Irene Javier , BSA- 3A

The 2008 Financial Crisis

The 2008 financial crisis was the worst economic disaster since the Great Depression of 1929. It occurred despite
aggressive efforts by the Federal Reserve and Treasury Department to prevent the U.S. banking system from
collapsing.It led to the Great Recession. That's when housing prices fell 31.8 percent, more than during the
Depression. Two years after the recession ended, unemployment was still above 9 percent. That's not
counting discouraged workers who had given up looking for work.

Causes

The first sign that the economy was in trouble occurred in 2006. That's when housing prices started to fall. At first,
realtors applauded. They thought the overheated housing market would return to a more sustainable level.

Realtors didn't realize there were too many homeowners with questionable credit. Banks had allowed people to
take out loans for 100 percent or more of the value of their new homes. Many blamed the Community Reinvestment
Act. It pushed banks to make loans in subprime areas, but that wasn't the underlying cause.

The Gramm-Rudman Act was the real villain. It allowed banks to engage in trading profitable derivatives that they
sold to investors. These mortgage-backed securities needed mortgages as collateral. The derivatives created an
insatiable demand for more and more mortgages.The Federal Reserve believed the subprime mortgage crisis would
only hurt housing.It didn't know how far the damage would spread. That's because it didn't understand the
true causes of the subprime mortgage crisis until later.

Hedge funds and other financial institutions around the world owned the mortgage-backed securities. The securities
were also in mutual funds, corporate assets and pension funds.The banks had chopped up the original mortgages
and resold them in tranches. That made the derivatives impossible to price.

Why did stodgy pension funds buy such risky assets? They thought an insurance product called credit default
swaps protected them. A traditional insurance company known as AIG sold these swaps. When the derivatives lost
value, AIG didn't have enough cash flow to honor all the swaps.

Banks panicked when they realized they would have to absorb the losses. They stopped lending to each other. They
didn't want other banks giving them worthless mortgages as collateral. No one wanted to get stuck holding the
bag. As a result, interbank borrowing costs (known as LIBOR) rose. This mistrust within the banking community was
the primary cause of the 2008 financial crisis,

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.

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 tobusinesses outside the financial sector.
 A further 8% went into credit cards and personal loans.

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:

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

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

Mr. George Kenneth Heebner

Mr. George Kenneth Heebner, Ken, CFA, founded Capital Growth Management Limited Partnership in 1990
and serves as its Chairman and Portfolio Manager. Mr. Heebner has been a Vice President of CGM Trust since
1990. He has been the Chairman and Vice President at CGM Focus Fund and has been Trustee since 1993. He has
an investment experience of 36 years and manages investment decisions. Mr. Heebner worked at Loomis, Sayles &
Company in the mutual funds management group since 1976, where he assumed overall responsibility for the area.
He began his career in 1965 at the A & H Kroeger organization as a Senior Economist and in 1971, moved to
Scudder, Stevens & Clark as a Vice President and Mutual Funds Manager. Mr. Heebner served as the Chairman of
CGM Capital Development Fund, CGM Advisor Targeted Equity Fund, CGM Mutual Fund and CGM Realty Fund. He
has been a Trustee of CGM Trust since 1993. He holds a C.F.A. designation. Mr. Heebner earned a Bachelor of
Science degree from Amherst College and an M.B.A. degree from Harvard Business School. Mutual Fund' A mutual
fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in
securities such as stocks, bonds, money market instruments and similar assets.