For a long time, the 2008 recession was just something that happened for me. I vaguely knew it had something to do with risky mortgages and crooks who were never thrown in jail, but beyond that, I had no clue how these two things had crashed our economy.

Any time I tried to ask adults questions about the ’08 recession, I would get a mouthful of jargon, and when I tried to ask further questions, I would get more answers which made no sense and left me even more confused. I was still in elementary school at the time; I mean, could you really blame me? But recently, I watched The Big Short, a movie about some guys who predict the crash before it happens and get rich off of it. Despite the movie’s best efforts to explain complicated concepts to me through celebrities like Selena Gomez, I was still unable to grasp the basics. It wasn’t until a few YouTube videos later until I finally got it (the most helpful video is linked below).

So I’m going to be explaining the crisis to you like I wish someone had to me.

A few things first. You need to know what a mortgage is. A mortgage is a basically a loan for a house. Let’s say you want to buy a house that is 100,000 dollars , but you don’t actually have a hundred thousand dollars sitting in your bank account. You do, however, have good credit history and a steady income, so the bank is willing to lend you the money. You can take out a mortgage on the house, which can look something like this: the bank will pay the 100 thousand for the house, and you have to pay back the bank 10 thousand a month every month for ten months with 10 percent interest. This means that each month, you would pay back the bank 11,000 dollars for 10 months, meaning you pay 110,000 dollars in total. Obviously, typical mortgages don’t require you to pay 11,000 dollars a month, I just used numbers that were easy to work with as an example. A real mortgage would be paid over a span of usually 30 years with small monthly payments. When you take out a mortgage, the bank essentially owns the house; you’re just paying the bank back while you live in it. If you default on your mortgage, meaning you can no longer afford to make the monthly payments, the bank will take your house and you will have to leave. This is called foreclosure.

So now that we have that basic fact down, let’s set the scene for the crisis. There are four players involved: the investors, the private banks (Wall Street), the government banks (Freddie Mac and Fannie Mae) and the homeowners. Before we get into it, you need to know about a few things first: the U.S Treasury/ government banks, second: dot-com bust and third: cash surpluses in Asia.

After the dot-com bubble burst (another unrelated smaller financial crisis) in the early 2000s, the U.S treasury lowered interest rates on bonds to one percent in order to boost investment in the economy. A bond is basically a piece of paper that you buy from the government which is worth a certain amount of money. The government pays you interest on it to hang on to the bond. The longer you hang on to it, the more it will be worth in the future. A bond is a very safe investment because the U.S government is virtually guaranteed to pay you back. The U.S. Treasury sets the interest rate on those bonds, which can vary depending on the times. A one percent interest rate is very low, which means two things; The first thing is that investors are less likely to invest in bonds due to the low returns, and the second thing is that this means that private banks can borrow from the government banks (Freddie Mac and Fannie Mae) at an interest rate of one percent. So this means private banks can borrow huge sums from the government while investors are discouraged from buying bonds. Keep in mind that investors during this time were just sitting on piles of money from their cash surpluses in Asia where investments had been a success. They were really looking for a smart place to invest.

Okay, so now that we have those three things covered, let’s continue. So the banks on Wall Street figured out a way that the investors and themselves could make a lot of money off of the housing market, which was booming at the time. Here’s how they did it: Let's say you’re looking for a house. You find one you like and are ready to take out a mortgage. You find a mortgage broker who signs you up with a bank. The broker makes a commission from the bank they work for because they signed you up to take out a mortgage with that bank, so they earned the bank some money. The bank then essentially “sells” your mortgage to an investor (also called an investment banker), and they make some money off of that. This is how banks actually make money.

The investment banker then uses something called “leverage” to buy even more mortgages from banks. Here’s how “leverage” works: Normally, if you have 10 bucks, you buy 10 boxes at one dollar a box and sell them for 11 dollars, thereby making a 1 dollar profit. Leverage is when you have 10 dollars, you borrow 90 dollars at a 1% interest rate, then buy 100 boxes and sell them at 120 dollars. With the 120 bucks, you pay back the loan with interest and make a profit. Basically, it’s when you borrow money to buy something you plan on re-selling at a higher price in order to make a profit.

So an investment banker would buy many mortgages from banks by borrowing money from government banks at a low interest rate of one percent. Then they package all the mortgages together in the form of a CDO (collateralized debt obligation). Think of a CDO as a box with three layers with each layer consisting of many mortgages. The top layer are the highest rated mortgages (AAA), the middle layer is made up of lower rated ones (BBB), and the bottom don’t really receive a rating so everyone knows they are risky. So what do these ratings mean and who gives them out? The ratings are a reflection of how likely the homeowner is to pay back the mortgage. If you’re a homeowner with a high income, cheap house and steady job, then your mortgage would probably be a triple A. If you don’t earn a lot and live in an expensive home, your mortgage is probably in the bottom layer risky zone. These ratings are given out by ratings agencies which check out the homeowner's finances and background in order to rate their mortgages.

Now that the investment banker has their CDO ready to go, they can begin selling shares of it to other investors. Investors can choose to buy from each of the three layers. People who buy the AAA mortgages are paid first when homeowners make monthly payments but at a low interest rate. People who invest in BBB mortgages get paid only after all the AAA investors have gotten paid but at a higher interest rate. People who buy the high risk mortgages get paid last but with very high interest rates since they run the risk of not any making money at all if the high risk people default on their mortgages. In this way, the everyone makes money: the bank who sold the mortgage to the investment banker, the investment banker who sold parts of their CDO and the investors of the CDO who see good returns. Everyone wins.

So everyone was pretty happy with this arrangement, and the investors wanted to buy into more CDOs to make even more money. However, in order to make more CDOs, you need more mortgages, but everyone who could afford to buy a house already had one. This is when things began to get shady. Banks wanted more people to sign up for mortgages so they they could keep profiting, so they began putting pressure on mortgage brokers to sign up people who couldn’t keep up with mortgage payments. Banks rewarded brokers who signed up many people, so brokers began doing just that. They gave mortgages to people without checking if they were employed or what their salaries was. These high risk mortgages are called “sub-prime mortgages.” Although they were risky, ratings agencies still gave them AAA ratings and stopped doing background checks on homeowners. Why? The banks paid them off to do this so that the banks could keep selling off these mortgages to investors pretending like these mortgages were safe investments.

And here’s where everything kind of fell apart. The people who couldn’t afford the mortgage payments defaulted and the banks foreclosed on them. If there are several foreclosures in an area, the prices of all the houses in that area decrease. In many cases, people were living in neighborhoods where their neighbors had been foreclosed on so their own houses were now worth less than the mortgage they were making payments for. These people figured there was no point in paying their mortgage off if their houses were now worth a fraction of what they were supposed to pay for it so they left their homes and let the bank take the house. Payments begin to dry up and the people who now own the mortgages are stuck with worthless houses which don’t produce cash and can’t be sold at a profit. The investment banker is particularly freaked out since he or she borrowed large sums of money in order to buy the CDO in the first place and now has no means of paying back the money. The banks, the investors and the investment banker are all trying to sell off their bad mortgages but no one wants to buy them. Everyone goes bankrupt. The government banks have loaned billions and can’t be paid back, and the same goes for the private banks and investors and investment bankers.

So how does this wreck the whole economy? Well, the people who had lost money when they had left their homes stopped spending so much in the market, causing businesses to suffer. When business’s profit dried up, they were forced to lay off workers meaning unemployment and poverty rates rocketed.

Let’s discuss the state of the private and government banks for a second. The private banks had lost people’s money, and the government banks had lost money too. In the Great Depression, people lined up to the banks to get money that just wasn’t there. Before people could begin doing that, our government bailed the banks out, meaning they gave them back the money they had lost. Although this was technically unfair since taxpayer money was being used to rescue banks which had made bad decisions, it was necessary in order to stop the Great Depression from happening again. This way, people’s savings and retirement were saved and they didn’t have to wait in line in front of banks for money that just wasn’t there. So whatever people had in the bank was still there, even though they may have lost money in other ways like through business or their homes. The government essentially owned all the private banks it had bailed out at that time. Now the banks have paid off what the government gave them and are once again privately owned.

Now let's tie all this info back to the movie (spoilers ahead, skip paragraph to avoid). How do these guys get rich at the end when everyone else loses everything? They do two things. First, they make an effort to do the hard research beforehand and find out that AAA mortgages are defaulting meaning something fishy is going on. Second, they buy something called a "credit swap" for a large amount of money. A credit swap is essentially a "bet" on AAA mortgages. Basically, the owner of the CDO agrees to pay the owner of the credit swap a certain amount of money if the AAA mortgages default. If the mortgages continue to produce money, however, the owner of the credit swap must pay the owner of the CDO a certain amount of money. In the movie, the protagonists bet millions of dollars on these swaps, and the banks are willing to accept the bets because they believe the housing market is so strong that they will never have to pay out these guys and that these guys will be the ones paying up all the time when the mortgages make money. Obviously, the banks make a mistake and when the mortgages default, these guys end up making billions.

We’ve mostly recovered from the recession, but economic growth has been slow. At least you now know a bit more about the causes and effects of the 2008 recession. If this article gets enough views, my next article will be about the government regulations that have been passed since then to stop people from repeating what lead up to the crisis and the corruption within the system. Some of this information is pretty disturbing, so be sure to check it out. Feel free to leave any questions you have in the comments below, and I'll be sure to answer them. If you're still confused, be sure to check out the YouTube video I found most helpful: