It has been more than a decade since the 2008 financial crisis that shook the world economy. What were the causes and consequences of the crash? How will this crash go down in history? What lessons have we learnt?
What was the 2008 global financial crisis?
The 2008 crash, often referred to as the Great Recession, was a major jolt to the global financial institutions – perhaps the strongest in a century. Fear that the world’s banking systems were headed towards collapse was just accelerating any such collapse. The US was battling a housing crisis, and the problems in the subprime market began making the news. Suddenly, all hedge funds and investors wanted an out. Tracing it back to 2007, financial firms and hedge funds owned more than $1 trillion in securities backed by these now-failing subprime mortgages – enough to start a global financial tsunami if more subprime borrowers started defaulting. Then, on Sept. 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman’s bankruptcy filing was the largest in history, surpassing even the previously bankrupt WorldCom and Enron in magnitude.
When did it begin?
On 15 September 2008, Lehman Brothers filed for bankruptcy. As a ballpark, this is considered the day when the economic crisis was set into motion. This is generally considered to be the day the economic crisis began in earnest. Before this, Bear Stearns Companies, the investment bank, had pledged up to $3.2 billion in loans in 2007 to bail out one of its hedge funds that were collapsing because of bad bets on subprime mortgages. Because of the way global finance was intertwined, securities linked to subprime loans were accumulated in all the banks and on all the financial markets around the world.
What caused the financial crash?
In layman terms, here’s what happened: there was borrowing on a huge scale, and this borrowing was injected into housing, but soon after it turned out to be unsustainable. The gap between debt and income began to widen due to rising global energy prices, curbing the ability of the borrowers to repay mortgages. Property prices began falling, which meant that the value of the assets held by the financial institutions also did. The banking sectors in the US and the UK were deteriorating until they were bailed or rescued by state intervention.
Thus, the crisis was boiling in the pot for a long time before it finally crashed in September 2008. Many economists claim to have predicted the 2008 crisis, but at the time, the dominant vibe was of complacency, of the opinion that nothing could crash the system, that the Great Depression was a thing of the past.
How Hedge Funds caused the global financial crisis
Hedge funds are, in part, responsible for the 2008 crisis because they added too much risk to the banking system. It is almost ironic because hedge funds are typically used to lower the risk and stock market volatility through data-based investing strategies.
Hedge funds rely heavily on short-term funding through money market instruments to generate enough cash to keep their margin accounts active. This is fine under normal circumstances, but when panic strikes, investors want an out from these and instead buy 100% guaranteed bonds or bills. As a result, hedge funds were forced to sell securities at bargain-basement prices, thus worsening the stock market crash.
The economies around the world have learnt their lessons – they are now keen on smarter international cooperation and a more robust payment and settlement system.
As an individual investor, however, what is the lesson learnt? One of the most important lessons learnt is that in order to prevent emotional-financial swings, create and adhere to a diversified portfolio. Hedge funds aren’t spotless in this arena, so your solution is to invest in mutual funds. Mutual funds investments are the best way to help you make a diversified portfolio that spreads out your risk across different asset classes.
Additionally, since mutual funds pool capital from different investors, it reduces the overall risk of investment. One of the defining characteristics of mutual funds is that they offer investors daily liquidity. Mutual funds are priced according to their net asset value (NAV) and investors can have their money upon settlement. If you choose to invest in mutual funds at Finserv MARKETS, you get to invest in your desired products without losing money on commissions. Finserv MARKETS also provides detailed insights into the performance of your funds, so you are aware of the returns and can make crucial decisions about such an investment.
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