The 2008 Financial Crisis - Essay Example

The 2008 Financial Crisis Prof The financial crisis of 2008 was one of the worst in recorded history. It began in the American economy because of cheap credit and subprime mortgage loans. When the housing bubble burst contagion spread throughout the financial system leading to high unemployment and sluggish growth. We need to examine the causes of the crisis to determine the best solutions. This paper will analyze the causes and consequences of 2008 financial crisis. It will explain the US subprime mortgage crises and the following costs on the economic growth instabilities. The report will explain the economic downturn and how it has affected the unemployment and led to uncertainty in different countries. It will also show the examples of how some countries economies been damaged and overcoming the problem. The truth is that the global credit crisis of 2008 was the worst that the world had observed since the Great Depression nearly 80 years earlier. Unemployment went sky high and growth receded from sight. It appeared for a time like the entire financial system as we knew it was on the point of falling apart. For many years to come economist will discuss how America ended up in such a position and what the root causes of the crisis really were. At this point there is a consensus on a number of points, including the subprime mortgage situation. This and a number of other points will be discussed in this paper. What is a financial crisis? This is an important question to ask at the outset of this paper. Financial crisis can be broadly applied to a variety of situations in which some financial institutions or industries suddenly lose large part of their value. The International Monetary Fund (IMF) states that a global recession would take a slowdown in global growth to three percent or less. By this measure, four periods since 1985 qualify: 1990-1993, 1998, 2001-2002 and 2008-2009. For example many situations were associated with banking panics, stock market crashes and financial bubbles. The result is that country loses its paper wealth unless there is a recession. These crisis are often unexpected and result in a great deal of wealth being wiped out. People suffer and it can take years for the economy to regain its balance. In the most recent example the subprime mortgage crisis was one of the first indicators of 2007 financial crisis. High default rates on subprime adjustable rate mortgages began to increase very rapidly. The long term trend of rising housing prices and better loans encourage borrowers to believe they would be able repay their mortgages quicker. “The first clear sign that the US housing bubble was bursting, the mid-2007 crisis in the sub-prime mortgage market (stemming from the significant increase in defaults), transmitted losses to a whole set of securitized financial products such as mortgage-backed securities” ( Lin, J. Y., 2008). The truth is that the American dream of home ownership had gone into overdrive. People who were unable to afford to pay mortgage payments were given mortgages. People with bad credit or unstable employment were given mortgages. With so many buyers in the marketplace, the value of homes was dramatically inflated. What happened next was very bad. Many of these bad mortgages were bundled up together and sold by financial institution as a kind of security to other buyers. Investors bought these products because they had a great rate of return because of the inflated value of the housing market. The result was that many investors and investment banks had balance sheets that were weight down with these mortgage-backed securities. They were highly leveraged. Once the first dominoes of defaults came, the investment banks scrambled to unload these bad debts. The only problem was that the banks themselves had trouble unbundling good debt from bad debt. There was a crisis of confidence in the markets. Contagion began to spread throughout the system. Many banks began to fail. The consequences of this situation and the collapse of numerous banks is still unfolding to this day. One of the worst effects of the crisis was the massive unemployment that was a result of all of these financial problems. Many people were laid off of work. New jobs were not create to replace the old ones, and as the crisis continued people stayed out of work longer. They used up their savings and began to look unemployable. They had big gaps in their resumes. Because recessions generally occur when there is a fall in consumer spending many firms decide to dismiss their employees and save money rather than invest. This has also led to many uncertainties among the working population. “The subsequent destruction of jobs and increased duration of joblessness will ensure that unemployment across the world will continue to rise and stay stubbornly high for some time to come, well after the economy has begun to recover” (Sher, V., 2009). The main problem of the current crisis is that unemployment in many countries has reached its peak. The German government has decided to invest a lot into infrastructure, thus they have occupied their workforce and invested into future prospective of the economy. However the UK economy has suffered a lot due to the fact that financial sector hold a big chunk of an economy. As a result many industries have been damaged. For example the UK steel industry has to shut down their factories in different parts of the country. These are problems that will continue for many years. In the United States unemployment is close to a record high. The stimulus spending has not done much to improve this situation. What can we learn from the serious problems engendered by the financial crisis? The truth is that there may be a few positive effects. A positive thing that the United State has done so far is to make a big deal about the crisis. They know that it is a serious business and must be addressed seriously. They have understood its consequences and what it means, which is more than can be said of the Japanese two decades ago who underwent a similar housing bubble and massive recession (Powell). President Obama takes it seriously and continues to warn the country that this is a real crisis in the history of the United States. The truth is that something like this was required to happen in order for there to be a correction to the system. So much had changed in the financial sector over the last 20 years, what with new technology and more sophisticated products. Reforms had not kept up. Now with the consequence of the crisis in front of our faces, we know just what must be done to fix the situation. Financial reform legislation is being pushed through many countries at the moment in an effort to improve the situation and ensure that such a situation does not occur again. One of the things that has been done, for example, is ensuring that banks do not have so much more debt on their books compared to the capital they are holding. This ratio must be lower, policymakers have decided. They want to ensure that their countries never find themselves in this situation again. This report has highlighted the main points of the financial crises and its causes. It has analyzed the major problems which have followed after the subprime mortgage crisis. The problem is bad, but governments are working on solutions to help alleviate the worst of the suffering. The most important thing we can do is study the crisis in order to ensure that it never happens again. References: Lin, J. Y. (2008). The Impact of the Financial Crisis on Developing Countries. Paper presented at the Korea Development Institute, 31 October. Seoul. Retrieved from http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.158.4591&rep=rep1&type=pdf Verick, S. (2009, August). Who is Hit Hardest During a Financial Crisis? The Vulnerability of Young Men and Women to Unemployment in an Economic Downturn. IZA Discussion Paper No. 4359. Retrieved from SSRN: http://ssrn.com/abstract=1455521 Krugman, P. (2007). “Innovating our Way to Financial Crisis.” The New York Times, 3 December. Retrieved from www.nytimes.com/2007/12/03/opinion/03krugman.html. David, M. Kotz (2009). The Financial and Economic Crisis of 2008: A Systemic Crisis of Neoliberal Capitalism. Review of Radical Political Economics, (305-317). Retrieved from http://rrp.sagepub.com/content/41/3/305.full.pdf+html. Powell, Benjamin, (November 19, 2002). “Explaining Japan’s Recession.” Mises Institute. http://mises.org/story/1099 IMF (2008). World Economic Outlook: Housing and the Business Cycle. Washington, DC: IMF Read More