1. Credit Crisis: Introduction
  2. Credit Crisis: Wall Street History
  3. Credit Crisis: Historical Crises
  4. Credit Crisis: Foundations
  5. Credit Crisis: What Caused The Crisis?
  6. Credit Crisis: Bird's Eye View
  7. Credit Crisis: Government Response
  8. Credit Crisis: Market Effects
  9. Credit Crisis: Lessons Learned
  10. Credit Crisis: Conclusion

By Brian Perry



This tutorial has examined the most remarkable period many investors may ever experience. The credit crisis reshaped the financial landscape, threatened the stability of international finance and changed Wall Street forever. Let's take a look at what we've learned:

  • Commercial banking and investment banking have historically been separated.
  • As part of a plan to reform the financial system, the Glass-Steagall Act separated investment banking firms from commercial banking firms.
  • Seeking higher profits, investment banks such as Goldman Sachs increasingly turned to riskier activities such as principal trading and investing to generate the bulk of their profits. Principal trading and investing occurs when a firm uses its own capital to invest in the markets in hopes of generating profits.
  • A financial crisis is often preceded by a bubble. A bubble occurs when many investors are attracted to a market sector, usually due to attractive fundamentals.
  • In addition to the emotions of greed and fear, a review of the historical record shows that several factors have been present at the onset of many financial crises. These factors include an asset/liability mismatch and excessive leverage and risk. Frequently more than one factor is present, and each factor can multiply the damage caused by one of the others.
  • In 2000, global financial markets entered a period that came to be defined by low interest rates and below-average volatility.
  • A global savings glut in the early 2000s contributed to extremely low interest rates in many traditional asset classes, and investors sought higher returns wherever they could find them. Asset classes such as emerging market stocks, private equity, real estate and hedge funds became increasingly popular. In many instances, investors also found above-average returns in staggeringly complex fixed-income securities.
  • Low interest rates and minimal volatility in the early 2000s allowed investors to employ leverage to magnify otherwise subpar returns without exposure to excessive risk levels.
  • Mortgage providers offered a variety of creative products designed to allow buyers to afford more expensive homes and lenders relaxed underwriting standards, allowing more marginal buyers to receive mortgages. Housing prices soared, peaking in 2006.
  • Securitization describes the process of pooling financial assets and turning them into tradable securities. The first products to be securitized were home mortgages, and these were followed by commercial mortgages, credit card receivables, auto loans, student loans and many other financial assets.
  • As the rate of appreciation in home values dramatically increased during the early years of the 21st century, many people began to believe that not only would home values not decline, but that they would also continue to rise indefinitely.
  • The models that investment firms used to structure mortgage-backed securities did not adequately account for the possibility that home prices could slide.
  • In 2008, the belief that home prices do not decline turned out to be incorrect; home prices began to slide in 2006 and by 2008, they had declined at rates not seen since the Great Depression.
  • As the decline in home prices accelerated, an increasing number of people found themselves struggling to make their monthly mortgage payments. This situation eventually led to higher levels of mortgage defaults.
  • Investors soon began to question whether financial institutions knew the true extent of the losses on their books. This uncertainty led to sharp declines in the stock prices of many financial firms, and a growing unwillingness to bid for risky assets.
  • Once investors began to avoid risk, liquidity started to freeze up, preventing corporations and other borrowers from accessing the credit markets.
  • During March 2008, Bear Stearns collapsed and was purchased by JPMorgan in a forced sale brokered by the Federal Reserve.
  • On September 7, 2008, the Federal Housing Finance Agency (FHFA,) in conjunction with the Treasury Department, placed Fannie Mae and Freddie Mac under federal conservatorship as part of a four-part plan to strengthen the housing agencies.
  • In September 2008, Lehman Brothers went bankrupt, Merrill Lynch was purchased by Bank of America and Goldman Sachs and Morgan Stanley became commercial banks in order to survive the crisis.
  • On September 25 Washington Mutual, the nation's largest thrift bank, was seized by the Federal Deposit Insurance Corporation (FDIC) and its assets were sold to JPMorgan in what was officially the nation's largest bank failure to date.
  • In times of crisis, central banks tend to lower interest rates in order to encourage borrowing and provide government guarantees on bank deposits to maintain confidence in the banking system.
  • The Fed lowered its key federal funds rate to provide additional liquidity to the financial system, expanded the range of collateral it would be willing to accept in return for loans, and provided direct lines of credit to a broader variety of financial institutions (previously only commercial banks could borrow directly from the Fed.)
  • In October 2008, the U.S. government approved the $700 billion Emergency Economic Stabilization Act of 2008 (the "bailout plan").
  • At its inception, the credit crisis was primarily reflected in the bond market, as investors there began to avoid risky assets in favor of ultra-safe U.S. Treasury securities.
  • To succeed at investing in a market downturn, investors must stick to a plan, stay on top of fundamentals and keep emotional responses to market volatility from clouding decisions.

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