Ten years ago this month – September 2008 – Wall Street took a huge nosedive. Today’s article will provide a summary of what happened in the financial crisis. Next month’s column will focus on how you can prepare for the next financial crisis.
The first clear indication of trouble occurred on March 17, 2008, when investment bank Bear Stearns was purchased in a fire sale by J.P. Morgan. The price was $2 per share, although it was later raised to $10 per share. The Bear Stearns purchase by J.P. Morgan was considered a government bailout because the U.S. government agreed to absorb $29 billion of potential losses (consisting of low-quality mortgage-related assets that Bear Stearns owned) after J.P. Morgan absorbed the first $1 billion of losses. Congress and the American people were not happy that the U.S. government was bailing out a large investment firm that had created its own problems with excessive risk.
Bear Stearns’ stock price was $93 per share in February. How could it plummet so drastically in only one month? To look at the underlying factors, let’s back up several years.
From 1997-2006 housing prices soared by an estimated 85 percent, according to the Case-Shiller index. Many people forgot that real estate is cyclical, and they believed housing prices would continue increasing. During this time, firms such as Countrywide, Washington Mutual, Indy Mac, and many regular banks were breaking rules by writing mortgages later described as low-doc loans, no-doc loans and liar loans. Many mortgage lenders were encouraging people to borrow far more than they could afford. Rather than requiring 20 percent down payments, they were allowing people to buy homes with nothing down. These loans were labeled “subprime” loans because the risk of foreclosure was high.