Causes, Trend, and Effects of the 2008-2009 Economic Crisis - Essay Example

The Causes, Trend, and Effects of the 2008-2009 Economic Crisis Introduction Economic crises are a common phenomenon that affects economies from time to time. In the recent past, the global economy has experienced economic crisis, which is believed to the worst after the 1930 Great Depression. The crisis was considered severe due to the macroeconomic problem that resulted. Implementation of financial crisis to curb the situation yielded no results. The crisis threatened even the largest corporation while several of small corporations became bankrupt. The crisis led to bailout of banks and other institutions by the government due to fear of collapse of entire economy. This paper focuses causes of the recent economic crisis, the trend, and its effects on the US economy and the world economy. The paper will also discuss the US government supported this problem. How the Economic Crisis Occurred By the end of 2006, the housing market was not performing well. The house prices declined considerably and households started increasing their savings. However, the financial institutions started reinforcing their lending standards. Nonetheless, US was experiencing considerable growth in exports, which offset the growing crisis to some extent. In the start of 2007, there were great losses from sub-prime mortgages, which demonstrated some failure in financial market. This marked the start of the financial crisis. Soon after, the crisis spread to banks where the interest rates soared (Riksrevisionen Web). Additionally, the equity prices tumbled and most financial institutions could not provide ordinary financial services. The private sector decreased their debts. Banks started experiencing severe financial problems to an extent that central banks started to provide liquidity to the almost collapsing banks. By the end of 2007, the problem worsened and central banks developed some short term measures to reduce the financial pressure on the economic markets. By 2008, the problem was getting out of hard and different countries started adopting serious measure. The UK nationalized Northern Rock while the US the Bear Stearns was facing crisis. The automobile, industrial, and the labor market sectors were collapsing. The level of unemployment was at its highest since 1980. The entire global economy was on a downward track (Riksrevisionen Web; Global Research Web). By mid-2008, the commodity prices increased rapidly. The financial institutions were still facing serious difficulties to increased interest rates by the central banks. The value of mortgage related assets, which had expanded rapidly in the previous year, began to decline at an alarming rate. This was a great threat to banks and mortgage institutions that were at the verge of collapsing. By August 2008, several financial institutions had collapsed. The move by federal government to enact policies was unsuccessful (Thomas and Hennessey Web). Examples of companies that collapsed in United States include Lehman Brothers, Fannie Mae, Freddie Mac, AIG, Washington Mutual, Hypo Real Estates and numerous banks. The government came up with rescue measures to prevent the collapse of the entire financial system, not just in United States but also in the entire globe. The public was losing confidence on the financial market. Central banks were force to cut down the interest rates to rescue the collapsing banks (OToole 188-192). By 2009, equity market began to recover and the situation started improving in the rest of the economic sectors. This was due to guaranteed lending to banks by governments across the globe. The banks started improving and the confidence in financial market started developing. Although the entire globe felt the effect of the crisis, United States was severely affected. The EU was not severely affected at the initial stages. However, the EU felt the effect at the end of 2009 when the equity markets in the region and banks were operating under uncertain situations. Causes and Effects of the Economic Crisis The financial crisis originated from the breakdown in global financial markets. The macroeconomic policies of the previous years aggravated the crisis. Several countries were operating under poorly regulated financial systems. The causes can thus be grouped into macroeconomic causes and the financial market causes (OToole 144-148; (Thomas and Hennessey, Web; Elliott Web). One of the macroeconomic causes was the low inflation and low interest rates. Most economies were experiencing low but stable inflation. The low inflation was attributed to opening of socialist countries to global trade and rapid technological growth leading to low cost labor this resulted in imbalances in world trade. Additionally, local trade unions were incapable of bargaining for better wages due to high labor supply. The effect was wage decline, which resulted in domestic inflation in different countries. Many countries changed their economic policies in the last decade to curb the inflation, which resulted in reduced interest rates. People borrowed to purchase houses whose prices began to escalate. This eventually led to increased debts and decline in household income. This underestimated risk triggered the crisis (OToole 170-175). High-risk taking was another macroeconomic cause of crisis. Bank deposits did not match the increased debt by households and banks had to borrow money from higher financial institutions. The buildup in debts led to build up in liquidity risk, which led to panic amongst investors. The investors engaged in very risky bonds since the treasury bonds were giving less returns. Additionally, most investors were borrowing to invest in very risky assets. The severely underestimated risk by financial institutions, investors, and other monetary authorities amplified the crisis. At some point, most financial institutions realized they could not refinance their operations due to the high underlying debts. The banks became reluctant to finance these institutions resulting in severe financial stress (Kolb280-283). The other macroeconomic cause was growing imbalances. Several countries were operating under account deficits for many years. However, oil countries that import oil were operating under growing account surplus and had invested in developed countries such as US. This imbalance resulted in low yields from government bonds as well as reduced revenues on fixed income financial assets. This led to added financial risks (OToole 201-204). Failure by governments such as the US Federal to address the establishing financial cycle resulted in further increase in credit and asset prices. Some government’s financial systems decreased the interest rates further. The governments and financial supervisors failed to intervene resulting in the deterioration of the situation. The financial systems were more vulnerable to shocks since they were over dependent on liquidity in securitization. The financial market participants are thus exposed to extreme risks, which they cannot measure (Kolb 282-285). When the crisis became eminent, there was an increase in economic uncertainty. This forced corporation to be cautious in their savings. Others had to suspend their planned investments. This led to declined aggregate demand intensifying the crisis further. Additionally, the participants in financial market tend to be interconnected making it harder to assess the risk. Other causes include prosaically credit conditions, decreased government control on the credit systems, lack of understanding on the risk facing the financial system, there was no harmony in international credit markets and failure of some banks lend to domino effect (Kolb 290-293). How The US Government supported the problem It is the role of governments to ensure economic stability by regulating the financial markets as well as institutions. The governments are also supposed to supervise financial institutions to ensure they are responsible in their financial operations. During the recent financial crisis, most financial institutions lacked appropriate supervisory structures and exposing public finances to excessive risks. The US government enacted policies that aimed at rescuing the failing banks and financial institutions. This was aimed at restoring the investors’ confidence on the financial system. Other measure included creation of financial system regulators and creation of Consumer Financial Protection Agencies. Additionally, the US government improved on the harmonization of international financial system. The US government has also established Federal Reserve for risk regulation purposes (Kolb 317-321). Conclusion The recent economic crises were the worst after the great depression. The main cause of the crisis was the poor financial regulatory and supervisory systems. This result in some institutions taking excessive risks and the remuneration policies by the government worsened the risk. Failure by governments such as the US Federal to address the establishing financial cycle resulted in further increase in credit and asset prices. The global crisis resulted in collapse of several banks and other financial institutions. The US federal government has established regulatory and supervisory systems to prevent such happening in future. Additionally, the government has set aside Federal Reserve for risk regulation. Works Cited Elliott, Larry. "Global financial crisis: five key stages 2007-2011." theguardian 7 August 2011. (Online) Global Research. The Global Economic Crisis: Causes and Devastating Consequences. 16 July 2012. Web . 8 Oct 2012. Kolb, Robert. Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future. New York: John Wiley & Sons, 2010. Print. OToole, Randal. http://www.globalresearch.ca/the-global-economic-crisis-causes-and-devastating-consequences/. New York: Cato Institute, 2012. Print. Riksrevisionen. The Causes of the Global Financial Crisis and Their Implications for Supreme Audit Institutions. 2012. Web. 8 Oct 2012. Thomas, Bill and Keith Hennessey. "What Caused the Financial Crisis?" Wall Street Journal (2011): Online. . Read More