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Are you running an economy startup? Here’s what you need to know

In economics everything is connected although it does not seem, even the situation countries crossing the ocean. In 2008 this situation could be clearly observed when the negative end was taken, the time when the financial market collapsed as dominoes due to the bubble that was inflating, beginning to grow in the United States and, being the first to fall to give the famous financial crisis known as The Great Depression.

About this financial phenomenon

It should begin by clarifying that there is no consensus on this financial phenomenon, there are certain similarities between the causes and consequences, but disagree in the development. It will try to be as general as possible, able to be read by all public.

Let’s place ourselves in the context of the United States, the dotcom crisis recently occurred and the fear of the tragedy of the twin towers, this caused people to perceive the country’s financial market in a risky manner, causing investors to feel withdrawn to ask for credit.

This context, added to the idea of the governors and policymakers had to be the saviors of the market, for which they intervened with their measures, causing the way to intervene in the financial market was to establish a low interest rate, encouraging investment and request for credit, but with smaller profits for the banks.

Banks are interested in a high rate

In economics there is a certain shock with respect to the interest rate, because banks are interested in a high rate because it implies a greater return when issuing credit, while investors want a lower one so that the risk of the money they move is lower, occurring then an optimal balance where both are satisfied, officially it is known as “Pareto optimal”.

When an external entity, in this case the Federal Reserve of the United States, sets a lower interest rate than the desired one, the investors are happy but the bank is unable to react as it should, eventually causing problems.

With the market for loans frozen by this blocked interest rate, banks resorted to alternative measures to acquire money, the answer they found were real estate mortgages.

These are private loans for the construction and purchase of homes throughout the territory. They used these because they were not regulated like normal loans, so they could issue them as the expression says, “like hot bread”.

The reason of this financial document

The reason they used this financial document was because they could issue it to people who did not qualify as eligible for a common private loan, implying that they could issue mortgages to people who surely could not pay them later. In addition, they focused on real estate because there was potential in the market, because at the time there were many rented and companies wanting to build houses.

As private banks started issuing mortgages right and left, they simulated as if they had the money to make other investments, so they made up the economy making it seem as if it were growing steadily, when it was really based on impossibility of payment.

This methodology lasted for several years, until they began to be requested in a slower way or to be close to their collection date, for which they began to collect the mortgages in groups to generate a large financial document, known as the subprime bonds, the which sold and renewed both their value and the dates of payment.

As you can see, the value of the bonds and the demand for real estate were inflating, increasing the value of both parties, based on nothing. The context for 2007 was a supposed banking with high movement, investments up to Europe and a growth of homes in the United States, increasing at the same time the people who bought multiple houses and then rent them.

However, like any bubble, it should burst at some point

The problem was when the banks had to start charging mortgages to support their growth and, as you can suppose, by lending to someone who can not pay, he will not.

Noting that banks could not acquire liquidity from mortgages, people feared another bank fall, causing them to take their money out of the bank, officially it is known as a bank run, causing banks to fall into bankruptcy. In addition, companies had to charge for the houses they built and sold on loan, for which thousands of people were left homeless.

The red numbers

As explained at the beginning of the article, the first dominoes fell on Wall Street, when red numbers appeared on all screens. Then it expanded to the entire state, and so on until it affected the entire United States, and, as we said, Europe was affected by its relationship with this type of document, causing that by 2008, the entire financial system of the world would collapse.

The way the United States managed to solve this was through the new intervention of the Government, where now the Central Bank and the government of the time acquire the debts of the people, but they become the main shareholders of the companies and private banks, allowing to finance the liquidity problems.

The reason he did this was to stop this act that had not been noticed, only a few could prevent this event, betting against a growing market for lies.

We advise to watch the movie “The Big Bet” or in English “The Big Shore”, which exposes the events that we describe but in a visual way, helping to follow the thread of the events.

Also published on Medium.

Published inStartups

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