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Jim Rickards describes how, during the lead-up to the 2008 financial crisis, there was about $1 trillion in subprime mortgages. These were loans given without documentation, income verification, or other typical requirements—essentially loans given to very risky borrowers. But a bubble mentality had taken over, where people thought they could buy a house, borrow against it, fix it up, sell it for double the price, and make easy money. This frenzy drove massive borrowing.

In normal circumstances, mortgage default rates rarely exceed 5%, which is already considered high. Yet at the time, experts and financial analysts like Ben Stein, along with central banks, thought that even if defaults went up to 20%—an unprecedented level—they could handle it. On $1 trillion of subprime mortgages, a 20% default rate would mean $200 billion in losses. This was comparable to the losses seen in the Savings and Loan (S&L) crisis of the 1980s, adjusted for inflation. The thinking was, “We survived the S&L crisis, so we can survive this too. Yes, it would hurt banks and impact stock prices, but we’d get through it.”

What they missed, though, was the hidden $6 trillion in derivatives tied to these subprime mortgages. This was the real issue. If 20% of those derivatives also went bad, losses would hit $1.2 trillion. These derivatives were created out of thin air, unregulated, off-balance-sheet instruments with no size limit. They were buried in complex footnotes—non-transparent and nearly impossible to track. So, when the crisis started to unfold, it was far worse than anyone had anticipated, and the contagion spread rapidly throughout the financial system.

Rickards argues that the 2008 crisis happened because we didn’t learn from the 1998 Long-Term Capital Management crisis. Each crisis seems to grow larger and require even greater interventions. In 1998, Wall Street had to bail out a hedge fund. In 2008, central banks had to bail out Wall Street. But now, if we face another crisis, who will bail out the central banks? Rickards warns that we’re reaching a point where there’s no one left to step in, and each crisis has escalated to a larger scale with even greater financial stakes.
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