More than a decade after the 2008 financial crisis plunged the global economy into recession, we still lack a proper explanation for why this happened.
Existing accounts identify a number of culprits such as financial instruments, traders, regulators, and capital flows, yet fail to understand how to put the different pieces of the puzzle together.
Professor Neil Fligstein, the American sociologist and academic at the University of California, Berkeley, presents a new reading of the contemporary economic crisis, an understanding of its causes and the linkage of the banking system in the United States to it, and its similarity with what the world knows today from the crisis Due to the effects of the COVID-19 pandemic.
Feligstein is director of the Center for Culture, Regulation, and Politics and co-chair of the New Political Economy Network Steve Vogel, and author of important books, one of which is “The Banks Did It An Anatomy of the Financial Crisis,” published by the prestigious Harvard University Press in 2021, The book provides an analytical reading of the two economic crises of 2008 and 2020 that affected people's lives.
To understand this, Al Jazeera Net conducted an interview with him in order to clarify these ideas for the Arab reader.
The world witnessed in 2008 a stifling financial crisis, which affected the economy of the United States of America and the world. How did this nation happen?
And what are its causes?
To understand what happened in the 2008 financial crisis, we must understand what banks are doing;
They act as financial intermediaries, taking deposits from bodies that do not need their money immediately and lending them to bodies that need money immediately.
Banks have to reserve some of what is being deposited as a reserve when depositors need their money.
This system works well as long as those who deposit money in banks are not trying to withdraw all their money at the same time, and when they do so it results in a so-called "bank run", as banks cannot sell their investments fast enough to pay their debts to depositors.
What happened in the fall of 2008 when the Lehman Brothers bank collapsed was a kind of "bank rush" for all of us.
Essentially, all the major banks in the United States as well as many of the largest banks in Europe have bought huge amounts of mortgage-backed securities using depositors' deposits.
When it became clear that the value of those securities was declining due to what was witnessed in the field of mortgages on homes, which were provided as payments for those securities, the banks had to either sell the securities to pay their loans, or provide more guarantees to depositors, who sought to take their deposits from the banks , only to find themselves unable to sell those securities at a price that could repay those loans;
This led to a major and rapid failure of the largest American banks, and many European banks, and led them to bankruptcy all because of their involvement in the same predicament.
The book "Banks Did It: Anatomy of the Financial Crisis" was published this year by the prestigious Harvard Press (Al-Jazeera)
How did the banks get into a financial crisis with the debt they were using to buy mortgage-backed securities?
Are these debts that were behind the explosion of the 2008 crisis?
My central argument in the book is that all the major banks in the United States and in Europe have become involved in a similar industry to make profits;
The industry is based on mortgage securitization, which has provided the banks that make up nearly 10 percent of the American economy with more than 40 percent of their profits, which peaked in 2003.
The book documents the historical shift from the decentralized real estate financing model;
That is, when local banks offered loans to homeowners, to the mortgage securitization model, mortgages became the raw material for securities being bought and sold all over the world.
I show through my book that by 2008, banks were making profits from all stages of the securitization process;
Banks were involved in creating mortgages, as well as producing and selling mortgage bonds, and buying and selling those securities for their own investments.
Which they did quite a lot by borrowing money in the short term to finance these activities, which gave the banks a comfortable business model that helped them make money through every detail of the process.
The book shows how this model has collapsed since the beginning of 2006, and here it is worth noting that the mortgages that arose in a time of rising housing prices contributed to creating amazing profits for its investors.
But when home prices started falling, the mortgage market began to deplete;
The banks found themselves faced with a sharp decline in profits;
You could not find enough mortgages to continue the securitization process.
This prompted her to offer loans to people with bad credit, and many homebuyers ended up defaulting on their mortgages.
When people stopped paying their mortgages, the securities that were produced based on the mortgage also began to fail, and the banks involved in all parts of this process were not able to withdraw in time, given that this model formed - as I indicated - the main focus of their work.
In your book, you referred to an important fact that the Federal Reserve was unable to intervene to limit the effects of the 2008 crisis because it did not understand it in the first place. How is that?
The Fed did not understand the financial crisis because it did not understand how all the major banks were making profits through mortgage securitization.
They did not see the relationship between the housing market and the need for banks to continue creating mortgages in order to produce and hold securities in order to reinvest them.
In fact, there is evidence that what caused the rise in house prices was the need for banks to obtain mortgages to produce securities.
Which the Fed did not realize, which led to the banks' debt and dependence on the continued availability of mortgages, as well as the rise in house prices to keep the whole process going.
When mortgage operations rebounded in 2007, the Fed believed that this would not have a significant impact on the US economy, or on the functioning and stability of banks.
But in the summer of 2008, there were modest increases in inflation due to higher food and oil prices;
As a result, months before the collapse of the entire banking sector, many Federal Reserve board members believed that the real problem with the US economy was inflation, not the bank's business model, which was about to collapse at the time.
Obviously, part of the problem was their use of macroeconomic theory to understand what was going on;
This theory did not help in understanding the reality between the financial system and its relationship with the mortgage market;
This led the Federal Reserve to adopt an exaggeratedly positive stance on what the situation could lead to the US economy.
In other words, the Fed did not understand the situation well, so it did not intervene to stop the crisis caused by the banks in the first place.
The world today is witnessing a new economic situation due to the Covid-19 pandemic, is it similar to what happened in 2008?
Or did the Fed learn from its past experience and introduce fiscal programs that reduce the crisis?
In the spring of 2020, a financial crisis appeared similar to the 2008 crisis, due to the economic downturn that the global economy experienced as a result of the Covid-19 pandemic;
Credit markets dried up, many could not borrow money due to lack of liquidity, borrowers were required to provide new guarantees or repay their loans, the stock market began to crash, and investors sold stocks in anticipation of a recession.
But this time the bank responded strongly to the credit crisis that faced banks and other financial institutions due to the pandemic;
The Fed began providing liquidity to financial institutions by buying large amounts of bonds, including mortgage-linked bonds, and it bought corporate bonds for the first time to prevent them from having to repay their loans in the face of an economic downturn.
He lowered interest rates to nearly 0% and gave all banks loans to keep them afloat;
These measures led to stability in the stock and bond markets in the United States, and led to positive gains in the stock market despite the severe recession that the American economy was experiencing.
The Fed learned a lot from its failed experience in the 2008 financial crisis, which helped it prevent the same crash again.
The financial crisis of 2008 left behind losers and beneficiaries in the American and global market, so who are the losers and the beneficiaries?
Was China really one of the biggest beneficiaries of the two crises (2008 and 2020)?
In the United States, the financial crisis had a direct impact in reducing people's income dramatically, but by 2009, the stock market was gradually recovering, and by 2011 house prices had risen again, and stock owners found that the market recovered quickly, which made their investments grow Again, homeowners whose homes were not taken out due to foreclosure also benefited from a rebound due to the rise in house prices in 2011.
The biggest losers from this crisis were the people who lost the homes that were their main source of wealth, and the people who lost their jobs during the economic downturn.
The labor market did not fully recover until mid-2010;
Which led to the entrenchment of income inequality significantly in the United States after the crisis.
As for China, it emerged from this financial crisis of 2008 as a great beneficiary;
The Chinese government has engaged in a trillion-dollar public works program, revitalizing the economy by investing heavily in new infrastructure, mainly in roads, trains, and the Internet;
As a result, the Chinese economy has not lost much of its growth despite the decline in many export markets.
China's economic performance in the wake of the COVID-19 pandemic has been better than most countries in the world;
Their economic response was strong and resolute;
They continued to achieve significant rates of growth in exports by providing the world with many commodities despite the closure;
Therefore - in both crises - the "Chinese model" showed its ability to reduce the impact of potential economic threats due to the closure of economic activity.
How can these financial crises be overcome in the future?
And how can reform the banking sector to avoid financial crises?
Prior to the financial crisis, economists viewed the financial innovation that produced securitization and other financial instruments that emerged in the 1980s through the 2000s as beneficial and profitable.
The central idea behind financial innovation, according to them, is that it distributes risks securely to those who can afford it in order to protect those who cannot afford it.
This is what made them think that it is not necessary to regulate the financial markets because the actors in it are able to protect themselves from risks.
Due to the crisis this perception has faded, and regulators now believe that they need to pay attention to making sure that financial markets are sufficiently regulated that they prevent small players from taking on debts that they cannot repay, which will inevitably lead to a new crisis.
In the case of the US, major banks have to undergo annual monitoring to see if their loan portfolios can withstand the slowdown.
One of the big changes that took place after the financial crisis is the ability of financial institutions to hold more capital as a buffer in a time of financial downturn.
Banks have also responded by expanding and engaging in more financial activities rather than focusing on the real estate sector.
The banking conglomerate now dominates the world's banks.
The mortgage market has disappeared in its previous form in the world in 2008.
There are no more high-risk loans and only people with good credit can borrow to buy a house, and central banks are becoming aware of the fragility and interconnectedness of parts of the financial system.
In the event of the economic downturn related to the COVID-19 pandemic, the Fed responded effectively to spare the economy a new financial meltdown crisis.