By Maristella Arifi | Bricksave
August 25, 2023
The collapse of a handful of US banks – including Silicon Valley Bank – earlier this year brought back some painful memories of the 2008 financial crisis. But are these comparisons fair, and should investors be worried about the US housing sector? This article explores the differences between then and now.
It might have been 15 years ago, but the 2008 Global Financial Crisis still lingers long in many people’s memories. So when some US banks – including Silicon Valley Bank, Silvergate Bank and Signature Bank – failed back in March, it was understandable that questions were being asked as to whether we were at the beginnings of ‘GFC 2.0’. So, to understand whether that’s a fair comparison, let’s first take a look at what really happened all those years ago.
It was the worst financial crisis since the 1930s, and it caused lasting shockwaves across the world. The 2007-2008 Global Financial Crisis was triggered by an overexpansion of credit channelled through the real estate market that overexaggerated the value of US house prices. As the US housing bubble burst, and more people defaulted on their home loans, financial instruments that were linked to those loans fell in value to such an extent that they were worthless. These financial instruments – known as mortgage-backed securities – had been packaged up and sold as investments to financial institutions across the world. All of a sudden, these worthless investments caused widespread panic and sparked bankruptcies. It started with the collapse of US bank Lehman Brothers in September 2008, and governments across the world had to step in, spending huge amounts to ensure other institutions didn’t suffer a similar fate.
Before we look at more recent events, let’s look at some of the lessons learned. The Global Financial Crisis was a harsh – but necessary – reminder of the risks involved in the financial system and the potential for full-blown crises to spread from one financial institution to another, all across the world. It emphasised the need for more robust risk management practices within financial institutions, improved transparency in the financial sector, and stronger regulatory oversight.
Investors learned some important lessons too. The crisis confirmed the importance of thoroughly understanding the products they invest in, to do their research, to be wary of investing at times when prices are overheating, and to remember that if something sounds too good to be true, it usually is. The good news is that the Global Financial Crisis resulted in some important changes designed to help ensure a similar situation wouldn’t happen again. Here are some of the key changes that were implemented:
1. Improved lending standards
One of the primary causes of the crisis was loose lending standards, particularly in the US housing market. Mortgages were being approved for borrowers who couldn’t afford them, and banks were not being thorough enough in checking whether these borrowers had the income needed to repay their loans, especially if interest rates started increasing. But since the crisis, lending standards have become much stricter. Lenders must now conduct rigorous checks of a borrower's ability to repay before issuing a mortgage. This includes verifying their income and employment status, assessing their credit history, and ensuring the borrower isn't taking on too much debt.
2. Tighter financial regulations
The crisis exposed a number of gaps and shortcomings in the oversight of financial institutions. As a result, most countries that suffered during the crisis have passed more strict regulations on those institutions. Examples of these regulations include:
So, what went wrong with banks earlier this year? Sadly, no amount of regulation can protect against people making bad calls of judgement. In the cases of Silicon Valley Bank, Signature Bank and Silvergate Bank, all three were heavily involved in lending to companies in the tech industry, and had significant exposure to cryptocurrencies. While these banks had invested their capital into long-term US Treasury Bonds, the value of these assets fell after the US Federal Reserve began raising interest rates in the US last year. The situation came to a head when depositors in these banks started asking for their deposits bank, which meant the banks had to start selling their assets, causing their collapse.
At the time of writing, it looks like the struggles of US banks have mostly been contained. The banks that collapsed did so because of bad judgement calls and bad timing, and this hasn’t spread across the world as it did 15 years ago. But most importantly, the US housing market is not in danger of collapsing, which was one of the triggers of the 2008 crisis. That’s because there are no indications that today’s higher house prices in the US are a ‘bubble’. For example, are larger number of US homeowners today have fixed rate mortgages. This means their repayments are ‘locked-in’ to a lower rate of interest. To underline this, according to Bloomberg, the number of adjustable-rate mortgages (ARMs) – where the interest rate changes as mortgage rates shift – peaked in March 2005 at 36.6%. However, in September last year the US Mortgage Bankers Association confirmed that ARMs made up only around 9% of all new home loan applications.
And more importantly, tighter regulations today mean that all mortgage applications are looked at much more closely to ensure potential borrowers will still be able to repay their loans should interest rates rise significantly.
Of course, it’s impossible to say that a crisis cannot occur in the future. No system is foolproof and risks are a part of investing. As such, there will always be isolated events that affect investors. But after a difficult 2022, the resilience of the US housing market in 2023 suggests things are turning the corner. Therefore, we suggest real estate investors should continue to closely watch the key indicators of financial and property market conditions, such as the Case-Shiller index. Doing the necessary research can help to answer those difficult questions and give you a better indication of whether it’s the right time to invest.
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