Are we heading towards the next global crisis?

We are on our way to another financial bubble, though it won't rupture in the way as the bubble of 2007-2008. The O8’ global crisis is considered the most severe crisis in the world that has happened after the Great Depression. It was not something which took place overnight, but a catastrophe that happened due to the series of developments that took place over many years. There are no individuals to blame for the disaster; The whole system is at fault.

   Modern ideologists from reputed educational institutions put forward ideas like deregulation of banks and made the necessary changes in law over the years which paved the way for the formation of the bubble, that eventually blasted. Somehow, a few political economists, individuals from - big banks, insurance companies, credit review firms profited a lot from this bubble while no one seemed to be aware of the much warned so called 'sudden breakdown'. In this paper I would like to critically disclose the factors which contributed for making this crisis so severe that the whole world felt its impact first and later compare them with present day market scenario.  

   The primary factor or the parent factor to lead such a misfortune is deregulation. The government had policies of strict regulation over the banks after the great depression. The political economists played their part in getting deregulation come to play in the financial sector. Deregulation permitted banks to make risky transactions with their customers money. Specifically, it allowed them to indulge themselves in hedge fund trading with financial derivatives. This lead to the formation of securitization chain. In this chain the banks sold mortgage backed securities, debt obligations and other financial derivatives to hedge funds. The hedge funds further sold these securities to investors. This turned out to be risk free for banks as all the risk was faced by investors. These investors further continued the chain by purchasing credit default swaps from insurance companies in order to avoid risk. Almost everyone started investing in securities including pension funds, hedge funds and even individual investors.

   As the majority of the loan taken in United States was in form of home loan this combination of real estate and insurance served as a very profitable business. The banks started pumping out as much loans as they could. They started giving large incentives in form of home loans to almost anyone as they were earning risk free money from it. This is where the problem was - they were increasing their performance by selling risky loans to investors. Furthermore, the insurance companies who were making money by selling credit default swaps to the investors also did not have the required capital to serve them in case of a large number of credit defaults. In this scenario, if one day we would see enormous number of credit defaults the investors would lose their money while the insurance companies would have nothing to back them. This would leave the banks on the verge of bankruptcy with millions of people losing their savings. As warned by many, the bubble blasted and this is what happened.

   In the span of these ten years a lot has been said about the crisis. We have seen countless rounds of discussions about who is to blame and who is not. More importantly, there has been a lot of much needed debate about deriving the right lessons from the crisis. There has been only one objective to all such trivia- to prevent such kind of devastation from happening or atleast try our best to do so. The question which has been haunting everyone’s head is are we heading towards a similar kind of dysfunction?

   According to me the answer to this question is yes we are on our way to another financial bubble, but it won’t possibly rupture in the same fashion as the bubble of 2007-2008. Most of the financial machinery which was  applied in the preceding crisis is still vital in the financial market. Financial tools including debt obligations, mortgage securities, derivatives and credit default swaps are still being used in the financial markets to carve out similar kind of products like the securitization chain. Although the use of such commercial tools and products is inevitable, there is one key difference in the functioning of markets between the time of 2008 crisis and present day.

   In today’s times, all the financial machinery is still effective but there is significant difference in the amount of prime and subprime mortgages with adjustable interest rates being given out and the numbers are not anywhere close to before. Even though there was an explicit use of all the tools available to the people concerned, the underlying problem which marked the crisis was quite simple. The banks were giving out loans to almost anyone meaning increasing their performances based on risk. People with low or moderate income were being handed out housing mortgage on which default was said to be inevitable. With the reduced number of loans being given out, we are dealing with a situation which is completely different than the scenario before. Earlier we had an oversupply of houses which required lending and now we have shortage facing affordability crisis.

   It may seem like that things are a bit stable, but it also takes a fraction of time for things to go the inverse way. Enemies like inflation which triggered the financial bubble of 2008 still remain a matter of concern. Although with the regulation on the volume of loans we may not see a crisis as severe , but we never know when the adjustable interest rates change paving way for another big bubble. The 2008 crisis had a global impact affecting millions of lives worldwide. Almost everyone was on the verge of losing their job while countless innocents lost their savings. The wrath can’t be forgotten.