Financial Crisis of 2008 - Research Paper Example

The financial crisis of 2008 The world economy is currently at its worst with most countries hit by the pinching global recession. Economists define financial crisis as a significant downturn in activity that affects all the economic segment, the decline in activity normally last for a certain period, which could be more than months or years. Effects of economic recession or financial crisis are usually witnessed in employment, industrial production and in real estate income (Magdoff and Bellamy 41). The technical economic indicator associated with recession is economic growth which is negative which in quarters is two consecutive when measured by a nation’s GDP (Gross Domestic product). The 2008 financial crisis affected all financial institutions in the world. The financial crisis endangered the total collapse of financial bodies, the reduction in stock markets all over the world, world government tried to apply bailouts to financial institutions but still it had little effect. In certain areas such as housing was badly affected in that it led to foreclosures, evictions and unemployment among many people. In addition, the financial crisis was responsible for the collapse or failure of major business, decrease in consumer wealth and recession in economic activities all over the world resulting to the 2008 financial crisis and leading to European debt problems or crisis. The financial crisis in the US was sparked by the housing bubble that influenced the values of securities in US associated with housing prices to destruction of financial bodies in the world. Further, the 2008 financial crisis was activated by intricate interplay of government laws that motivated home ownership offering them cheap interests on house loans. In October 2008, questions emerged regarding the issue of bank solvency, downturn in availability of credit to citizens and the destroyed investors confidence which had a negative influence on the world stock markets especially in the US and Europe where securities experienced massive losses in 2008. During this time, global trade decreased as availability of credit tightened. The US government reacted to this phenomenon with fiscal stimulus packages for financial institutions, monetary laws expansion, and bailouts (Magdoff and Bellamy 72). The US financial crisis left many shocked because it severely affected their lives. The crisis ended in late 2008 and the beginning of 2009 in the US when the congress enacted the recovery and reinvestment Act of 2009. After viewing the two movies, “Too Big to Fail’ and the “Margin Call” it is clear that the US financial crisis began in the housing industry specifically in the mortgage market known as subprime, which spread to prime mortgage, and other types of debts that mortgage firms in the US faced. The movie “Too Big to Fail” clearly shows the real events that took place in that the US banks and other financial institutions counted losses as high as third of the total financial or bank capital. The films shows that the crisis caused to sharp decrease in bank lending that resulted in severe downturn in the economy of the United States of America. Between August 2008 and October 2008, the subprime borrowers in the US have affected the availability of credit and decreased the repayment of loans. Subprime loans are risky because they are likely to suffer from default than loans offered to prime borrowers. Therefore, if a borrower makes timely repayment of his or her loan, the lender may claim the control of the property. In August 2008, the value of subprime mortgage borrowers stood at over $ 1 trillion with the total of over $ 7 million outstanding mortgage balance. This eventually led to the increase in lending of loans to subprime borrowers with the perception that the prices of houses will continue to increase with time. Further, this act was aided by the increase of non-bank autonomous mortgages, which regardless of their smaller share in the market contributed a lot to the housing industry. By August 2008, all the house loans in the US were either foreclosure or delinquent. The subprime mortgage stretched to government sponsored institutions such as Fannie Mae demanding bailout from the federal government as portrayed in the “Margin Call.” By September 2008, housing prices in the US decreased by over 19%. This decrease in the housing prices implied that many borrowers had negative equity in their respective homes; therefore, their houses were valueless as compared to their mortgages. Borrowers had an incentive to default on their house loans because mortgages or house loans are nonrecourse debts safeguarded against the property. In response, the federal government directed the treasury department to give $25 billion in their loans and purchased shares of Fannie and Freddie on the stock market. The subprime mortgage was activated by the influx of funds from private sector, the predatory lending behaviors of the mortgage providers and the banks entering into the mortgage markets. By October 2008, the Congress in the US passed the bailout bill in an attempt to rescue the financial institutions from collapse. Panic was high in that many people had lost their jobs in the previous month. Further, the Federal Reserve tried to increase the banking liquidity by accepting to lend $ 540 billion to money markets and lowering the Federal Reserve funds rate to 1%. Unfortunately, these methods did not succeed in rescuing the economy as LIBOR lending rates increased to 3.4% while companies such as Dow Jones reacted by plummeting 13% in the entire moth. At the end of October 2008, BEA announced that the US was in recession. The two movies shows real events that happened and these events triggered financial crisis thus affecting lives of many people. Legislation to address the financial crisis As a reaction to the financial crisis that hit the world, the US started working on a legislation that would solve the crisis and make financial institutions recover from losses they got from the crisis. The United States of America proposed the “Dodd-Frank Wall Street Reform and Consumer protection Act” that was later signed into law in 2010 by president Obama. The legislation was passed as a reaction to the 2008 financial crisis as it tried to bring some important transformations to the financial regulation and management. This legislation was justified as it came with transformations in the financial regulatory sectors that influence all federal financial regulatory bodies and all financial institutions in the US. Further, the federal government used monetary and fiscal policies to address the financial crisis. The “Dodd-Frank Wall Street Reform and Consumer protection Act” sought to prevent possible of outbreak of such financial crisis in the future. The legislation establishes an oversight for the financial institutions and money traders, inserts new consumer guard or protection from exploitation concerning lending prices and credit cards behaviors, and coerces some previously concealed financial transactions into regulation. The legislation established financial oversight team or council that had the role of watching the behaviors and trends of financial markets. Further, the council was mandated to undertake oversight of the major financial institutions whose failure in the market might affect the country’s economy. The council had to ensure that discipline prevailed in the financial market by eliminating perceptions from traders that the government would protect them from making losses in case their business collapsed. The legislation ensured that companies that had troubles in managing their finances would be coerced to sell their assets. The law gave the federal deposit insurance corporation authority to investigate and break up financial institutions whose collapse would activate wider financial crisis. The money used on such resolution activities is offset by money paid as fees by major financial institutions in the US rather than taxpayers. The legislation ensured that consumers are protected from oppressive lending and credit card practices (Magdoff and Bellamy 89-92). Liquidation in industrial engineering The FDIC is the liquidator of those banks or financial institutions that do not belong to the SIPC. Liquidation has had an impact in the sense that it determined decisions and actions that were necessary in ensuring that there was financial stability in the US while affecting financial firms that had the tendency o preserving their funds. Further, it made shareholders of banks and other financial bodies do not get their payment until all the claims, and funds are settled. This in turn meant that the legislation increased the extent to which financial agencies may be liquidated by the government. There was need to have additional or alternative source of funding autonomous of FDIC Deposit Insurance Fund to be applied in situations where there is non-bank financial firm’s liquidation. Monetary policy in industrial engineering Monetary policy means the changes effected in money supply and interest rates in order to contract or expand aggregate demand. During the financial crisis, the federal government reduces the interest rates and increase money supply in return. However, for monetary policy to be effective the confidence that both the consumers and businesses have in it play a pivotal role. Reduced interests rate may be inconsequential response to recession if the consumers and businesses do not take advantage of the reduced interest rates and increased money supply. This would in return greatly affect the recovery of and flow of money by the federal government. Fiscal policy Fiscal policy means the changes made about taxes and expenditure of the federal government with the main purpose of contracting or expanding aggregate demand level. In reference to the financial crisis of 2008, fiscal policy was applied when government lowered people’s taxes and in turn increased its spending. Fiscal policy affected large financial institutions in that they were forced to pay more taxes while spending less in an attempt to avoid break up However, fiscal policy largely depended on savings. If the people save more while the businesses import more than fiscal policy counters recession contrary to the reverse. The reverse, which in this case is less saving and importing activity, ultimately scuttles recovery measures. The federal government tried to increase its spending while lowering taxes, this means that the progressive income tax is reduced and this in turn increases aggregate demand during recession thus enabling recovery. Aggregate demand decreases in overheated expansion. As a result, the tax and spending changes result to recession deficit and huge surplus overheated expansions. However, the extent of success in the implementation of this economic strategy is greatly inclined to the amount spent by the government after reducing taxes. The more it spends to activate supply of money to the consumer, the faster the recovery of the expenditure in industrial engineering because more money is pumped in the area for research and purchase of raw material. What ethical implications were involved in this financial crisis? The banning question among citizens is that what caused the financial crisis in 2008, and how would we think of the economic and social costs of the financial crisis. The crisis was triggered by some breaches in ethical reasoning by bankers and money traders. The cause of the crisis can be attributed to ethical breaches in the sense that there was poor control of risks, leverage was too high, and traders willfully gave in to bubble like states in housing markets. Many financial institutions misled borrowers in that they were satisfied with the unethical behaviors to get loans. Some borrowers did not represent their incomes and assets in a rational way while others gave false information about their intention to buy houses. Within an ethical platform, such behaviors would not have led to rewards as the banks and financial institutions needed to verify the data they got from borrowers, and denied to grant loans to those applicants who did not qualify. Unfortunately, financial institutions did the opposite thus leading to the financial crisis. The most pertinent ethical issue in the financial crisis of 2008 was evident in the actions and behaviors of the financial institutions and banks that gave easy loans to borrowers without verification if they were worth or not. They interpreted wrongly the terms and conditions of the mortgage loans to the borrowers and in some situations applied appraisals that were inappropriate. They ignored to follow correct and required procedure in registering loans, and when it was discovered that there was no documentation during foreclosures, some financial institutions fabricated documents. In many situations, the ethical abuses can be attributed to the poor or lack of training of low-level employees who were directed and assured that they were working in a correct manner. Such failures are associated to lack of code of ethics and poor ethical orientation by these financial firms. The problem is that such ethical issues have been ignored and that the practice still exists. It is apparent that ethical failures in the actions of some financial firms and consumers before the financial crisis struck. It is significant to note that banks and other financial bodies had they acted in moral or ethical manner; they could have avoided the unethical behaviors. It is because of lack of ethical guidance that led to the financial crisis in 2008. For a long time, the government has been behaving unethically in the sense that it promoted and encouraged home ownership among the citizens who could not afford to service their loans. Further, the government was adamant in holding accountable those people who engaged in unscrupulous activity that led to the financial crisis. The government held that it could not fine financial institutions because the financial sector was too delicate. This decision was unethical and it encouraged financial firms to continue with the behaviors. Works Cited Magdoff, Fred and Bellamy, John. The Great Financial Crisis: Causes and Consequences. New York: Monthly Review Press, 2009. Print. Margin Call. Dir. Chandor, J.C. Perf. Bettany, Paul and Spacey, Kevin. Warner Bros, 2011. DVD. Too Big to Fail. Perf. Giamatti, Paul and Asner, Ed. Sony Pictures, 2011. DVD. Read More