is the effect on the monetary system when the gold standard was thrown out.

      We live in a universe of abundance - and until mankind learns to give up the struggle to survive and learns to love life and love living we will continue to have problems.

      Way to much wealth and power in the hands of too few these days. Big Business and Big Government both are the problem. Foolish we are to believe that the answers to economic change lies in either government policies or big business actions. Like your handle "Power to the people"

      Thanks for a good hub

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      Carozy: Thanks, you are becoming one of my favorite fans. It's nice to know that my work is being shared and appreciated by others.

    • carozy profile image

      carozy 5 years ago from San Francisco

      Well done, thank you for sharing. I will share this also. You've made this complicated situation easy to understand.

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      Brett, thanks for your comments and thank you for SHARING

    • Brett.Tesol profile image

      Brett Caulton 5 years ago from Thailand

      A very interesting review of the build up. The financial system is seriously flawed, I just hope they manage to keep balancing things and a complete collapse doesn't happen.

      Thanks for SHARING.

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      molometer, you are so right and we need to inform the public so that they can make informed decisions. Thanks for the comments and thank you for SHARING.

    • molometer profile image

      molometer 5 years ago from United Kingdom

      You have covered all the bases here. Well Written and interesting. Voted up and SHARING

      This current meltdown does indeed have a long history.

      I am always surprised when 'the public' are shocked by the boom bust nature of capitalism. They obviously never read any books?

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      Thank you. I'm glad you understand it much better. Please pass it on. Everybody should understand what really happened.

    • moonstruck4ever profile image

      moonstruck4ever 5 years ago from somewhere in upstate New York

      Well written and now I understand it all that much better.

      Thank you!

    • peoplepower73 profile image
      Author

      Mike Russo 5 years ago from Placentia California

      Thank you. The videos just go into a little bit more detail.

    • truthisntstupid profile image

      truthisntstupid 5 years ago from Missouri

      I wish I could watch your videos, but I don't have good high-speed internet available where I live. Great summary of what went wrong, though!