Financial Crisis & Recessions

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The financial crisis happened because banks were able to create too much money, too quickly, and used it to push up house prices and speculate on financial markets.

1. Banks created too much money…

Every time a bank makes a loan, new money is created. In the run up to the financial crisis, banks created huge sums of new money by making loans. In just 7 years, they doubled the amount of money and debt in the economy.

M4-Base-Money-Graph

2. …and used this money to push up house prices and speculate on financial markets

Very little of the trillion pounds that banks created between 2000-2007 went to businesses outside of the financial sector:

  • Around 31% went to residential property, which pushed up house prices faster than wages.
  • A further 20% went into commercial real estate (office buildings and other business property)
  • Around 32% went to the financial sector, and the same financial markets that eventually imploded during the financial crisis.
  • But just 8% of all the money that banks created in this time went to businesses outside the financial sector.
  • A further 8% went into credit cards and personal loans.

Sectoral-Lending

3. Eventually the debts became unpayable

Lending large sums of money into the property market pushes up the price of houses along with the level of personal debt. Interest has to be paid on all the loans that banks make, and with the debt rising quicker than incomes, eventually some people become unable to keep up with repayments. At this point, they stop repaying their loans, and banks find themselves in danger of going bankrupt.

4. This caused a financial crisis

As the former chairman of the UK’s Financial Services Authority, Lord (Adair) Turner stated in February 2013:

adair.turner-1“The financial crisis of 2007 to 2008 occurred because we failed to constrain the
financial system’s creation of private credit and money.”

Lord Adair Turner, speaking as chair of the Financial Services Authority, 6th February, 2013

This process caused the financial crisis. Straight after the crisis, banks limited their new lending to businesses and households. The slowdown in lending caused prices in these markets to drop, and this means those that have borrowed too much to speculate on rising prices had to sell their assets in order to repay their loans. House prices dropped and the bubble burst. As a result, banks panicked and cut lending even further. A downward spiral thus begins and the economy tips into recession.

5. After the crisis, banks refuse to lend, and the economy shrinks

Banks lend when they’re confident that they will be repaid. So when the economy is doing badly, banks prefer to limit their lending. However, although they reduce the amount of new loans they make, the public still have to keep up repayments on the debts they already have.

The problem is that when money is used to repay loans, that money is ‘destroyed’ and disappears from the economy. As the Bank of England describes:

“Just as taking out a new loan creates money, the repayment of bank loans destroys money… Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy.” (Money Creation in the Modern Economy, Bank of England p3-4)

So when people repay loans faster than banks are making new loans, it’s like draining the oil from the engine of a car: the economy slows down and prices decrease. As a result the economy risks slipping into a ‘debt-deflation’ spiral, where wages and prices fall but people’s debts do not change in value, leading to debts becoming relatively more expensive in ‘real’ terms. Even those businesses and people that weren’t involved in creating the bubble suffer, causing a recession.

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  • Dirk Campbell

    Yes, I want a stable economy. Not a growth economy! This planet does not have the resources to supply the consumption we have now without the biosphere collapsing, let alone increasing consumption. When the biosphere collapses guess what? The economy tanks with it and so does the human population. Check out the Club of Rome’s ‘Limits to Growth’ report. You must plan for a shrinking economy not a growth economy otherwise you are just part of the problem, ‘positive money’ or not.

    • Timothy Haug

      actually, were are at about 10% of planet sustainability at the moment. planet overpopulation is a problem that we could overcome, but we would have to invest heavily in space travel technology and terraforming technology. It would be feasible to terraform both Mars and Venus for human habitation. The process currently would be prohibitively expensive though for Venus.

      Another option is interstellar travel to nearby habitable worlds. This, while expensive, is an attainable goal since a NASA scientist reworked the mathematics for creating a warp field. In Trek speak it would be equivalent to warp 1.1 and take approximately 10 years to get to our nearest neighbor that is thought to have all the ingredients need to sustain life. It is about 100 light years away.

    • pat

      You Luddite!

      From the Wikipedia article “Peak uranium”:
      “the current reserves of uranium have the potential (assuming breeder reactor technology) to provide power for humanity for billions of years, until the death of our sun, so nuclear power can be termed sustainable energy.”

      And there are more planets!

      Making more with less is growth, in the case of computers and cell phones and all technological advancement.

      What are computer chips made out of? Dirt. What are buildings made out of? Dirt. There is no shortage of dirt.

      Desalinated water costs only costs a few times more than what people are currently paying for already fresh water. And we have oceans of water to desalinate.

      You are like a hunter-gatherer decrying that their aren’t enough deer and berries in the forest to feed everyone!

      And the fatness of Americans is proof that we have more than enough food, and we haven’t even begun to reach our food growing capacity. And that’s even with people eating a lot of meat, since we could feed 10-20 times as many people if we were all vegetarians.

      “When the biosphere collapses guess what? The economy tanks with it and so does the human population.”

      So your solution is to ‘tank the economy and human population’ to solve ‘the economy and human population tanking’. You villain!

  • jamie

    Have you guys read up about Éirebank in Ireland..? http://www.eirebank.ie

    • emilfiijg

      wanna meet up

      • hgf

        sure

  • Robert Hoogenboom

    .

  • Zero Profit

    Banks are an essential part of our economy. Banks main function in an economy is get deposit from THE PEOPLE and from this deposit makes loan. The difference in the deposit interest and the loan interest is their revenue. Revenue minus their operational expense is their profit.

    What happen with our financial crisis is that banks aside from getting deposit from THE PEOPLE, they get them from the central bank that print the money. Central bank would infuse money into banks through 3 mechanisms, 1. buy government bonds 2. loan money to banks 3. buy mortgage assets or securities from banks. During the financial crisis, central bank in the United States would print $7.7T to buy mortgage and securities from banks ABOVE market price to recapitalize them. For example, if a mortgage is worth $200,000 in the bank’s book, the Federal Reserve would pay the bank $300,000 for that mortgage. The result of this activity helps banks recover and the Federal Reserve becomes owner of millions of houses. The people react to this unfairness by refusing to pay their mortgage. The ill effect from this is, small banks begin to collapse as a result of people stop paying their mortgage. That in turn causes massive layoffs, fewer loans made … creating a ripple effect in the economy resulting in massive unemployment.

    To fix this problem, the central banking system must be replaced by a distributed banking system where the people decide how much new money to print and that each person in the country get a share of the new money. This will bring the power of the monetary system to the people where it rightfully belong.

    There’s a way to calculate this base on GDP, inflation rate, and consumer price index.

  • charles3000

    A sovereign nation should take the full seigniorage on all money put into its economy and not give that privilege to privately owned banks. A monetary system based on a privately owned central bank is outmoded. Governments need to retake the right to supply all money to the economy of their citizens.

  • MM

    http://wh.gov/lRCHz

    Here’s some more information about this petition:

    Globalism and technology have translated into record profits,
    offshore bank accounts, lower taxes, and cheaper labor for America’s
    companies. American workers are more productive than any other time in
    history. Yet, our wages have stagnated for decades. Simply put, the
    lower demand for labor has allowed employers to reap their deserving
    benefits. Though, as we move forward into change and establishing order,
    we must take steps to preserve capitalism for the future. To accomplish
    this, America must do as it has done before by making work fair and
    prosperous for all. Please support non-exempt status for all. This will
    help liberate the salaried employee from an overworked unhealthy
    lifestyle; so that, we can give these hours to those who are desperately
    seeking work.

  • Sky Wanderer

    Brilliant job identifying the private banks’ money creation, and their subsequent withdrawal of money from the economy, as a primary reason of the Crisis.

    “Banks lend when they’re confident that they will be repaid. So when the
    economy is doing badly, banks prefer to limit their lending”

    The reason why realizing of above is crucial: the banks regard lending to the richest individuals and banks as the the safest from their perspective, therefore they limit lending to the richest, ie to those who least need it, and these richest entities used much of these funds for lending to governments, who however “handle” the government deficit by austerity measures and spending cuts, which then further hinders the created money to return into production. This is the case not only in the UK but all over the Western world.

    This factor further reinforces the global processes that triggered Global Capitalism and the subsequent global Crisis in the first place.

    The following charts display some of these processes – based on a presentation series by Dr. Richard D. Wolff (Harvard-Stanford-Yale trained distinguished economist / professor) – along with the process-flow of the potential recovery from Crisis:

    https://twitter.com/glopol_analysis/status/442219863344308224/photo/1

  • Harry Alffa

    Instantly rebalance the flow of new money now (without waiting for Positive Money to happen) by linking banker/bank taxes to unemployment level/cost.

    http://www.bailoutswindle.com

    Dynamically set bankers’ top-rate income tax to ten times the percentage unemployment level :-
    2007: ~50% top-rate income tax
    2012: 81% top-rate income tax
    Now: ~70% top-rate income tax

    Dynamically set the bank-levy as simply the presentation to the banks for the cost of Jobseekers Allowance:
    2007: £1.7 billion
    Now: £6 billion.

    This simple change (as easy to do as Alistair Darling’s Banker Bonus tax) will instantly force the banks to provide honestly priced finance to SMEs. This is crucial to growth, and goes some way to the objectives of Positive Money.

    I hope you can adopt this approach as a stepping stone, which will rob the banks of their political power, on the way to having a full Positive Money economy.

  • Justin

    It goes farther than this though… it wasn’t just that they couldn’t be paid back… for that to be the case, more money simply needed to be printed.

    The crisis was orchestrated, manipulated, implemented intentionally. It was designed to be a shift in money. Not just the crash, but the lead up. The borrowing of capital was in and of itself a major redistribution of wealth. From there, the entire economy was very intentionally shuffled into a singular-like hierarchy… it was then intentionally run as hard and as large and as fast as it possibly could… daisychained off of itself incredibly far…. and, then, at the key point… utilizing the very system above… large quantities of cash-money were withdrawn from critical market accounts at a key point. Within a matter of hours.

    Under the fractional reserve system, there literally weren’t enough real dollars on hand to hold up the inflated fractional dollars… at this, the lines of credit got pulled, which led to more pulling, then more pulling.. the entire thing pancake collapsed onto itself, with each sub-structure holding up the above inflated structure collapsing underneath the weight of the above… combining with it, and putting yet more force on the sub-sub-structure beneath it that the substructure and all above it were now crashing in to… much like the World Trade Center floors above ‘pancaking’ onto the ones beneath…

    market curbs were only designed to go so far and, then, like on Sept 11th, the market had to just ‘shut down’ to cease the (largely digital) run on the banks.

    There was a US senator that went on air and explained this not 6 weeks after it happened.. and alluded that it was the Russians doing it to us in response to ‘us’ having done it to them ~6 months before… causing *their* collapse of ’08. …ie, a retaliatory response.. a form of ‘economic warfare’.

    A HUGE degree of wealth was shifted from Russia to the US and others in a matter of hours, even more in days. It was simple to do: basically set up a TON of checking accounts, each with <$10'000 in them… spread them across multiple banks, and do this across multiple shell corporations. More so, leave the money in them, untouched, for years at a time so that the banks build around them feeling very secure about their (cash) holdings in them…. doing riskier and riskier deals knowing that this 'high credit' 'highly secure' deposits sat in their 'vaults' (digital or literal).

    Then, in a pre-timed situation, set up your various corporations and their various accounts to transfer the money then withdraw it in a very short period of time… pre-crash, and even with post-9/11 banking laws in place, withdrawing <$10'000 was something you could do immediately by walking into the bank with no forms signed… thus, slowing the process and allowing the system to know what's going to happen.

    Rumor has it … both from that senator (who's name escapes me, otherwise I'd link to the youtube video where he explains it) and other sources afterwards… that it was something small, in the order of $55billion… but, via fractional reserve banking, that inflates to over $5 trillion… and, with $55b being withdrawn and shifted over seas in one fail swoop… , that collapses $5trillion+ in lending power… and, thus… collapse.

    After balancing it out, adjusting for it, etc… and, accounting for money that was available for the banks to lend but not actually lent out… it amounted to about $2.2trillion.. ie… the amount of the bail out and stimulus combined.

    The original $55billion? it's been readjusted, reinvested, or otherwise just sat on.

    In short: it took $55b to create a multidecade long reverberative change in not just the US and global economy… but the history of things to happen due to that.

    Was a brilliant move for those positioned to know that it was going to happen… or that were orchestrating it to begin with. Scarier still, that the loop hole was SO obvious before it happened that it could've been *any* group that could've done it… not just the one that ultimately did do it.

  • Timothy Haug

    Nice but only part of the story. Here is the rest of the behind the scenes story that liberal Democrat politicians hide from the general public.

    NOTE: I edited as much of the blame game politics out as i could as I don’t want anyone to think this is a presidential blame game piece. Just a factor in what actually lead to the housing debt bubble that caused the crash.

    The
    day the democrats took over was not January 22nd 2009, it was actually
    January 3rd 2007, the day democrats took over the House of
    Representatives and the Senate, at the very start of the 110th Congress.

    The Democrat Party controlled a majority in both chambers for the first time since the end of the 103rd Congress in 1995.

    For those who are listening to the liberals propagating the fallacy that everything is “Bush’s Fault,” think about this:

    January 3rd, 2007 was the day the Democrats took over the Senate and the Congress. At the time:

    The DOW Jones closed at 12,621.77.

    The GDP for the previous quarter was 3.5%.

    The Unemployment rate was 4.6%.

    George Bush’s Economic policies SET A RECORD of 52 STRAIGHT MONTHS of JOB GROWTH.

    Remember the day…

    January 3rd, 2007 was the day that Barney Frank took over the House
    Financial Services Committee and Chris Dodd took over the Senate Banking
    Committee.

    The economic meltdown that happened 15 months later was in what part of the economy?

    BANKING AND FINANCIAL SERVICES!

    It started with Jimmy Carter and his Housing and Community Investment
    Act of 1977, broadened by Bill Clinton, enforced by Janet Reno, then
    sent over the cliff by Frank & Dodd. Oh, Obama, as an attorney in
    Chicago working on behalf of ACORN, successfully sued Citibank for loan
    discrimination under Reno’s tenure!

    Unemployment… to this
    CRISIS by (among MANY other things) dumping 5-6 TRILLION Dollars of
    toxic loans on the economy from YOUR Fannie Mae and Freddie Mac
    FIASCOES!

    Bush asked Congress 17 TIMES to stop Fannie &
    Freddie – starting in 2001 because it was financially risky for the US
    economy.

    And who took the THIRD highest pay-off from Fannie Mae AND Freddie Mac? OBAMA

    And who fought against reform of Fannie and Freddie?

    OBAMA and the Democrat Congress.

    So when someone tries to blame Bush..

    REMEMBER JANUARY 3rd, 2007…. THE DAY THE DEMOCRATS TOOK OVER!”

    Budgets do not come from the White House. They come from Congress and
    the party that controlled Congress since January 2007 is the Democrat
    Party.

    Furthermore, the Democrats controlled the budget process for 2008 & 2009 as well as 2010 & 2011.

    In that first year, they had to contend with George Bush, which caused
    them to compromise on spending, when Bush somewhat belatedly got tough
    on spending increases.

    For 2009 though, Nancy Pelosi &
    Harry Reid bypassed George Bush entirely, passing continuing resolutions
    to keep government running until Barack Obama could take office. At
    that time, they passed a massive omnibus spending bill to complete the
    2009 budgets.

    And where was Barack Obama during this time? He
    was a member of that very Congress that passed all of these massive
    spending bills, and he signed the omnibus bill as President to complete
    2009.

    If the Democrats inherited any deficit, it was the 2007
    deficit, the last of the Republican budgets. That deficit was the lowest
    in five years, and the fourth straight decline in deficit spending.
    After that, Democrats in Congress took control of spending.

    • hgf

      if you think anyone gonna read that…. ur wrong

      • hgf

        that is nearly as long as something else…

        • Timothy Haug

          sorry, im dumb like that

  • Timothy Haug

    You can skip through the top section of the post below and get to the meat and potato’s of it starting at: BANKING AND FINANCIAL SERVICES!

  • Patrick Trombly

    The crisis was the result of credit creation but the culprits were the central banks. This was a short-rate phenomenon, not a long-rate phenomenon.

    The rapid rise in prices began in the late 1990s even while rates were flat or slightly up. This is because nominal incomes were rising. This didn’t slow down in 2000-2001 because you’re getting prequalified at last year’s income versus debt service at present rates.

    From 2001-2005, median household income in the US rose by less than 10% NOMINALLY. Yet the maximum house price point for the median household rose by 57%, which more than accounts for the commensurate 46% rise in the Case-Shiller index. Most of the rise in affordability took place from 2001-2003. What made the maximum price point rise was the Fed’s rate cuts after 9/11. The Fed cut its benchmark rate from 6.25% to 1% by 2003, with most of the cuts coming right after 9/11. At the suddenly sharply lower rates, a given income could support a lot more debt; that debt in the hands of buyers bid house prices up; that value combined with the continued low rates enabled existing homeowners to refinance with significant cash out, and the amount of mortgage debt o/s in the US more than doubled.

    ARM rates plummeted, and as rates stayed low, the banks’ margin on short-priced loans compressed. During this time, the 30 year mortgage rate also fell, but only by 125 bps, not 525 bps. And the canary in the coalmine – ARM share of all mortgages more than tripled, from 10% to 35%, from 2001-2005.

    In mid-2004 the Fed began to slowly raise rates back up – and prices stopped rising. The long rates kept falling but the prices stopped going up.

    Some people point to “crazy” lending standards. These were largely put in place beginning in mid-2004 – after most of the price rise had taken place. Another factor – delinquency rates had plummeted to record lows, and stayed at record lows until late 2006. We can look back now and conclude that delinquency rates fell because the Fed was lowering the bar (not everyone took the max, and so payments temporarily declined even as debt was rising) and because most of the cash-out refis left cash available for debt service prior to its being spent. But at the time, banks and investors took the falling delinquency rates and rapidly rising collateral values as signals to adjust their lending standards. There had also never been a law against lending to people without perfect FICOs – the prohibitive factor had always been constraints on the supply of credit – – once you’ve made the loans to the “good borrowers,” there was so little money left over that the “bad borrowers” could borrow only at very high rates – which itself limited the amount of debt they could take on, as the high rates translated into much higher payments on the same debt. With the dramatic expansion of credit, there was plenty of money left over to make loans to “bad borrowers” and at attractive rates, which were more likely to cash-flow. If you want to consider the banks “riverboat gamblers,” go ahead, but they got their chips from the central bank, the odds looked a lot better than they ended up being, and they were following the same rules they’d always followed.

    Another factor often mentioned is “exotic mortgages.” This is a red-herring. The “exotic” feature of an “exotic” mortgage was the rate, which was the Fed’s rate plus a margin – a margin that got smaller and smaller as the Fed kept inflating (the rate is maintained by buying or selling whatever amount of securities is required to bring the market rate to the target rate – in the early 2000s, this was a matter of buying). The 2/28 structure was implemented because prices were rising so fast that banks lending on a 2/28 basis, even at 90 or 95 or 97 percent loan-to-value, were better collateralized two years in than they had been lending on a 30/30 basis at 80% LTV ten years earlier. And there is minimal payment “shock” from a 2/28, all other things being equal – for the first two years of any 30-year mortgage, the payment is almost entirely interest anyway.

    The payment shocks came in when ARMs re-set. When home prices started slipping back, more homes became worth less than the loan amount, a term known as “under-water.” High-LTV-at-origination likely contributed to this, but again, such structures were put in place in response to a rapid price appreciation that could not have happened but-for the sharp cut in the rates.

    Simply put, on the demand side, there is the Fed’s direct effect and the Fed’s indirect effect, through the banks. And how much do you blame the banks for that? What exactly is it that you would have expected the banks to do? Not make loans that had been made possible by virtue of Fed policy? The whole point of Fed policy WAS to create, in lieu of rising incomes, a wealth-effect to boost spending, and to “promote full employment” – it turns out that the only “employment promotion” was in construction, mortgage banking and retail jobs that would disappear in 2008-9. It’s a terrible policy to be sure. But is it the banks’ job to thwart it? Keep in mind also the mechanics of how rate policy works – the Fed buys as many securities and in whatever amounts are required to make the rate happen, and the rate is set to make certain economic objectives happen. If the banks hadn’t made the loans, one can only assume that the Fed would have cut further, to 0%, as it has done since.

    On the supply side, single-family-detached-home developers are financed on a project-finance basis – i.e., at floating, Prime-based rates – and often with carried interest. Their cost of capital fell dramatically after the 9/11 rate cuts, and they built more homes from 2001-2005 than they’d built from 1987-2000 – – more in 4 years than in the prior 14. They COULDN’T have embarked on a building spree in the prior 14 years because the short rates were too high, and their cost of capital is based on the short rates. The overbuilding contributed greatly to the crash. There are no red herrings, no changes to bank lending standards, nothing at all to muddy the water on the supply side – it was pure credit-expansion bubble as described by Mises and Hayek decades ago.

    Greenspan blames a “glut” of “foreign (read, Chinese) savings” flowing into long securities. But we’ve clearly shown this to be a short-rate-driven bubble, and the long rates stayed low, and even fell, even as US home prices peaked and started to slide. Also, the Chinese like other investors were reading the same delinquency rates and collateral price appreciation as the banks and making the same misinterpretation, that these were independent factors exhibiting strength, rather than temporary blips driven by the initial injection of fiat credit. Keep in mind also where that money came from – US homeowners who took advantage of the refi-with-cash-out boom in the early 2000s spent a lot of that money on goods imported from China… Those same dollars were then reinvested in US mortgages. Greenspan’s smart enough to put this trail together. He just hopes that you aren’t.

    If it was the Fed, you’d expect (and if it was Chinese savings flowing into long-tenor US securities, you wouldn’t expect) that US house price appreciation would have been more pronounced in states in which ARM market share was the highest – and that’s exactly what happened.

    If it was the Fed, how did Europe experience a housing bubble? The ECB also cut rates, and their bubble was pronounced in countries whose mortgage markets were characterized by floating or short-rate mortgages and long amortization periods, like Ireland and Spain. In Spain, there was substantial overbuilding because builders are financed the same way that SFDH builders are in the US. Countries without short-term pricing on mortgages didn’t experience either a price bubble or a building boom. One could re-write the lending structures to thwart Fed policy but then, why have the Fed policy? Wouldn’t it be simpler to just not inflate, given that no good came of it?

    If it was the short rates and not something else, you’d expect other bubbles in short-rate-driven assets where there were no changes to lending standards.

    Well, here’s one:

    Taxi medallions (financed on a 3/25 basis) were a contemporaneous short-rate-induced bubble. Medallion prices followed the same math and the same path as house prices starting after the post-9/11 rate cuts – the difference is that unlike houses, they don’t increase production of taxi medallions in response to a rise in prices or reduction in rates, and so the supply limits held the bubble together until the Fed cut rates back down again, enabling the bubble to continue.

    Hopefully in going on for so long I’ve laid to rest a lot of myths.

  • Pancho Montalvo

    So, in other words, the senator from Connecticut and his boyfriend, did not influence Sallie Mae in anyway…and Banks (CEO’s) did not plundered into the bailouts which we the stupid little people pay, so a few bags can live in mansions because they are special…

  • Jay L

    Too bad the crooked big banks were bailed out by the taxpayer- thieves and crooks! And guess what? They got away with it!

  • Jack Williams

    Who was this article written by and when?? Referencing a few points, thanks!

  • 1Bambinone

    Economists have become like goats, they don’t think in terms of how God does His things they just spit words and numbers. If one just study the economy in places where the currency is the original currency and where the police force is mantained at low pay than one can understand that when the government fights crime there is no recession and even the fuel is at low cost. When they change the currency whatever massonic alliance they are using to call for military like police, such alliance becomes an aggression against traditional police force and all of the people because the military unions start to work against the people and any arrest they make becomes highly illegal. In fact they never arrest those working for the police force for the simple reason that they know they are at fault and the criminals become their only target. They also know that a policeman is paid on a 24 hour basis and such indian like paycheck cannot guarantee loyalty to the government. Taxes grow higher not only because they need more money due to bad lack and natural disasters but also because they use taxes to punish anyone that does not obey to a wrong system. People get sick easier and kids die into the hospitals. Shame on them because they have become the goats slave of the goat of the satanic cults where people really dress like animals.

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