The Importance of Financial Markets/Institutions

For proof of the importance of financial markets and institutions, one need look no further than the 2008 U.S. subprime mortgage crisis. The U.S. economy is still recovering from that crisis. Its consequences seriously impact quality-of-life for individual citizens and families, and those consequences are the direct result of the behavior of financial institutions acting upon the financial market.

Ed Hampton is a bagger at a Gainesville, Fla., Publix grocery store, a 55-year-old man whose eloquence makes him seem more executive than grocery worker. Prior to the recession, he was chief financial officer for an advertising firm, but that firm did not survive the financial crisis. To keep his family afloat, he took the only job he could find. He says he feels lucky to have work, even if it’s for significantly reduced pay. According to Thomas Conlon and John Cotter’s “Anatomy of a Bail-In,” the U.S. market lost nearly 9 million jobs during 2008 and 2009. That means that 9 million men and women have had to accept underemployment, collect food stamps, or move back in with their parents in order to feed their families. The Hamilton Project, which tracked earnings of workers who lost their jobs for economic reasons during the recession, says earnings dropped by 48 percent two years after the recession began. The lucky ones like Hampton who were quickly reemployed were still making 17 percent less.

The crisis began much earlier than 2008. The U.S. housing bubble peaked in 2006 when interest rates, banks’ increase of loan incentives, and a cultural normalization of debt contributed to the approval of unprecedented numbers of subprime—or, less-than-ideal, often predatory or fraudulently underwritten—mortgages. Banks hoped to earn high returns on adjustable-rate mortgages signed at a low interest rate that could be increased according to a scale that favored the banks. They thus approved loans for low-income borrowers who would have been ineligible for mortgages under stricter guidelines or if financial institutions had employed above-board practices. According to Michael Simkovic’s “Competition and Crisis in Mortgage Securitization,” lending rates increased from a historical high of 8 percent to a staggering 20 percent from 2004 to 2006.

When housing prices began to decrease and the rates for those mortgages began to increase, those low-income borrowers became incapable of making payments, which led to a rate of defaulted loans high enough to collapse those financial institutions and, in so doing, the national economy. The global financial crisis of 2008 followed, creating thousands of Ed Hamptons throughout the country.