The document summarizes how the financial crisis occurred through the mortgage market. It discusses how brokers connected lenders and home buyers, how mortgages were bundled into securities (CDOs) and sold to investors, and how the overuse of risky subprime mortgages and securitization led to a housing bubble. As home prices declined and mortgages defaulted, the value of CDOs declined causing losses for investors. A combination of factors like low interest rates, risky lending, and the use of leverage exacerbated the crisis.

1. A.HOW DID FINANCIAL CRISIS HAPPEN?
MORTGAGE MARKET
Model 1: Mortgage market:
This model show how the mortgage market works. At first, Brokers connect lenders with
house buyers (or house owners) and take commission for each successful deal. Lenders lend
money to house owners in form of mortgages. Then, lenders sell those mortgages to banks.
Banks buy those mortgages and through the process of securitization will transform those
mortgages into securities which are called CDO (Collateralized Debt Obligation). After that,
they will sell CDO to investors, other banks, hedge funds and other financial institution.
1.CDO (Collateralized Debt Obligation) - Mortgage securitization
Mortgage securitization is a process that transforms mortgages into securities which are
called CDO (Collateralized Debt Obligation). Mortgages in CDO were ranked and then were
traded like securities. Table 1 is an example of CDO ranking. In order to concretize, imagine
CDO was simply a box of mortgages where mortgages were put into 3 smaller boxes named
Safe, Okay and Risky. The mortgage payments paid by house owners would be poured into
the Safe box first, then the Okay box and finally the risky box. The interest rates rate would
be different 3%, 5% and 10% respectively based on different level of risk that each box
represent, the box being poured first will have the lowest interest rate and so on. After that,
banks would sell those boxes to different investors who prefer different level of risk: the
Okay box to investors who always wanted safe investments, the Okay box to other bankers
and the Risky box to hedge funds & other financial institutions who loved taking risk for
higher return. All of the investments were great and very dependable because the house
price would increase forever. The house owners could sell their houses for higher prices in
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2. future; brokers earned great commission; banks and lenders had great deals; and investors
could enjoy secured investment with 3% return, a lot higher than 1% of Fed rate. Even if bad
situation of mortgage defaults happened when the house owners could not afford their
mortgages, banks could still take back the houses and sell for other people for higher price.
Thus, mortgage become a very safe investment, somehow seems to have no risk at all. As the
result, securitization had made mortgage become the most widely traded in credit market
and accelerated the form of housing bubble.
Table 1:
2. Sub-prime mortgages
New problem occurred when qualified house owners already ran out long ago even
though there were other thousand people wanted mortgages. Thus, brokers, acting only as
middle men, lowered down conditions for easy credit. There was no requirement for down
payments (deposits), no proofs of income, and no documents at all. Those exotic and risky
mortgages were called Sub-prime mortgages (under-standard mortgages). Sub-prime
mortgages became commonplace and the brokers who approved these loans absolved
themselves of responsibility by packaging these bad mortgages with other mortgages and
reselling them as “investments. (Ryan Guina, 2008). Banks also did not care about the origin
of Sub-prime mortgages because they would transfers the risk to other investors, bankers
and other financial institutions. Besides, as long as house prices were expected to continue
going up, there were nothing to worry about. In fact, many of these sub-prime mortgages are
ticking time bombs.
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3. 3.Expectation of house values appreciation and housing bubble formed
In the 1980s when the US actual profit rate declined seriously to the lowest since after
the Great Depression, the capitalist state applied many economic policies to stimulate the
economy, especially the Community Reinvestment Act (CRA) encouraging the banking
industry to target increased homeownership in the US. Support for “affordable housing”
became a key part of local & national politics (Whalen, 2008). Moreover, higher growth rate
of population led to higher need of home, so more mortgages to buy houses were purchased.
Obviously, the stimulus policy together more needs at that time made the real estate a
hot cake of which everyone wanted a piece. And the strongest stimulation was manifested by
FED interest rate of 1%.
For the “cheap” rate, dozens of intermediary banks didn’t hesitate to supplement their
liquidity by borrowing the central bank plenty of cash, then they could make more lucrative
loans and mortgages and other deals. The housing market became hotter and hotter when
values of houses went up every month. As borrowers, people, were offered affordable-
seeming repayments by banks, higher demand drove up house values. There had been a
consecutive trend of price increase among 1990s. A new rise appeared in the beginning of
2002 but still fluctuated slightly. It was in the third quarter of 2003 when the rate actually
made its effects on real estate market. Then, house prices sharply soared promptly in the 3
following years.
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4. This remarkably higher house prices mean that lenders could lend out even bigger
mortgages, which translated into more money for the lenders, insurers and investors.
How come people could unwarily fall into a fiscal scheme? Traditionally, Americans have
been acquainted with buying homes by credits. It is experienced that homebuyers should not
put the real estate possessions in pledge that they cannot afford and that they should repay a
partial amount in advance in order to be ably suffer any one unexpected house price decline
and can still have positive mortgage values (Paul Krugman, 2009). In reality, people
overlooked basic principles and enjoyed excitement from the flying house prices out there.
In response, they decided to jump into the hot playground without any consideration of
credit-worthiness. Besides, subprime loans which are loans for real estate that are granted to
individuals who do not have the ability to obtain a prime mortgage just engaged borrowers
in a little amount of payment in advance; the rest of the borrowed amount plus interest
would be monthly paid. The point here is that once this interest rate got higher, these people
could not be able to pay their loans, but they didn’t know or didn’t care about that aspect.
What they believed at that time is the real estate would keep appreciating! That’s how the
bubble was swelling.
A big gap between home ownership demand and affordability is considerable, as
indicated in the figure.
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5. In the side of creditors, they were happy to lend people who couldn’t afford the
mortgages because they had nothing to lose. Providing that their borrowers defaulted, they
just needed to seize the houses and put them back on the market where prices were rising.
Simple and easy money. Each debtor who was too optimistic even didn’t pay attention to
how qualified what he had in hand as a mortgage was as he wouldn’t keep it. Instead, he
would sell it to investors who didn’t understand what they were trying to put thousands of
dollars in.
4.Mortgages defaults and the explosion of housing bubble:
The housing price artificially went up too fast. Figure 4.a shows the home price indexes.
Figure 4.a
Brokers and banks forgot that the economic favorable condition could be changed
somehow; people might lose jobs and income, etc; that personal defaults could cause
payment avoidance. Especially when housing prices were propelled too high, the sub-prime
mortgages turned out to be unable for the homebuyers to afford their mortgages anymore,
or to buy new houses. Housing foreclosure increased quickly until seized houses just can’t
handle the situation. Boom! The bubble exploded. Past due sub-prime mortgages rose to
18.8% in 2008. The housing price started going down remarkably. CDO now became difficult
for reselling. As the result, even qualified homeowners, who properly had the ability to pay,
also wanted to walk away. The reason is they felt it unreasonable to make payments while
they could buy a new house with much lower price. Mortgages and CDO appeared hard to be
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6. sold. No one wanted to get more bombs, simply because they were well-aware that the
housing bubble already burst.
When investors realized what was going on with their money, they gradually stopped
purchasing CDO. It demonstrated securitized-back mortgages were not saleable, which
meant they had to suffer all the CDOs without any inflow to come. Bankruptcy was
unavoidable, particularly when mortgages become the largest type of debt, account for more
than 65% in 2000s as shown in figure 4.b. The time bomb finally exploded.
5.The overuse of leverage:
The economy at least wouldn’t have to endure such a great loss of two-digit trillions of
dollars if people hadn’t overused leverage.
Leverage is borrowing money to amplify the outcome of a deal. How does leverage
work? Let’s take an example of Mr. A & Mr. B, who have 10 dollars in hand and want to make
profit. Mr. A does not use leverage and Mr. B use leverage. Mr. A uses 10 dollars to buy a box,
then resells it for 11 dollars and takes profit of 1 dollar. Mr. B, by using leverage, he can
borrow 990 dollars more (99 times more than what he has). So he has 1,000 dollars in hand.
Mr. B takes 1,000 dollars to buy 100 boxes, also resell at 11 dollars for each. As the result, Mr.
B can earn $1,100. After he pays back 990 dollar he borrow with 1% interest and transaction
fees, he will have 90 dollars left as profit. Apparently, Mr. B by using leverage can earn profit
90 times higher than Mr. A.
Leverage can give Mr. B the opportunity to make huge profit. However, it contains greater
risk. Let consider the case in which Mr. A and Mr. B can only resell their boxes at 9 dollars
for each. With simple calculation, we can easily find that Mr. A still has 9 dollars, but Mr. B
not only loses all his money but also incurs a debt of 100 dollars.
The reality where abundance of cheap funds exists drove banks crazy with leverage.
Most investment banks were leveraged by a ratio of 40 to 1, and they were dealing with
billions of dollars instead of thousands. Government sponsored mortgage giants Freddie
(FRE) and Fannie were using leverage closer to 100 to 1, because of their supposedly stricter
lending standards and implicit government backing. As you know, when asset prices are
rising, this system works like a dream, but let's look at what happens when asset prices
(in this case – houses) move downward. Indeed, leverage exaggerates the power of sub-
prime mortgage bombs; magnify the destructions to 40 times even 100 times. And that is the
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7. reason made dozens of banks and financial institutions ran into bankruptcy, which led to the
collapse of financial market and finally become financial crisis 2008.
B. WHAT ARE THE CAUSES?
So, what or who caused financial crisis?
The long list of culprits will be: “Congress, for overzealously pushing homeownership; the
Fed, for keeping interest rates so low; predatory lenders, for taking advantage of unqualified
and sometimes vulnerable home buyers; and home buyers, for getting in over their heads;
the White House, for letting banking regulations become too loose; finance executives, for
selling products they didn't understand while enjoying outsized profits; mark-to-market
accounting, for accelerating the downturn; rating agencies, for mischaracterizing paper; and
short-selling hedge funds, for betting on doomsday—thereby ushering it in.” (Jack , Suzy
Welch BusinessWeek issued in 2008, September 25)
Those reasons above are all right. It is absolutely true that they are factors (or culprits)
that caused financial crisis. However, there is something that we would like to mention
about.
1. The real wages
Figure 7.a
Annual growth rate in
productivity
3
2.6
2.5
2 1.7
1.5
1
0.5
0
88-98 98-08
Data: bureau of Labor statistic
The annual growth rate in productivity kept increasing since 1988. In the period of
1998-2008, it increased up to 2.6% a year, nearly 1% higher than the period of 1988-1998.
1% seems to be small but 1% of 14 trillion dollar GDP per year is a huge number.
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8. However, the real wage of working forces, who created such that increase in wealth, turned
out to get less money. (Figure 7.b)
The question is where does that wealth go? If working class could receive truly for their
contribution, they would be able to afford for their houses, able to afford their cars and they
would not occur into huge debt.
Figure 7.b
REAL WAGES
median weekly earnings for college graduates
1060
1050
1040
1030
1020
1010
1000
990
2001 2002 2003 2004 2005 2006 2007 2008
DATA: Bureau of labor statistics, business week
Full - time workers without an advanced degree
1.The credit-economy
In US and other capitalist countries, the money economy appears as the basis of credit-
economy. Figure 6.a present US total market debt as a % of GDP. 1933 is the year of great
depression. US society was overrun with both borrowers and lenders. A debt of a typical
family got swelling (Figure 4.b). In 2008, savings of an average household was only $392
whereas the debt became $117,951, 300 times bigger than savings. Consumer debt,
encompassing mortgages, home equity loans, installment loans, and credit cards kept
growing and there is no signal that the growth would slow then. Among them, mortgages
were increasing rapidest.
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9. After all, a ripple effect from the collapse of subprime mortgages froze the credit market
and finally led to financial crisis over the US.
According to the article “The U.S economic crisis: causes and solutions” by Fred Moseley, issed in
March 2009, after World War II, from 1950 to the mid 1970s, the rate of profit in the U.S. economy
declined almost 50 percent, from around 22 to around 12 percent. U.S faced the problem of “twin
evils” of high unemployment and high inflation. In 1970s, they adopted expansionary fiscal and
monetary policies like increasing government spending, lower taxes, and lower interest rates in
order to reduce unemployment rate. But then those policies resulted in high inflation. In 1980s, US
adopted restrictive policies to fight over inflation but then it lead to higher unemployment. As the
result, the “twin evils” effects cause the decline of rate of profit.
In order to deal with the decline in rate of profit, capitalists applied a lot of strategies.
First, they reduced real wages or at least avoided increase in real wages so that all the
benefits of increasing productivity will lead to increase in rate of profit. Second, they cut back
on health insurance and retirement pension funds. Third, they use “downsizing” and lay off
as the method to forces workers to work harder or the workers will lose their jobs so that
productivity will increase. As the result, in the period of 1998 - 2008, the productivity
increased 2.6% per year, nearly 1% higher than the period of 1988-1998 while the real
wages controversially reduce dramatically from 2002 to 2008. (Figure 7.a & 7.b). Most
workers today have to work longer and harder for less. Marx’s “general law of capitalist
accumulation” - that the accumulation of wealth by capitalists is accompanied by the
accumulation of misery for workers - has been all too obvious in recent decades in the U.S.
economy (and of course in most of the rest of the world)
However, the increase in productivities also create abundant of goods and services
needing to be consumed. Besides, the increase in rate of profit also create a lot of
tremendously rich capitalist (or investors) who own a lot of money and need a place to
invest their money in or to lend their money out. The only method is to create more and
more credits, more loans so that workers with low income can afford those products. Thus,
the American economy is built on credit. Mortgage is a form of credit, which has the fastest
growth and has the biggest contribution in the structure of credit market.
The big questions are: why the working class, the main force creates the wealth of society
can only get little? In order to stimulate consumption, why capitalist do not increase real
wages instead of using those money to lend out so that the pressure on credit market would
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10. not be that big and economy growth would be more sustainable? Those questions have
exposed huge conflicts in US economy in specific and capitalist economy in general.
Figure 6.a
Figure 4.b
Source: The New York Times
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11. II.CONCLUSION
Financial crisis 2008 started from the housing sectors, the ripple effect from the collapse
of sub-prime mortgages had frozen the credit market and finally led to financial crisis over
USA. Huge weigh of mortgage in
leverage
credit market
Mortgage defaults ----------------------------- frozen credit market --------------------------
Credit economy
banks bankcrupcy ------------------------------- financial crisis 2008
Dozens of causes can be inferred through the happening. Above all of the causes, the
conflicts existing in US economy -the unfair distribution of wealth between the dominant
class (capitalists) and dominated class (working class) - is actually the beginning of
everything, not only in financial crisis 2008, but also all of the crisis, economic depressions,
etc in the past and later on will also be the cause of crisis in future.
As long as the dominant class is still capitalists, all solutions (like bail- out) are only
temporarily effective.
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12. III.REFERENCES
1. Ryan (September 29, 2008). The 2008-2009 financial crisis: Causes and Effects. Retrieved
from http://cashmoneylife.com/2008/09/29/economic-financial-crisis-2008-causes/
2. Manav Tanneeur. How the economic storm led to the economic crisis. Retrieved from CNN
http://edition.cnn.com/2009/US/01/29/economic.crisis.explainer/index.html
3. Wendell Cox (October 28, 2008). Root causes of the financial crisis: A primer. Retrieved
from http://www.newgeography.com/content/00369-root-causes-financial-crisis-a-
primer
4. The downturns in facts and figures. Retrieved from BBC
http://news.bbc.co.uk/2/hi/business/7073131.stm
5. Boom, Burst and Blame – The inside story of America’s Economic Crisis. Retrieved from
CNBC http://www.cnbc.com/id/31187744/
6. Kimberly Amadeo. What caused the subprime mortgage crisis? Retrieved from About.com
http://useconomy.about.com/od/criticalssues/tp/Subprime-Mortgage-Crisis-Cause.htm
7. Kimberly Amadeo (January 15, 2008). Housing market 2008 outlook – It’s a burst.
Retrieved from http://useconomy.about.com/b/2008/01/15/housing-market-2008-
outlook-its-a-bust.htm
8. Giáo trình những nguyên lý cơ bản của chủ nghĩa Mac-Lênin - nxb chính trị quốc gia
9. Paul Krugman (2009). The return of depression economics.
10. Fred Moseley (March 2009). The U.S economic crisis: causes and solutions. Retrieved from
http://www.mtholyoke.edu/offices/comm/news/20700.shtml
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