The 2008 Financial Crisis is the worst economic disaster since the Great Depression, it reshaped the world of finance and investment banking. This year marks the 10th anniversary and the effects are still being felt today.
It was a combination of debt and mortgage-backed of assets. There was an explosion in the issuance of bonds backed by mortgages. Investment banks were buying mortgages from mortgage issuers, repackaging them and then selling off specific tranches of the debt to investor, there were less and less new mortgages to securitize so the structured products groups at banks started repacking.
Theoretically, the pooling of different mortgages reduced risk and therefore the assets were quite safe, the greater number of the mortgages being securitized were of poor quality. The ratings agencies who rated the both mortgages and collateral debt obligations did not fully appreciate the low-quality mortgages backing the assets they were rating, or they overestimated the benefits of diversification in the housing market and as a result, many of the mortgages and collateral debt obligations were rated the top. The defaults in the mortgage markets caused a collapse in the value of the collateral debt obligations, which created a cascade of additional problems as the multitude of collateral debt obligations were executed, dragging down the balance sheets of the major players in investment banking. This lead to the freezing of private credit markets.
The collapse of the debt obligations lead to a significant problem since no one was trading debt obligations it was no longer clear what they were worth. The financial system is based on trust. So, the evaporation of trust meant that no private financial institution where willing to lend its scarce cash to any other since the former couldn’t trust that the latter was correctly revealing the extent of its collateral debt obligation holdings, and neither could be sure what those holdings were worth. The liquidity problems turned to insolvency, when private lending froze completely numbers of important credit markets, such as commercial paper. Consequence non-financial businesses were unable to get access to the financing they required to function normally, leading to problems in the real economy.