The Financial Crisis of 2008 - Essay Example

Teacher The Financial Crisis of 2008 Introduction The history of modern civilization is certainly wrought with period of economic instability that threatens the very fabric of society. Only history can gauge what we learn from each crisis and grow from it as a community, but the global economic crisis of 2008 certainly looms as an indicator of what can happen when credit flows too freely and the capitalistic nature of much of the world quickly begins to crumble. At the current time, the economic crisis of 2008 goes down as the most troubling financial situation America, and indeed the world, has faced since the Great Depression back in the early 1930s. From its outset, while the causes of the crisis comprised of numerous economic factors on a global scale coming together to form a perfect storm of financial peril, it became clear that the crisis itself would threaten the total collapse of many of the world’s largest financial firms (Basher & Balli 2304). This would necessitate the governments of many of the Western powers to decide whether or not they could afford the banks fail, or whether they would have to prop them up via bailout packages. In addition, one of the primary factors contributing to the collapse of the financial sector was a severe housing crisis caused by countless millions of individuals around the world who found themselves suddenly unable to pay their mortgages. This alone set off a chain reaction of economic conditions, such as high unemployment and foreclosures, that would send house prices plummeting to pre 1980 levels and left many wondering if there was any way out. This short study examines the issues related to the mortgage crisis and the impending threat of bank failures, all bought on by the global financial crisis of 2008. Mortgage Issues and the Housing Bubble The aptly termed ‘housing bubble’ in the United States is considered by many economists to be the precipitating factor in causing the global financial crisis in 2008. Beginning in late 2005, an alarmingly high number of individuals with subprime and adjustable-rate mortgages began to default on their obligations. At the time, many banks and mortgage lending institutions in the United States were providing easy credit, even to individuals who had an established record of poor credit, or you really did not qualify for the level of loan they were requesting. The economy was solid and robust, so banks began to take on much more risk than was really logical. At the same time, prices throughout most sectors of the real estate and property sectors began to soar, resulting in skyrocketing prices. To compensate, mortgage lenders often were forced to resort to creative lending practices in order to get many homeowners qualified (Stiglitz 328). Low adjustable rate mortgages, for example, were offered where customers paid little to no interest for the first several years of the loan, making payments affordable. As the rate adjusted upward, however, homeowners quickly found themselves unable to make their payments. This occurred in mass, at the same time, resulting in a crisis that occurred seemingly overnight. In addition, many homeowners were offer zero down mortgages on homes that were overvalued to begin with. This resulted in a situation where homes were upside down for thousands, and in some cases hundreds of thousands of dollars, precluding homeowners from being able to sale to get out from under their mortgage. As a result, millions of homeowners began to simply walk away from their homes, leaving banks without any money, and without any way to sell the home again due to the housing bubble simply bursting (Earle 789). The so-called foreclosure epidemic really began to occur in mass around late 2006. Its effects are still being felt today as much of the wealth that Americans had accumulated via their homes simply vanished. The housing market simply has not rebounded to any measurable degree. It has also served to erode the financial strength and capital of lending institutions around the world, causing them to not only severely tighten credit and lending policies, but also to see their own liquidity suffer at the same time. It is now estimated that the global financial losses incurred as a result of housing crisis that occurred from late 2006-2009 is in the trillions of American dollars (Rossouw 68). It is also noted that at the height of the housing boom, competition for borrowers was fierce. Everyone, it seemed, was in the market for a new house and lenders went to incredible lengths in order to offer creative lending packages designed to lure new customers over to them. At this time, unfortunately, the number of individuals seeking a new home who were actually deemed credit worthy was extremely limited. This did not stop financial institutions who had money to lend, however, and the subprime lending spree began. During the years of 2004-2007, a high number of loans that never should have been underwritten were granted, and have since been defaulted on. Laws have since been strengthened to hopefully prevent this from happening again in the future, but the damage still lingers to this day (Grabel 39). Banks in Crisis and Failure Mode Due to the lower interest rates that were in effect in the early past of the new century, borrowing was encouraged. In fact, during the first three years alone, from 2000-2003, the Federal Reserve Board opted to lower the target interest rate from 6.5% to 1.0%. When factoring in for inflation, it was simply not a savers market. Many opted to borrow money to take advantage of the housing market before it burst. Basically, banks lowered the interest rate to try to dampen the effects of the dot-com bubble that occurred in the late 1990s, and to help spur economic recover after the terrorist attacks of 2001 (Peihani 465). At first, the policy did help to spur the economy, and the economy was rebounding quite solidly. Prevailing bank and economic policy, however, did not adjust and before long the banks were finding themselves to be in a crisis of liquidity as individual and corporate borrowers alike were suddenly unable to meet their financial needs (Li S120). To compensate, there was an almost immediate and additional down pressure on interest rates that kept forcing the hands of the Federal Reserve. This was, in essence, created by the reality of an increasing current account deficit throughout the United States. This peaked right along with the housing bubble previously discussed back in 2006 (Kilinc 2010). The housing crisis was not the only precipitating factor, however, as a growing trade deficit in America was forcing the nation to borrow money from its global partners. This entailed bond prices within the country being bid upward, thus forcing interest rates to gradually be lowered to nearly 0%. In the eight period from 1996-2004 alone, the current account deficit in the United States increase by more than $650 billion. This amounted to 5.8% of the total Gross Domestic Product for the country (Szyska 212). Because of this, a slew of foreign investors entered into the American market, in essence flooding it with a food of capital. This was then used by the banks to issue the record number of loans that it did in the early part of the century, greatly contributing to the impending banking failure throughout all sectors of American society. Conclusion In actuality, the Global Financial Crisis of 2008 was created by a variety of factors that came together to result in one of the greatest periods of economic turmoil that the modern era has ever seen. Each of the factors, when taken separate, could probably have been solved rather easily. The banking sector, however, began lending money freely to individuals and businesses who did not have capacity to repay. The money, however, came from foreign investors, which resulted in many banks to fail, and those too large too fail were bailed out by various Western government, such as the United States and the United Kingdom. This bailout occurred largely because of the diplomatic crisis that would have ensured if foreign investors would have lost their money, or if America would have been unable to repay its debt obligation for other nations. In the end, it was the lure of higher bond rates and a burgeoning housing market that attracted the investors in the first place. Poor policy took over much of the banking sector, as to compensate for the lack of interest savers were getting, loans were at record low amount in order to prop up liquidity and provide an influx of capital to a struggling system. In the end, all of these components simply combined in late 2006 to crash the banking and housing markets. Moving forward, there are many lessons to be learning from the Global Financial Crisis of 2008. In reality, however, there will likely be many more such periods to come, as economic history does have a way of repeating itself. During the good times, as was the case in the early 2000s, economic policy loosens and money perhaps starts flowing a bit too freely. In the future, nations of the world must set stricter lending regulations and ensure that predatory lending practices are not allowed to continue. That will not only protect individual citizens, but also work to help prevent a total collapse of the financial system as we know it. Works Cited Basher, Syed Abul and Balli, Faruk. “International Income Risk-Sharing and the Global Finan cial Crisis of 2008-2009”. Journal of Banking and Finance, 37.7 (2013): 2303-2313. Earle, Timothy. “Trust, Confidence, and the 2008 Global Financial Crisis”. Risk Analysis, 29.6 (2009): 785-792. Grabel, Irene. “Global Financial Governance and Development Finance in the Wake of the 2008 Financial Crisis”. Feminist Economics, 19.3 (2013): 32-54. Grigor, L. “Financial Crisis of 2008”. Problems of Economic Transition, 51.10 (2009): 35-62. Kilinc, Zubeyir. “Special Issue: The Global Financial Crisis of 2008-2009: An Opportunity for Development? Journal of International Development, (2010). Li, Ji. “A Yin/Yang Perspective on the 2008 Global Financial Crisis”. British Journal of Management, 23 (2012): S119-S125. Peihani, Maziar. “The Global Financial Crisis of 2008: An Analysis of Contributing Trends, Policies, and Failures”. Banking and Finance Law Review, 27.3 (2012): 465. Rossouw, G. “Global Business Ethical Perspectives on Capitalism, Finance, and Corporate Responsibility: The Impact of the Global Financial Crisis of 2008”. Asian Journal of Business Ethics, 1.1 (2012): 63-72. Stiglitz, Joseph E. “Lessons from the Global Financial Crisis of 2008”. Seoul Journal of Economics, 23.3 (2010): 321-339. Szyszka, Adam. “The Genesis of the 2008 Global Financial Crisis and Challenges to the Neoclassical Paradigm of Finance”. Global Finance Journal, 22.3 (2011): 211-216. Read More