Causes of Global Financial Crisis of 2008-2010 Essay Examples & Outline
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Causes of Global financial Crisis of 2008-2010
The crisis that erupted in the financial systems of developed countries in the autumn of the year 2008 affected almost all economies throughout the world. The result of this crisis was job losses, bankruptcies as well as cuts in the incomes of millions of people. The global financial as well as economic crisis that erupted in the wake of the collapse of the company Lehman Brothers in the year 2008 led to what can be described as a reconsideration of different earlier approaches that were based on several self-regulating abilities of the market (Obstfeld, 2012). It is of the essence to especially understand that the role of the anti-cyclical macroeconomic policies in order to sustain economies and jobs was widely acknowledged. This paper is going to look at three major factors that led to the financial crisis of the year 2008-2010 and some of the solutions that could have been offered to avoid the problem.
It is of importance to understand that although the crisis originated from the financial system, one of the underlying factors that led to the collapse of different financial systems around the world was the inefficient distribution in gains from growth that occurred during the pre-crisis period (In Barth, 2012). In fact, in most developed countries, wages grew less than it would have been justified based on the productivity developments during the two decades that had preceded the crisis. In fact, wages as a percentage of GDP declined in the majority of countries, while the share of the different gross profits in GDP in most countries increased (In Barth, 2012).
Therefore, in most countries, wage moderation meant that stagnant real income for low paid workers and their families. The wage moderation caused a build p of private debt; therefore, despite the stagnant real incomes for the families, they were able to purchase durable goods as well as housing through credit. Further, because of inadequate regulation, the banks were in a position to provide credit to the households, despite the fact that under the normal prudent criteria such loans would not have been made.
Therefore, the expansion in the domestic demand in the United States and other economies that are advanced was mainly funded by the accumulation of private debt. In the case of the emerging economies where the financial system can be said to have been more tightly regulated, the wage moderation had a direct impact in further weakening the respective country's domestic demand. The debt led demand made the U.S monetary authorities to raise interest rates and this led to failures in loan repayments that quickly spread throughout the financial system and eventually the almost collapse of the economy.
Subprime lending can be described as the second main factor that led to the financial and economic crisis of the year 2008-2010. This is because at this time there was what can be described as bad competition between mortgage lenders for revenue and market share, and when the supply of the creditworthy borrowers was limited, the mortgage lenders decided to relax their underwriting standards and by doing this they led to the origination of what can be said to be riskier mortgages to less creditworthy borrowers.
The Government sponsored Enterprises had managed to policy the situation and maintain high underwriting standards prior to the year 2003. However, after the year 2003, the market power shifted from the securitizes to the originators and this led to an intense competition which led to lowered standards and therefore risky loans. It s of the essence to understand that the worst loans originated from the year 2004-2007 and this were the years where there was the most intense competition between the lowest market share for the GSEs and the securitizes (Cumming, 2013). Therefore, at the end of the day there was an increase in subprime lending in the United States and this was a major contributor to the financial crisis of the year 2008-2010.
The third most important factor was the growth of the housing bubble in the United States. It is of the essence to understand that between the year 1998 and the year 2006, the price of the typical American house increased by around 124%. This housing bubble resulted into many home owners refinancing their homes at different lower interest rates, or even the financial consumer spending taking second mortgages which was secured by price appreciation.
There was increased investments that sought higher yield and this pool of money doubled up in size from the year 2000 to the year 2007. Wall street connected this colossal amounts of money with the mortgage market in the United States and this led to enormous fees that accrued as a result of the mortgage supply chain. The collateralized debt obligation in particular enabled different financial institutions to obtain investor funds in a bid to finance their subprime and other lending and this in effect increased the housing bubble and generated larger fees.
However, the tide turned as the repayment rate amongst the creditors failed, the average U.S housing started to fall and they declined to over 20% from their mid-2006 peak (Cumming, 2013). It is of the essence to note that as the prices declined, the borrowers that had adjustable-rate mortgages could not be able to refinance in a bid to avoid higher payments that were consequently associated with the ever increasing interest and they began to default. During the year 2007, the lenders began foreclosure on around 1.3 million properties, and by the year 2008, 9.2% of all the U.S mortgages were either outstanding or were in foreclosure. This further rose to 14.4% in the year 2009 (Kolb, 2012).
The subprime lending cause could have been solved by tighter regulation of the shadow banking system. This is because the shadow banking system was hugely responsible for the subprime lending. There is a need to regulate these institutions in a systematic manner. There is a need to increase several provisions such as the registration requirements for the advisers of hedge funds which total assets more than a certain sum of money (Rodrigues, 2011).
There is also a need for the money to go through exchanges as well as clearing houses in order for the government to better understand what money is moving and where. This regulation is important as it tackles the risk that previously existed in this unregulated sector. There is also a need to put regulation on the shadow banking system in terms of securitization as well as money market funds (Rodrigues, 2011). The use of registration will also be of importance in order to ensure that there exists more transparency in the shadow banking system. This solution is important as it would resolve the factor of subprime lending and ensure that it never occurs again.
Cumming, D., Dai, N., & Johan, S. A. (2013). Hedge Fund Structure, Regulation, and Performance around the World.
In Barth, J. R., In Lin, C., & In Wihlborg, C. (2012). Research handbook on international banking and governance.
Kolb, R. W. (2010). Lessons from the financial crisis: Causes, consequences, and our economic future. Hoboken, N.J: Wiley.
Obstfeld, M., Cho, D., & Mason, A. (2012). Global economic crisis: Impacts, transmission and recovery. Cheltenham: Edward Elgar.
Rodrigues, L. N., & Dubovyk, V. (2011). Non-traditional security threats and regional cooperation in the southern Caucasus. Amsterdam: IOS Press.