There’s been a shift in the real estate industry over the last several years, with an increasing level of investment in technology. This investment is what is driving

Causes for the 2007-08 Financial Crisis

The 2008 Financial Crisis was like a slow moving car crash. Although many assume that the crisis started in September 2008, it started at least 13 months prior to that. Most insiders in the financial industry were well aware of a major trouble brewing.

The first sign of a severe crisis was in August 2007 when four Bear Stearns funds collapsed and most good traders woke up to that. In the next 15 months, it was just a slaughter of the pigs (public money) by people who could see the economic data.

There are many books written on this. I will give a brief synopsis of the crisis:

  1. 1997-2006 Housing Bubble: there was a huge housing bubble since the 1990s fueled by ultra low interest rates and the collapse of the stock market in 2000. The dotcom crash sent the interest rate too low and households were scared of parking their money either in stock markets (risky!) or in bank deposits (no interest). Thus, excess money chased homes. The moment I saw the chart below (from the book: “Irrational Exuberance”) in early 2007 I was scared to no bounds. In that period almost every economic data were off the charts and setup for a massive collapse.
  2. Financial innovation: in the late 1980s, the financial industry started experimenting with a lot of new ways to securitize (package) investments. However, innovation can be a doubled edged sword and just like you have created a new thing called “road accidents” with the introduction of automobiles, there are new ways to create disasters. Just like you have regulations for factories dealing with hazardous chemicals, you need strong regulations for companies dealing with complex financial instruments. A lot of new tools were totally complex and opaque that created both the boom and the burst.
  3. Change in character of Wall Street Firms: until the 1970s, Wall Street Investment Banks operated like service companies. They were held in private and were not capital intensive. Since the arrival of mainframes, then PCs and later algorithmic trading terminals, the industry has grown capital intensive. Since they got capital intensive, they went after public money. This resulted in a classic Principal-Agent Problem: the managers didn’t worry as about risk any more, since they were playing not with their own money, but with poor shareholders’ money.
  4. The business model of rating firms: on the Wall Street, there are 3 main Credit Rating Agencies that everyone* trusted – S&P Global, Moody’s Investors Service and Fitch Ratings. However, these companies were making money only from those who wanted their funds to be rated. Thus, there was an incentive for them to inflate the ratings a bit as the sales guys in these firms wanted to get more bond issuers come to them.
  5. Regulatory issues: since the 1980s, the R-word was considered as bad as the f-word. There was a mistaken assumption that regulations were anti-business. First, they allowed commercial banks to run their investment arms. The Federal Reserve, Securities and Exchange Commission, FDIC and other regulators were mute when banks were betting their house.
  6. Media feeding herd behavior: Investment Bubbles are as old as financial markets. Even 400 years ago there was a Tulip mania that broke many investors. Fortunately, these bubbles were fairly local. However, the arrival of mass media and technology significantly amplified fads and crappy logic (“real estate prices can never go down”). Time magazine and 1000s of blogs proudly proclaimed a new era of housing reality:

These factors fed on each other causing a perfect storm. The Hedge Funds just called the emperor naked. The disrobing of the emperor was done by the whole society.