How Has the Financial Crisis 2007 Affected the Economy - Coursework Example

The 2007-2008 financial crisis The 2007-2008 financial crisis is cited by economists and financial analysts as one of the greatestfinancial crisis after the 1930’s Great Depression. The financial crisis is a subject of contentious debate because it led to an economic crisis that severed the lives of households. Banking institutions exist as intermediaries in the economy while the major parties are the supply side and the demand sides. Economists had not speculated whether a financial crisis could permeate into the normal lives of people such the aggregate economy could almost collapse. The crisis threatened the collapse of the big banks and tumbled the stock markets. More essentially, it significantly affected the housing market thereby leading to non-payments, evictions and unemployment. Real estate collapses and bank collapse Mortgage lending is cited as the principal cause to the 2007-2008 financial crisis. Most of the factors that led to the crisis revolved around housing. It is essential to note that outright ownership of houses had always been an expensive affair, in the developed countries, thereby giving private house developers a momentous economic opportunity. The thesis of the financial crisis, as related to the housing market, regards a housing bubble, which ignited a rise in the values of securities tied to US based mortgages. In this sense, the global financial institutions, which are significantly connected, almost collapsed. This was a complex and intricate mix of policies that accelerated home ownership. In turn, there was an easier access to loans, overvaluation of mortgages, irresponsible trading practices, and relatively limited capital holdings of financial institutions given the commitments they were making1. Although housing prices were higher before 2007, a thereafter decline prompted individuals to buy houses. The existence of easy credit from financial institutions coupled with an attitude that housing prices would escalate, in the future, encouraged high-risk borrowers to attain adjustable rates for their mortgages. The mortgages lenders seduced borrowers with temporary low rates, which readjusted to normal market prices. The higher market prices necessitated higher payments, which most borrowers had not foreseen. In this sense, most borrowers were not able to repay their loans thereby affecting the financial institutions’ capital holdings and earnings. Some borrowers tried refinancing their mortgages, but the housing prices had significantly fallen2. The debtors who could not meet the relatively stringent debt obligations began defaulting their monthly payments. In 2007, most lenders carried foreclosure proceedings at the risk of lower housing values. In turn, the financial institutions, which were mainly banks, could not acquire back the lent money and expected profits. Competitive pressures and given government regulations influenced triggered sub-prime lending. Sub-prime lending refers to the concept of high-risk lending whereby borrowers possess questionable credit history thereby projecting a higher risk of loan default. Such policies enabled the key investment banks to increase their issuance of mortgage-backed securities and prop their financial leverage. The existence of predatory lending, however, aggravated the financial crisis. Economists predict that certain lenders had realized the concealed low value of houses. They, therefore, took advantage of this situation to gain from vulnerable borrowers. In predatory lending, lenders lure borrowers to acquire unsafe secured loans. The lending parties would advertise low interest rates for mortgage refinancing. These loans would occur as detailed contracts, which would later be switched for more expensive contracts3. The unsuspecting customers would pay lower interest rates than the interest actually charged by banks. In the end, the financial institutions would lose their money as individuals paid lower interest rates. In addition, banks engaged in risky behavior that entailed shoddy examination of the creditworthiness of customers. Consequently, the banks lost their money to defaulters. Low interest over the years The existence of low interest rates is cited as one of the fiscal policies that created the financial crisis. Out of an earlier fear of recession, the government has increasingly lowered interest rates. For instance, in 2001, the US government decreased interest rates from 6.5% to 1.75%. Low interest rates are an extension of Keynesian Economics, which propose the involvement of the government in the market. The government can either manipulate taxes or use interest rates to stabilize and enable growth in the economy. In terms of interest rates, the government buys bonds and other forms of securities from the market thereby lowering interest rates. Keynes believed that the demand side is essential to the growth of an economy. In this sense, the government has increasingly lowered interest rates in order spur both capital and consumer expenditure. This is because lowering interest rates is akin to lowering borrowing costs. Increased consumer demand means improved revenues from companies. In the context of the financial crisis, low interest rates meant lower pricing houses. In turn, individuals increasingly purchased houses believing that they were cheaper to acquire. Low interest rates Low interest rates will continue to exist in the markets because of notable reasons. To begin with, governments, since they heavily rely on Keynesian economics, are wary of a possible recession. There is, therefore, an enhanced need to spur capital and consumer expenditure in the economy. Lowering interest rates cheapens the rate of buying capital and borrowing for consumer expenditure. In the end, consumers and producers acquire higher income to purchase given goods. This maintains the growth of companies who rely on the market to purchase their goods. Low interest rates will also be used to spur consumer expenditure by establishing price stability. Interest rates possess an indirect relationship with money supply, but possess a direct relationship with inflation rates. In turn, when interest rates rise, inflation rates rise thereby threatening consumer expenditure. This occurs because higher inflation rates lower the value of income that consumers hold in their pockets. Most governments are currently keen not to increase interest rates lest they destroy the economic livelihoods of individuals who suffer money illusion. This is because most governments have realized the inability of consumers to gauge their level of income given the existing market conditions. In close relation to this concept, low interest rates will continue to occur because of the government’s urge to guard and improve employment rates. When the financial crisis triggered an economic crisis, many individuals lost their jobs as companies tried to downsize on their expenditure. This occurred because companies were selling fewer goods to an impoverished market. Although interest rates possess an indirect relationship with employment rates, low interest rates are essential in increasing capital and consumer expenditure. Higher expenditure suggests increased revenues for companies, which thrive on a high-income market to purchase more of their goods. In addition, it is crucial to highlight that lenders prefer giving way their money at interest rates higher than given inflation rates. In this sense, most lenders, since they fear the possibility of financial crisis, would wish the economy to maintain low inflation rates. The contemporary primary indulgence of current financial institutions regards courting risk rather than acquiring more profits4. Most financial institutions, especially banks, will continue to be wary of excessive profits at the market. This suggests a new theme of sustainability as banks correctly gauge the potential of the market. Governments also maintain low interest rates in order to strengthen banks. Governments have realized the centrality of banks in the economy. The banks facilitate the flow of capital and they have a huge potential at influencing an economic crisis in the country5. Low interest rates will continue to ensure consistent revenues for banks, which primarily rely on borrowings to make profits. This occurs as consumer income becomes difficult to predict. Low interest rates, since they mean lower yields on bonds, will continue to guard predatory traders from taking advantage of borrowers. This is because lenders are highly attracted to higher interest rates that yield high income on trading securities. On the other hand, this will pose the risks of individual borrowing against poor credit histories6. Low interest rates lure consumers to borrow more money from financial institutions because of a relative ease of paying. However, when interest rates rise in the future, there is an increased rate of defaulters who may not be able to repay their loans. It is arguable that the 2007-2008 financial crisis is one of the most complex financial crisis that has occurred since the 1930’s Great Depression. The financial crisis affected the global economy since banks could not lend capital to firms. In turn, firms made less profits and cut down on the size of their employed workers. Increased unemployment meant that firms could sell fewer goods and services. The housing crisis is the principal contributor to the financial crisis. The housing bubble, due to temporary low interest rates, lured sub-prime borrowers who could not pay back the mortgages once the interest rose. In addition, irresponsible mortgage lending by banks, that entailed shoddy examination of customers’ creditworthiness, made financial institutions lose their money. Thereafter, predatory lenders manipulated mortgage holders who were refinancing their loans. Misquoted house values, therefore, made banks lose their money as borrowers paid less that stated prices. Currently, there is a worry of persistent low interest rates as the governments strive to rise out of the recession. The governments will rely on low interest rates to maintain price stability, secure banks, and support the growth of firms. 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