The Global Financial Crisis Part I: The Gamble That Stumped Them All

The global financial crisis of 2008 that emerged as a consequence of the burst of the American housing bubble has undoubtedly been the most severe socio-economic calamity of the 21st Century thus far. Initially affecting the subprime buyers venturing into an unstable housing market, the fiasco quickly spread to investment banks and other financial institutions. This led to widespread bankruptcy filings and severe restrictions to credit access, effectively halting any form of investment due to a then-toxic financial system. In this entry, I shall attempt to argue via Ulrich Beck's theory of the Risk Society that this financial apocalypse was inevitable due to the very fact that we currently inhabit a world that is predicated on manufactured risks, yet our lack of understanding of said risks and associated ontological insecurities impede the creation of a secure social climate. Risk has become normalised and in their actions, people adopt both optimistic-fatalistic attitudes due to the possibility of there being high gain and high loss, and this is particularly evident in financial speculation. The implication of this theory is that the world is very much one of gambling, and because of an as-of-yet lack of knowledge relating to certainty of outcome, people justify their risky actions with a "you don't know if you never even try''-like mantra, knowing not when to stop.

So, when did it all go haywire? The outbreak of the crisis may be traced back to August 2007, when a combination of a mortgage price bubble, novel financial innovations and a blind eye turned by regulators served as the final straw in a flawed market. However, chronologically speaking, the immediate trigger has its provenance in the turn of the century. A bubble formed within the American housing market as a result of home prices increasing every year from 1995 to 2006, a price increase which strayed significantly from fundamental issues involved in the purchase of a house, such as household income. A new financial innovation known as "subprime lending" was introduced, which all of a sudden made customers of poor means among the most appealing on the housing market. Before 2000, such mortgages were virtually non-existent, with the common type of mortgage being the fixed-rate mortgage. Subprime lending in essence refers to the loaning of sums of money to people who are known to lack the creditworthiness necessary for reimbursing prime loans, usually due to circumstances that highlight personal misfortunes, notably unemployment, divorce expenses or other costly endeavours. As a general rule, such individuals have had FICO scores below 600, although there may occasionally be variation in the scores that classify borrowers as subprime.

Moreover, in order to increase the appeal of the housing market, mortgage lenders had developed what became known as adjustable mortgage rates (ARMs), which were very flexible in their nature. For example, they did not include any down payments and some lenders even permitted borrowers to delay repayment of some of the interest due monthly and add it to the principal sum. As these kinds of mortgages were established on the expectation that house prices would continue to rise, they were branded "adjustable" so as to give off the impression that they were malleable to price rises in the market. Such flimsy mortgages were then passed to financial engineers operating in large banks who appeared to make them into low-risk assets, by pooling a large amount of them. These pooled mortgages were thereafter utilised as backing for collateralised debt obligations (CDOs), which in structured finance refer to financial products backed by a pool of loans. Once loans such as mortgages, automobile loans and credit cards to individuals and corporations are approved by commercial banks, they are sold to investment banks which repackage these loans and proceed to sell them to investors. The subsequent reimbursement of the principal and interest on the loan are passed through to the investors. The promised repayment on the loans to the investors give the CDOs their value, hence why they are called "collateralised". After 2003, the source of such collateral became reduced entirely to subprime mortgages as a result of the housing boom, and due to the soaring popularity of CDOs, home lenders became increasingly willing to extend credit access to highly risky borrowers, with near-appalling FICO scores. However, once the bubble burst due to continuously rising mortgage defaults, the banks and the investors suffered catastrophic losses. Of course, one may make the argument that investors were the inculpable ignorant victims of relentless gamblers, due to their pursuit of safe tranches as rated by prolific rating agencies such as Moody's. Such agencies were paid obnoxious amounts of money by the investment banks that created the CDOs, and thus ratings would not have been based on proper criteria and rigorous analysis, but rather on the vogue of risk-taking.

This incessant risk-taking may baffle the outsider who would naturally pose the question of why regulators did not discourage such damaging behaviour, or even still, why such behaviour occurred in the first place. It is here that Beck's work on the Risk Society will help clear the skies.
In Beck's frame of mind, the inception of the Risk Society is to be seen as the sequel to the natural, more specifically, the end of nature. This refers to the focal shift from the effect that natural cataclysmic events have upon human anxieties to the effect that human work has upon nature, and this notion may be expanded to broader aspects of professional lives where innovations, such as in finance, have had debilitating consequences for material flourishing rather than soothe troubled waters. In other words, according to the Risk Society theory, advancements in knowledge have failed to create a safe and secure social climate, for intellectual progress has always resulted in more complex issues raised rather than in simplified solutions. Concerns over the world economy, and by extension, financial operations and their logistics all fit under this framework. Let us employ the rise in speculative trading as an example of the Risk Society theory applied to the financial world. Speculation is the act of trading an asset that bears a high risk of losing its nominal value, yet concerns over such risks tend to be counterbalanced by the promise of high returns following investments in such assets. It is this hope for substantial gain that gives impetus to speculative efforts for otherwise there would not be any point in them. In the case of the housing bubble, the consumptive tendencies that fueled house prices revolved around an increase in disposable income. Individuals who had raked millions from soaring stock prices wished to spend their newly-accumulated wealth, driving the savings rate to 2% in 2000. The consumption boom of the 1990s that was brought about by this surge in stock prices equally meant that people were now willing to spend hefty sums of money on more lavish homes as part of their wealth expenditure plans. Yet this triggered a bubble because there was a widespread rise in demand when the short-term, the housing supply was relatively fixed. Consequently this increased demand led to an increase in prices and as prices increased in the most popular areas, price increases began to merge with buyers' expectations. Consequently, the expectation that prices would continue to rise determined home-buyers to spend much more money on housing than on any other product or service. This also had a significant effect on the rate of housing starts, with the average rate per year rising exponentially to 25% by 2002. Unsurprisingly, the bubble began to burst in 2007 when the house starts boom led to an over-supply of housing that could not support prices
On top of it all, as American house prices were straying further and further away from the fundamentals of the housing market, the financial sector adopted complex but highly risky devices in order to support the ever-expanding prices. This was the springboard that catapulted the practice of lending subprime loans. What was even more staggering was the fact that these comprised 40% of the loans given to home-buyers at the peak of the bubble in 2005. This large anomaly alone should have been enough to alert financial regulators to the increasingly frail U.S. housing market. It is a sheer absurdity to believe in the apparent creditworthiness of subprime borrowers given the frigid state of the labor market at the time and unstable employment rates. Instead, albeit erroneously, regulators cheered at the astounding amount of ownership of homes across the country. However, the apparent success of such ventures may be attributed to the short-term thinking in relation to yielding profits rather than the future that was in doubt with regards to how long this scheme would last. Nothing better exemplifies the preoccupation with the immediate future rather than the concern with the anxiety-ridden long-term that Beck wrote about extensively than the widespread use of credit default swaps (CDSs). Essentially, credit default swaps act as insurance that the buyer acquires in the likelihood that a negative credit event, specifically a default, is due to happen and they were sold by the banks. This initiative permitted state as well as local or state governments to sell their questionable bonds more easily, as they would have backing bestowed upon them via the sale of the CDSs. The mentality behind those credit default swaps effectively put short-term profit on a pedestal, discarding the possibility of long-term financial gain, even lacking any concern with the survival of the corporations that act as buyers of said swaps. Financial executives are typically given bonuses based on reaching certain profit targets or pursuing certain stock options. Thus all in all, such incentives are designed to showcase short-term profits.

Consequently, as Beck would argue, the manufactured uncertainty brought on by speculative finance has become an inescapable aspect of our lives, one that we can barely escape and that confronts us with constant risk. This would partly explain why the financial crisis was inevitable. Given the focus of banks on the achievement of short-term profits in order to fill pockets rapidly, there was no concern with the future. The prospect of immediate greed clearly weighed greater than any fair play towards home-buyers who were fooled by banks vis-a-vis the viability of subprime mortgages. Even more shockingly, this greed had been legitimised by the doctrine of neoliberalism that set sail in the early 1980s, during the rule of the Reagan Administration.

At its core, neoliberalism is characterised by the principle of laissez-faire economics, emphasising the importance of a deregulated market that was devoid of state intervention under the pretense that a heavily regulated market would equate to having a distorted market. This ideology may be traced to the work of Milton Friedman who was an ardent advocate of the notion of the free market, popularised by Scottish economist Adam Smith. Smith essentially called for a system free from any government intervention, one in which the laws of supply and demand are not affected by government policies and most important of all, one in which the consumers themselves are able to set the prices of goods and services via the open market. Yet as alluring as this sounds, the doctrine of deregulation has done nothing but serve as a medium via which multinational corporations acquire great capital at the expense of all else, and this includes excessive risk-taking that, as was the case with the outbreak of the global financial crisis, leads to widespread sub-par and devastating economic effects, including depression. Financial regulations are thus necessary in order to reduce to a tolerable amount the quantity of risk that financial institutions ought to take in their operations, with a special emphasis on speculation. Unfortunately, the legitimisation of neoliberal ideologies via seals of approval from reputable economists pertaining to prestigious universities subsequently diverted attention from the dangers of a deregulated market and arguably the ignorance of regulators regarding the anomalous housing market in light of soaring home-ownership may reflect "irrational exuberance" at the supposedly successful free market.

Therefore, to conclude, it comes as no surprise that the global financial crisis of 2008 was an inevitable gamble given the economic ideologies that were ratified, encouraging entrepreneurship and venturing. The doctrine of neoliberalism falls nicely under Beck's umbrella category of manufactured risks for, contrary to Smithian conceptions of the market as being a priori, speculation and other risky financial innovations did nothing to create a secure financial climate, but rather focused on the short-term and left the future in bleak uncertainty. This crisis was very much a time bomb, and the countdown began long ahead of the bubble burst, one that represented the most perilous gamble in history.


  1. Replies
    1. Thank you very much for the kind words! I'm glad that I could offer a comprehensive article.


Post a Comment

Popular posts from this blog

Post-Communism as a Modern or Postmodern Phenomenon?

The End of an Era: A Postmodern and Phenomenological Examination of Socialism and Capitalism

Erdoğan and the Turkish Lira Crisis: The Pseudo-Sultan That Is Making Atatürk Roll Over in His Grave