Many worrying signs are shaking investors. After 12 years, US banks seem to have not learned their lessons. Wild and uncontrolled financial speculation is unfortunately still a common practice in the United States. The easing of the Volcker law – which has limited the bank speculation – now could dramatically replicate the 2008 financial bubble. In addition to this, the complications that arose due to the crisis caused by Covid-19 could unfortunately act as a lethal weapon.
2008 crash: how it all began
Until the late 1990s, banks had to offer collateral in order to obtain a mortgage in the United States. From the late 1990s, following political choices, federal agencies began financing mortgages on behalf of the most marginalized. The goal was to take charge of the people most in difficulty who could not access the mortgage before then. It was the birth of subprime mortgages that sparked the 2008 crash.
In this way, they began to provide loans also to people with negative credit scores. US banks had no problems with disbursements. In fact, they considered themselves covered by federal agencies and by the extremely positive trend that the US real estate market had in that period. The real estate market, according to avid bankers and speculators, could have not only protected the bank in the case of the creditor’s insolvency, but would have even brought a profit to the bank, which could have sold the property at a higher price if it had not received the installments.
The key elements of the 2008 crash: SIVs, CDOs and its derivatives
In addition to this, the banks found ways to free themselves from the risks and responsibilities acquired by selling them to the financial markets.
In fact, the banks created SIV (Special Investment Vehicle) companies, which dealt with the granting of mortgages, without showing that those companies were actually owned by them. The banks later transferred the mortgages to the SIV companies, receiving in exchange for the SIV securities. Afterwards, they reselled the newly purchased securities, called CDOs, to the market. By reselling them, the banks recorded huge profits freeing themselves of all responsibility. The SIV CDOs were deemed safe even by the largest American rating agencies because they grouped mortgages of many American families and even if some of them had declared insolvency, the others would have averted the worst if not compensated for the flaw. By virtue of this reasoning, some financial institutions created other financial instruments with the aim of attracting more and more capital. We are talking about CDO-squared (general titles that grouped many basic CDOs) and CDS, a sort of insurance on SIV obtained after paying an insurance premium. In the event that the SIVs had declared insolvency, the buyers of the CDS would have received substantial compensation. The problems came when banks and financial institutions exaggerated the SIV concession, ensuring much more than the maximum possible. When the chain of subprime mortgages broke, investors found themselves all tied to a few highly insolvent financial institutions, creators of many difficult to understand and interconnected financial instruments.
The worrying element in common between the current situation and that of 2008
Although the dynamics are different, there is a worrying element that unites what happened during the crisis of 2008 so far: the greedy financial speculation of bankers and financiers.
According to Bloomberg, following the revision of the Volcker law passed in 2008 that put the stakes to savage financial speculation promoted by the shadow banking system (a circle of powerful bankers and financiers who shrewdly evaded any type of control), the US banks would be ready to invest a whopping $40 billion of their funds. If these funds were invested with leverage, the banks would run the risk of experiencing losses far greater than the amount invested. If the operations went well, the banks would earn huge sums. In the event that investment operations go wrong, the banks – given the enormous capital involved – could replicate a financial bubble similar to that of 2008. If this happened, the government would necessarily have to intervene by paying public money to ward off the worst, as the banks involved would be considered too important and prestigious to go bankrupt.
In that case, the consequences could be disastrous also due to the already negative balance sheets of the US banks and the difficulties encountered by the US and global economy after Covid-19.