Where in the world do you get this alternate history? This is incredibly ridiculous. The Great Recession was caused by the failure of giant financial institutions that had engaged in extremely risky investments in the housing market, called "swap derivatives" and the issuance of easy mortgages.
I agree that subprime mortgages were the initial cause of the recession.
The Great Recession of 2008: What Happened, and When?
2006. How the Subprime Mortgage Crisis Caused the Recession
In 2006, the
subprime mortgage crisis erupted. On November 17, 2006, the Commerce Department warned that October's new home permits were 28 percent lower than the year before.
At this point, the mortgage crisis could have been prevented. But the Bush administration and the Federal Reserve did not realize how grave those early warning signs were. They ignored declines in the inverted yield curve. Instead, they thought the strong money supply and low-interest rates would restrict any problems to the real estate industry.
They didn't realize how reliant banks had become on
derivatives, or contracts whose value is derived from another asset –– essentially betting that these assets will perform well. Banks and
hedge funds sold assets like
mortgage-backed securities to each other as investments. But they were backed by questionable mortgages.
These
interest-only loans were offered to subprime borrowers. These high-risk people are most likely to default on a loan. The banks offered them low interest rates. But this “too-good-to-be-true” loan type resets to a much higher rate after a certain period. Home prices fell at the same time interest rates reset. Their defaults
caused the subprime mortgage crisis.
Banks had sold too many mortgage-backed securities than what could be supported by good mortgages. When home prices started falling in 2007, it signaled the onset of the real estate crisis.
Banks felt safe because they also bought
credit default swaps. They insured against the risk of defaults. But when the MBS market caved in, insurers did not have the capital to cover the CDS holders. As a result, insurance giant American International Group almost went belly-up. The federal government saved it.
Banks relied too much on derivatives. They sold too many bad mortgages to keep the supply of derivatives flowing. That was the underlying
cause of the recession. This financial catastrophe quickly spilled out of the confines of the housing scene and spread throughout the banking industry, bringing down financial behemoths with it. Among those deemed “too big to fail” were Lehman Brothers and Merrill Lynch. Because of this, the crisis spread globally.
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But why were the big banks so involved in these risky assets? It was the repeal of the Glass-Steagall Act in 1999 which allowed them to use depositor's money gambling on risky assets. While I do give President Clinton some of the blame it was the Republicans who pushed the repeal through Congress.
This 1933 Law Would Have Prevented the Financial Crisis
Repeal
On November 12, 1999, President Clinton signed the
Financial Services Modernization Act that repealed Glass-Steagall.
Congress had passed the so-called Gramm-Leach-Bliley Act along party lines, led by a Republican vote in the Senate.
The repeal of Glass-Steagall consolidated investment and retail banks through financial holding companies. The Federal Reserve supervised the new entities. For that reason,
few banks took advantage of the Glass-Steagall repeal. Most Wall Street banks did not want the additional supervision and capital requirements.
Those that did became too big to fail. This required their bailout in 2008-2009 to avoid another depression.
