What causes the 2008 crisis?

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I am not an expert on this. There are two causes of the crisis in 2008. The intermediary cause is, of course, the drop in real estate prices. Because the real estate is the collateral of the loan, if the price of the collateral is lower than the price of the loan, the rational thing to do is to default.

Of course, a bank isn’t someone that needs more houses. When they have this collateral they don’t need, all they want to do is sell. That creates more sell and lower real estate prices even more.

Most market mechanism is self-balancing. Yet this one is self-perpetuating. I think anything self-perpetuating is a very interesting anomaly. All the huge profit is in there. But that’s really beside the point. Let’s get back to the track.

What’s the original cause? Who knows. The left says too much deregulation. The right says that forcing the lender to blindfold themselves in an industry where adverse selection is common is the cause.

There are regulations that force lenders to lend to “minorities.” The “minorities” here are not Jews, Chinese, Japanese, Italians, Indians, or Russians. It’s just code words for those whose credit rating is bad.

My guess is a little bit of both with fraud involved. So this “subprime” lending is leveraged. A lot of “dangerous” loan is issued. It shouldn’t be.

On average, those dangerous loans shall, on average lost money. However, with creative accounting, somehow, people can make it look healthy and then leverage things out.

Imagine you, putting all your money in bitcoin. Even if bitcoin will, on average, go up, it’s not wise. A subprime mortgage is like that. Someone is taking the interest difference at no risk to himself. He repackages the high-risk loan and mix it up and borrow money at a lower rate to finance that.

Another issue is the failed insurance principle. Say I lend money to 100 high-risk lenders at a high-interest rate. If all 100 lenders may default independently with each other, I am fine. On average, I know a certain percentage will fail to pay, and on average, I still make money. Some investors will realize that this averaging out stuff will lower my risk. I can then borrow at say 2% interest rate from such investors and lend to the high-risk lender at say 10% interest rate. On average, I should be rich.

But then, due to crisis, all those loans collapse at the same time. The bankruptcies of the 100 lenders are not independent events. They are correlated. It’s like putting all your money in crypto and see that when the Bitcoin price drops, so are Ethereum, Litecoin, and everything else.

Of course, the wisest financial experts don’t gamble with their own money. With bankruptcy law, you can gamble with other people’s money. Imagine going to a casino. You borrow $1 million from the bank, and you put it red. If red came out, you repay your loan and have $1 million. If black came out, you would declare bankruptcy. I’ve heard this is what Fannie and Freddie did.

So if things go the way it used to be, I will pocket my 8% interest difference. If shit hits the fan, some government will bail the fuck out of me while taxing innocence.

Knowing how to pull those things up is the cornerstone of financial literacy.

I will teach my kids finance. I am going to be a father again, by the way.

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