The paper "How Has the Financial Crisis of 2007 Affected the Economy of the US" is a good example of a macro and microeconomics case study. The global financial crisis that swept across the entire global economy between 2007 and 2008 left many people vague about its causes and its effects on the world economy. The roots of the financial crisis can probably be traced to financial markets’ deregulation in the Western European economies, the US, and the UK that began in the 1970s and took effect in 1980s. The deregulation removed regulatory controls by governments leaving organizations free to trade widely across activities and territories.
Before the deregulation, banks, stockbrokers, building societies, and insurance companies specialized in their spheres of trade. Geographically, the operations of these institutions were constrained to their countries. With deregulation, these financial institutions were allowed to operate and make money from financial markets worldwide. Liberalization of credit was the effect since borrowing was made easier making it easy to expand personal debt, especially mortgage debt. The effects were initially felt in the property sector, and later to other sectors of the economy (National and International Issues 2015 p. 2).
Financial institutions led huge amounts of money to people whose creditworthiness was questionable, and when interest rates rose, the people could barely afford the repayment of their mortgage loans. Default rate increased to record levels with the sub-prime loan defaulters unable to pay their loans. The impact of the defaults cut across the entire financial system because banks and investors had purchased many of the mortgages and other Collateralized Debt Obligations (CDOs), including bonds and assets (BBC NEWS 2009).
The credit crunch was occasioned by increased liquidity and loose monetary policy (Martin & Milas 2009 p. 1). It was a series of an event after event beginning from low-interest rates and increased lending by banks to sub-prime borrowers, to increased house prices and speculation on financial markets, to the high default rate, then the financial crisis, and finally reduced bank lending that resulted in shrinking of the economy. Therefore, the great recession that began in 2007 can be associated with lax lending standards that increased personal debts and caused real-estate bubbles, housing policies by the US government, and failure to regulate fully non-depository financial institutions. The US Housing Sector and the Financial Crisis The financial crisis in the US began in the US housing market in the 1990s due to low-interest rates, lax lending, and speculations in the financial market.
For instance, financial institutions seeking to maximize profits engaged in complex financial processes that were characterized by poor risk analysis, highly leveraged borrowing, and limited credit regulation. The housing bubble burst in conjunction with other asset bubble instigated the credit crisis.
Various financial innovations ensued to reduce the risk only to cause its spread to the financial markets and also to the real economy. Before the late 2008 crisis, policy institutions in the US seeking to address liquidity concerns, prevent mortgage foreclosures, and stimulate demand came up with various policy responses. The policy responses included legislation aiming at mortgage foreclosure mitigation and stimulation of demand, Bear Steams bank to be taken over due to its failure, and the creation of the Federal Reserve (Fed) to lower interest rates and enhance liquidity schemes to abate credit crisis.
However, financial crisis crept in with the fall in house prices and downgrading of mortgage-based securities to reflect risk reassessments of late 2007 and early 2008. The financial shocks of 2007/2008 changed the approach. The US Treasury was given the mandate to administer the Emergency Economic Stabilization Act that was passed by the Congress in 2008. The Bank of Lehman Brothers that had collapsed due to the financial crisis was not bailed out by the Fed and the US Treasury. Capital injections into economically troubled financial institutions were administered by the US Treasury in exchange for common equity stakes and preferred stock.
AIG, an insurance company that had collapsed, was bailed out by the Fed and the Treasury. The short-selling of financial institutions was suspended by the Securities and Exchange Commission. The government launched Stability and Homeowner Affordability Plan to enable refinancing of mortgages by struggling homeowners. The $787 billion American Recovery and Reinvestment Act were passed to strengthen the US economy’ s demand. However, these actions failed to prevent a rapid decline in asset prices because institutions wanted to get rid of risky burdens and restore their capital ratios.
Increased default rates coupled with rapidly declining asset prices posed problems to mortgage lenders in assessing the value of collaterals and many mortgage institutions collapsed due to the sinking of their dividend, credit, and strength ratings (Marshall 2009 p. 3).
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