We have seen this with investment bankers being jailed for taking too many risks and squandering billions.
I missed this before. I can't let this one go, it's just too silly.
No investment bankers have been jailed for taking risks.
They also didn't squander billions either. That's not what caused the recession to happen.
This is what caused the recession of 2008:-
In the modern financial system you get 4 players. Banks, businesses, investors and government.
Banks: Loan money to investors
Investors: Invest money into businesses
Businesses: Use money to produce goods and services
Governments: Oversee things and regulate the system to keep it in check
Banks need large amounts of capital to be able to keep loaning to investors and they profit from the interest.
Banks get money by people in the financial system making deposits and saving money. Specifically saving. Checking/current account capital can't be used for long-term investments since the money is being used more often.
Now, in the late 20th century interest rates were high, consumer spending wasn't as rampant and therefore people were saving a lot more than spending. This gives the banks money, who in turn lend to investors who in turn pump money into businesses who grow. There's more balance.
What started to happen was interest rates declined and consumer spending increased. People stopped savings and actually started taking out credit cards.
This has several effects. First of all the banks capital supply dries up. Businesses start making more money and grow fast needing more investment from investors. Investors then want to borrow more from banks. Banks are also lending more to people who are spending with credit cards. The system starts to unbalance.
Now, this is a problem the banks faced so to make more money they started increasing the target mortgage market to include the sub-prime market. They pushed hard to get people on mortgages then they bundled the sub-prime mortgages up into financial products which they sold on in the open financial market. Problem temporarily solved.
The banks(investment banking department, totally separate from regular banking) and investors(hedge funds, dedicated investment outlets rather than banks) who bought these financial products then used a tool called leverage, which is basically borrowing against existing assets.
If I am worth say $1mil from say 2 properties at $500k(assets) each I could approach you and borrow another $1mil. My leverage ratio would be 1:1 and the volatility of my leverage would be the volatility of the 2 properties. For properties in a stable market volatility is low and overall risk is low.
Now let's say I borrow $10mil. I'm then leveraged 10:1.
So after buying the mortgage financial products(these are assets that make money from interest payments just like my properties above), the investors then leverage against these financial products(sub-prime = huge volatility, but investors would have calculated the volatility to be within safe limits for their intended amounts of risk), borrowing more money to reinvest.
Can you see where this is going now.. ?
Next what happened was people started defaulting on mortgage payments and suddenly all the debt that was leveraged on these sub-prime mortgages is looking like it's going to be in trouble.
One of the problems was there was no way of distinguishing between sub-prime financial products and normal ones so everyone stopped trading in these financial products out of fear. That in its self caused problems.
From there everything just crumbled like a deck of cards with the sub-prime financial products at the bottom because so much debt was leveraged on these.
It's like you lend me $5m and suddenly my $1mil in net worth turns to zero because no one's buying houses anymore and I can't sell up. So the leverage ratio is essentially infinite. My houses are empty(no payments) and I can't sell them. Boom.