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"Appraise the proposition that the bank failures and crisis of 2007-8 could have been foreseen from academic work published prior to 2004"
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In the United States, the Federal Government was left with no option but to initiate a bailout program to secure the financial markets and control the crisis before it spread to other parts of the world. Over a period of time the crisis became a global financial crisis and many banking institutions around the world felt the shock.
As the financial system faced rapid deterioration, many causing factors came to surface. There are many factors which have been pointed out as those which contributed to the banking crisis. This paper aims to analyze the literature which was developed prior to 2004 which contained information which could have been used to avoid the current bank failures and crisis which have reshaped the economy of the world. This paper will look at some of the root causes of the banking crisis and the ways in which it could have been avoided, while looking at the literature which was available prior to 2004 which could have been used to predict the crisis.
A report by the Inter American Development Bank (2004) states that in order to avoid costly banking crisis it is essential to understand what causes them in the first place. One of the prime reasons for the banking crisis was the deregulation. In the past there have been incidents where deregulation of a particular industry showed similar trends. One such example is the airline industry which did well initially following the deregulation but eventually some of the airline service providers were forced to face bankruptcy. This is one example which could have been used to determine what the outcome of unmonitored banking and mortgage lending practices could have resulted in. Secondly banks did not consider the integrity of the borrowers when lending them huge amounts of money. Even individuals who were not fit to obtain loans were approved large sums of money.
A) The US boom
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The financial crisis of the period 2007 and 2008 has been an outcome of credit crunch and liquidity crisis mainly in the United States. This crisis has been generated in the United States at the beginning and then it spread through the entire world with the decline of the world’s largest financial system (Hirsch, 2011, p.5).
1. What happened in the 2007 financial crisis? Through asymmetric information hence adverse selection, the 2007 financial crisis was caused by the action and inaction by the government (Lounsbury 2010), which created a platform over which both banks, and bank-like institution taking excessive risks specifically in the mortgage backed security market (BBC News 2009).
The mortgage loans were backed by exotic securities on which unsuspecting investors had invested their money. The investors included investment banks who had only invested public money held by them on fiduciary capacity. Fiduciary relationship should be highly regulated.
Even as the economic crisis became the most serious to face the capitalist countries, since 1929, it had far reaching consequences in the social lives of many people who lost employment while many others who were qualified failed to get job opportunities.
When considering the possible causes for this economic situation, fundamental defect of the free market system is the prominent reason for the crisis. In the US economy, a secure and sustainable economic order is not ensured by the economic regulatory. As a result, banks and financial institutions in the developed countries are not restricted from spending more than what they can afford.
The disruptions confirmed "the potential for rapid and destabilizing spillovers among markets and countries and raised the prospect of a more challenging environment to come". He observed that the possibility of negative consequences of further adjustments originating from the U.S.
However, in August 2010 a judge in the federal courts ruled that the scheme as contrary to the views that are held by the united states constitution and thereby blocking its implementation. Before the scheme was declared
The 2007-2009 Global financial crisis threatened the collapse of some of the greatest financial institutions. The reason the effect was felt by many financial institutions is that they had invested mortgages which lead to deterioration in the balance sheet of the banks as a result of housing bubbles.
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