How to answer "what caused the 08 financial crisis"

Make sure you know your audience. I remember a story of someone who told an interviewer at a BB that the big banks caused the crisis and the interviewer ripped him apart

it was caused by jesus being mad at america for all the homosexuality.

the housing crisis first and foremost...too much lending to those who couldn't pay off mortgages.

Then you have the complex financial instruments themselves such as mortgage backed securities and derivatives that were royally fucked when the housing market collapses along with Fannie and Freddie

Lastly, firms with too much leverage (debt to equity) think Bear and Lehman

Then you also have CDS insured by companies like AIG.

AIG's stock value was around $1500, now it's at $25

is it ok to blame the Fed for keeping rates too low too long? Ok to blame fannie/freddie?

Yeah, definitely ok to mention the fed. I had this question also, and I made sure to talk about the rating agencies giving many MBSs/CDOs AAA ratings when they should have been junk.

size up your interviewer and choose one of the following:

poor people minorities congress fed

Blame that gay fuck barney frank.

You can include that a line about how the banks were partially to blame without spinning things out of control and losing your chances at getting the job. Basically, you need to take a factual approach to what happened with the banks because Wall Street is as much to blame as everyone else.

Basically... all you need to touch on is is that this was caused by a number of factors - the political drive to allow everyone to own a home, which dates back to the Carter Administration and the legally (read: Lawsuit driven) led movement towards allowing anyone who wants a mortgage to get a mortgage (I want to say this goes back to the mid-90s where a number of banks were sued because they would not give poor candidates for loans access to loans), cheap credit spurred on by the Fed and Greenspan as a result of Tech Crash of 2000 and LCTM's failure, rising home prices and a subsequent bull market, the rise of CDS, wall street's involvement in this, the inter-connectivity of the financial markets and how Too Big To Fail (I'm looking at AIG in particular who insured how much notional as a CDS Counterparty) institutions could have destroyed the world, political lobbying and the like, the quants and broken models - ie your model only assumes a 2% default rate and doesn't account for the off chance that there might be a 12% default rate, especially with everything at the same time. There's a lot to talk about... Just don't get too preachy about one doing more harm than good. Get your facts straight, know what happened and lay it out in a very straightforward manner.

And if anyone says that the banks weren't at fault or thinks that should be glossed over, I have a bridge to sell you in Crooklyn.

Read "The Quants" and you'll have plenty of ways to answer this. If I wanted to give a slick and succinct answer I would say: how do you price (ie assess the risk) a basket of bad mortgages? Turns out that you can't do it very accurately but we believed we could and that led to the crisis.

Blaming the government and people spending beyond their means hasn't failed me yet.

The political structure created an unstable situation that banks and homeowners had a highly leveraged position in, and when the economy went south, everything deteriorated rapidly. The government stepped in to keep things running in the short term while consumers and corporate America restructured their debt habits. The government will, in turn, be required to restructure its own debt habits in the not too distant future.

If they question you further, answer with the same bias they project onto their questions.

DONE

Simple answer Carter, Clinton and Janet Reno.

President Jimmy Carter sponsored the well-meaning Community Reinvestment Act (CRA) in 1977. It required banks and savings and loans to offer credit to “underserved populations” so they could obtain credit, including home ownership.

In 1991, the Home Mortgage Disclosure Act required lenders to report rejection rates by race. Lenders were informed that their loans would be examined for evidence of bias. Violators would face fines -- get this -- as high as $500,000. The Democratic Congress in 1992 passed the Federal Housing Enterprise Act, providing HUD the hammer to carry out Congressional intent to “meet the mortgage credit needs of all potential home buyers, including those with low and moderate incomes.”

The 1992 act was the fuse that lit the largest housing blow-up the U.S. has ever seen, because one provision required that mortgage giants Fannie and Freddie “should accept down payments of 5 percent or less, ignore impaired credit if the blot was over one year old, and otherwise loosen (their) lending guidelines.”

If she didn’t like the reports on who was getting loans and who wasn’t, then Attorney General Janet Reno bullied the banks with quotas and faulty statistics to literally extort millions of dollars from banks by alleging racial discrimination if they didn’t play along. This intimidated many banks to agree to pay cash settlements so they could avoid trials and negative publicity

-- http://www.bizpacreview.com/index.cfm?fuseaction=news.details&ArticleId…

Depends:

--If your interviewer is a sociopathic clown, then blame "big gubermint" and "Barney Frank!"

--If your interviewer isn't a sociopath, you can dive into the real reasons, as follows:

1.) The Fed keeping rates way too low for way too long coupled with assholes like Alan Greenspan telling people to use their home as a credit card (he actually said these things)

2.) Shit bag lending houses like Countrywide and related firms massively shifting their new loan portfolios towards high growth, high margin "products" such as sub-prime and option-ARM loans

3.) Big Banks (or, Too Big To Fail banks) enabling the rapid rise of subprime lending via the creation of MBS and CDO products which "reduced risk" (actually, it just spread the brutal risk all over the place leading to an eventual apocalypse)

4.) Thanks to some collusion between the banks and the ratings agencies, these suspect products were given investment grade ratings (sometimes AAA). Keep in mind that the ratings agencies were incentivized to give the "best" ratings possible in order to grow faster and more profitably

5.) It's important to note that these shitty products were rated investment grade (and sometimes AAA) because it allowed pension funds and mass investment houses to fill their portfolios with "safe" and high yielding products. Think of it this way, these CDO products were often considered as "safe" as US Treasuries, but had a higher yield. So, big investment funds craved these products.

6.) Because of the supposed safety and high yield nature of these products, there was a top down demand for sub-prime mortgages. The demand for these products led to a demand from the banks to the lenders for new fuel for their MBS and CDO products (in the form of sub-prime loans)

7.) This top down demand allowed lending houses to further erode their lending policies, simply because they could participate in a game of hot potato - as soon as the loans were made, they were sold off to the banks who then made "safe" high yielding investment products to sell to investment firms.

8.) Let's be clear, a lot of the investment houses they sold these products to rely on the ratings of the products when making an investment decision. Their portfolios demand that they hold a certain level of investment grade products. Hence, why the demand was so great for them.

9.) In July of 2007, the ratings agencies did something unprecedented. They had two days of mass downgrades for hundreds of previously investment grade MBS and CDO products. This immediately caused the market to freeze up, and rendered these previously investment grade products completely illiquid. The game of hot potato had come to an end, and anyone holding this garbage was in for a world of pain. Oh, and when I say "anyone" I mean "everyone."

To conclude, if anyone wants to be so simple minded as to ignore the facts and blame "liberals" or some other such non-sense, tell them to eat a fat dick. Even though their fantasy world may help them sleep better at night, it's not real and should give you no comfort.

For additional background, I recommend reading any of the following:

--The Levin-Coburn Report on the Financial Crisis (even just the summary, it's incredibly well researched with all source docs available to read)

--Griftopia by Matt Taibbi

--Exile on Wall Street by Mike Mayo

I forgot to add "The Big Short" for a fun version of things.

Also, if you want, listen to this lecture by Dr. Michael Burry. He made a boatload of money by seeing the causes of the crisis ahead of time. This is a great lecture and only takes about 30 minutes of your time and will leave you incredibly well-informed.

http://www.youtube.com/embed/fx2ClTpnAAs

Heister:

For one, my first point blamed government. Two, if you remove exotic CDO products from the mix which spread risk throughout the system, the crisis wouldn't have been anywhere near as bad. The CDO products were financial AIDS and exacerbated the problem 1,000 fold. Hence my focus on what Wall Street did.

The video I posted with Michael Burry articulates this better than I ever could (and he places more emphasis on government).

Additionally, what a bs response. "If you hate Wall Street so much..." One can point out obvious mistakes and terrible things that were done by the banks and not hate Wall Street. Self-reflection and self-understanding is important in life, though apparently not to many people on Wall Street. Banks do a whole lot of good when the focus on smart lending and advisory. It doesn't mean that there isn't a lot of bad. Plus, I work in fucking middle market PE, it isn't even remotely related to the financial chicanery of CDOs.

Beyond that, i won't argue this anymore. It's a huge time suck and people only hear what they want to hear. Fine, blame government and act as though Clinton / Barney Frank / Nancy Pelosi had a gun to the head of the folks at Countrywide. Be my guest.

Watch Inside Job, although it blames a lot of the crisis on banks it is a great movie.

There are mountains of evidence showing the lending houses purposefully shifted their lending habits by choice, not because of government mandates.

That said, sure, government played a role. So lay that out, too. The facts are the facts, and none should be overlooked.

To the OP - best of luck if it ever comes up in an interview.

I think the safe way to answer this one is by telling the interviewer that 'everyone' played a part.

1) Gov't - By pushing subprime loans on lenders in poor areas that could not afford them. 2) People - By not reading the small print on their ARMortgage; by borrowing more than they could afford 3) Ratings Agencies - For rating subprime tranches AAA. Moreover, the AAA rating is earned based on how deep your tranche is; not the mortgages within. Stupid. 4) Banks/Insurance Companies - For being so nearsighted and letting smarter individuals take out CDS on MBS. This is how AIG got creamed.

And I'm sure the list goes on.. you can't stick the blame on just one person.

Of course you can say Obama. You can never go wrong with that : )

Totally forgot about AIG. They sold CDS so recklessly that they could never ever ever ever ever cover them. In fact, I think you can blame the head of AIG FP during the run-up to the crisis more than anyone else on Earth for making the crisis as severe and insane as it was.

What a dick.

TheKing, while I may disagree with part of the assessment (Namely the fact that you skipped over a basic "30 years of politics starting with Carter and going through W." for which both parties aided in creating this mess in lieu of a single point discussing the Fed. And, for the record, yes, it was both parties fault. You cannot blame one side or the other for the mess.), you definitely laid things out well. I think you are however, slightly off on one point. While you imply government action caused this vis-a-vis Fed action by keeping the interest rateslow, that's technically not true. The same can be said about what Heister said about the Fed, in that his point is also partially incorrect.

The Fed is a quasi-government agency. They are a private institution with certain governmental oversight and protection. They have this very weird status in that yes, they do report to congress and have congressional oversight, but they can, at the same time, go ahead and do what they want with respect to running the central bank. So when the Fed engages in market action, etc. they are acting as a private institution and the central bank of the US free of involvement by Congress. However, the Fed is still legally bound to the requirement of congressional oversight. Read the Federal Reserve Act - it lays everything out pretty clearly.

So, TheKing, while it may represent and imply government action, it really doesn't. Heister, while the Fed may have the benefit of being a private institution, it is still a quasi-government agency with federal oversight.

Scooby, while I appreciate the zeal to point out that it was a "liberal agenda", it wasn't solely Clinton, Carter and Reno nor would I suggest taking the view of a conservative who happens to own a Financial Services Company as gospel. Take everything with a grain of salt.

The King is pretty spot on here. A lot of people think it was shit like the CRA or Fannie and Freddie because they hear the talking points being reiterated. The most hard hit areas aren't urban slums, and Fannie and Freddie were pressured into getting into the sub-prime business around '05-'06 because everyone else was making bank.

While a lot of things contributed to the mess, to me, the key piece was the Gaussian copula: http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all

This enabled sub-prime lenders to get increasingly reckless, as investors and ratings agencies both went with the numbers that said shit didn't matter and that it was cool to buy securities backed by shitty mortgages. CDS compounded the mess.

But in reality, there is no clear answer. Your interviewer probably wants to hear what they think, and plenty of people on the street still don't have the right answer.

The Fed is a government agency when people want it to be a government agency, an an independent entity when people want it to be an independent entity.

Furthermore, the constant necessity to place blame on either "evil banks" or "evil government" is useless. The two are intertwined in various different ways. Banks hire lobbyists to write rules and regulations to be enforced by government agencies filled with former employees of those same banks. This dance goes on and on.

The idea that corporations are somehow separate from government is idiotic, considering corporations need government in order to exist. Without a charter granted by a government, a corporation would be a lowly partnership, and all the advantages of limited liability would vanish.

The root cause of the financial crisis was a cascading failure of trust from the ground up. In a system built entirely on trust, this caused a panic on a massive scale.

Loans were typically made by mortgage brokers to untrustworthy borrowers. These brokers often used fraudulent paperwork to originate the loan, and often gave them to people with no income.

The banks bought these loans and sold them to investors. When the loans went sour, investors no longer wanted to lend money, not only to the untrustworthy borrowers, but to trustworthy borrowers as well, including banks.

Commercial paper markets dried up, as did other forms of short-term borrowing. Banks were afraid to lend to each other, let alone an individual borrower.

The entire system is built on trust, and the moment the illusion of trust disappears, everyone panics, and everyone loses.

I agree with TheKing wholeheartedly, I will add into that however a section before his first point, of the US Government (GWB) passing an edict that everyone deserves a chance to own their own home, and if the banks did not lend, they would be penalised.

the crisis started just as every other financial crisis has started since 1913: massive bubble caused by the fed eventually blowing up. this one was just exacerbated by the current account deficit that managed to move a lot of the MBS debt off shore to gullible german landesbanks and asian SWF dumb money. AIG's CDS writing is incidental. that's just the cream for the likes of Kyle Bass but people are being fucked because the MBS market has collapsed and that was what they were using as Tier I capital in lieu of treasurys and now their balance sheets will be crippled for decades barring massive recapitalizations via the Fed which means grandma is going to get robbed twice, first through bubble implosion of her home equity, and second through inflation which is the main cost of said recapitalization.

wow all these long ass posts.....here ill make it simple

excessive credit creation(aka feds fault)

All this and no mention of ratings arbitrage? How about originating banks selling mortgages to GSEs to package as MBS and turn around to sell the AAA tranches back to the originating banks so they could halve their capital requirements? How about doing it again with CDO (and again once more with CDO Squared)? There was just so much leverage! And of course no one understood that you have to use an options pricing model for ABS, or did any kind of meaningful sensitivity analysis of their own risk models. How about the legislation requiring many investors to only buy AAA fixed income products, which led to MBS blowing up in the first place? Why do you think Europe's mortgage sector is only ~20% originate-to-distribute (MBS), while ours is still 60%+?

This is what drove the boom in MBS, which in turn triggered the financial crisis, which wasn't really about MBS at all; it was a systemic interconnectedness unable to tolerate MBS' aggregate shock. It could have been any asset class blowing up, or even just a rumor that Lehman was actually a ponzi scheme... once there was a panic and therefore a run, the die was cast, all of AIG's CDS was going to get called, and credit markets were going to freeze up.

Personally, I blame the cause (MBS boom) on 1) an off the books federal entitlement program for home-ownership, 2) poor ratings standards, 3) irresponsible leadership at the GSEs. Everything else is static.