Unveiling the Secret behind the Birth of Bitcoin : PART 1
The global economic crisis of 2008 was triggered by various factors, but it is important to understand the root cause behind it. While some may attribute the crisis to the stock market, others may point to the real estate business. However, the origins of this crisis can be traced back to a particular event that set off a destructive cycle of economic downturn. Many people may not be aware of this pivotal event, so let's delve into its story, which ultimately paved the way for future technological advancements, including the widely discussed Bitcoin.
In the mid-1990s, a wave of internet-based businesses emerged, sparking optimism about their potential to shape the future. These businesses were seen as the tools of tomorrow, much like how we now talk about blockchain, AI, IoT, and the Fourth Industrial Revolution. Similar to the current trend of investing in cryptocurrencies without a comprehensive understanding, people back then were also caught up in the hype and eagerly invested substantial sums of money in internet companies.
However, their expectations of immediate returns from these investments were not met, leading to the creation of an internet bubble. This bubble appeared substantial from the outside but lacked substance within, making it susceptible to bursting at any moment. And indeed, that's precisely what occurred around the year 2000 when internet-based companies incurred substantial losses. Consequently, the stock market in the United States experienced a downturn, as numerous investors had allocated their funds to these companies. To mitigate potential losses, individuals swiftly withdrew their money from the stock market.
Holding onto money without generating profits is an unfruitful strategy. Hence, people began searching for new investment opportunities. In many countries, individuals often turn to banks as a reliable investment destination due to the perceived lack of risk. However, during that period, American banks found themselves with excess capital. This surplus can be attributed to economic downturns in Asian countries during the 1990s. To safeguard their funds from these downturns, Asian nations, along with Russia, deposited a considerable amount of money in American banks. Additionally, many individuals who had earned money from the stock market also chose to deposit their earnings in these banks. Consequently, the interest rates offered by American banks decreased by 1-2%. Faced with these low-interest rates, affluent entrepreneurs began seeking alternative investment avenues.
During this period, the real estate industry in America experienced significant growth. The concept of owning a home and car, often referred to as the American Dream, resonates strongly with many Americans. With low-interest rates offered by banks, numerous individuals took advantage of bank loans to purchase flats, fueling the prosperity of the real estate market. As a consequence, flat prices steadily increased, attracting the attention of investors who began investing in real estate, further bolstering the industry.
While traditional banking services are well-known, most countries also have investment banks that primarily cater to large organizations. Recognizing the challenges faced by American traditional banks, investment banks devised a plan to involve commercial banks in their operations. Consequently, investment banks began acquiring loans that customers had obtained from traditional banks to finance their home purchases. These acquired loans were then combined to create bond loans, which were subsequently sold to investors.
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Let's delve into an illustrative incident: Imagine a bank that lends $1 million to each of 10 individuals, totaling $10 million. After one year, the bank would typically receive $12 million in loan repayments from these individuals. However, in this case, the bank decides to sell these loans to an Investment Bank for $10.5 million. The Investment Bank then combines these 10 loans to create a bundle known as a Collateralized Debt Obligation (CDO), which they sell to wealthy investors for $11 million. Consequently, within one year, the investors' accounts are credited with $12 million. It's evident that the bank, through this transactional paperwork, earns a profit of $0.5 million within a matter of days.
Due to the higher profit rates associated with bond loans, investors have been opting for them instead of depositing money in banks. As a result, the demand for these loans has been on the rise. Moreover, investment banks were utilizing credit rating agencies to assess the quality of these CDOs. Credit rating agencies specialize in providing ratings for financial investments. The real estate business was flourishing, and customers were diligently repaying their installments, taking advantage of the low-interest rates offered by banks. As a result, the Collateralized Debt Obligations (CDOs) associated with these payments received top ratings, further boosting the success of the bank's bond loan operations.
Banks typically conduct comprehensive assessments of a customer's financial situation before approving a loan, ensuring that borrowers have the means to make timely repayments. However, as a profit-driven approach, banks eventually began offering Adjustable-Rate Mortgages to a broader range of customers, seeking to maximize their earnings. An Adjustable-Rate Mortgage is a loan where the interest rate fluctuates based on market conditions. With low bank interest rates at the time, even individuals who may not have otherwise qualified for a home loan were enticed to borrow from banks, aspiring to achieve homeownership. Unfortunately, this practice heightened the risk level within the banking system, including the real estate sector.
to be continued.......