Financial Crisis And The Subprime Mortgage Crisis Essay Sample

Business

The 2008 financial crisis, also known as the global financial crisis, dramatically hit the world. The collapse of Lehman Brothers especially affected the world’s financial system. One by one the most developed countries were setting into recession with their financial markets being in a complete mess. As a result, it turned out to be the worst recession in the last 80 years. Monetary and financial decisive actions taken by governments prevented if from growing into depression compared to the level of the Great Depression. Still, recovery remains slow and GDP is still below its pre-crisis level. Moreover, the global financial crisis added to some regional problems, for example emergence of the euro crisis.
There are plenty various things that directly or indirectly contributed to the development of the crisis. It also had multiple causes. The most obvious one is the financiers who claimed to have found a way to eliminate risk when in reality they became complacent of it. But not only should they be blamed for this, but also central bankers and other bodies that did not forbid such attitude. The second reason is macroeconomic stability with stable growth and low inflation that preceded 2007. Asia contributed to the global interest rate decrease while Europe was especially active borrowing in American money markets. The world seemed become less risky and more prosperous until the trigger was pulled.
The complacent financiers initiated irresponsible mortgage lending to increase at a high pace. “Loans were doled out to “subprime” borrowers with poor credit histories who struggled to repay them”, the Economist writes (“Crash Course”). The big bankers turned these risky mortgages into low-risk securities by putting a few of them together. But pooling could work only if there was no correlation between the assets. These pooled mortgages were used to back CDOs that differed by their exposure to default. High ratings by Moody’s and Standard&Poor’s persuaded investors to buy them. It was a mistake to trust these rating agencies that were so generous in their assessments and possibly paid by the banks interested in CDOs sells. Securitised products met their demand in the market because they offered higher yields while the interest rate was low. There is still no unanimity among the experts and analysts about the reasons of these low rates. Whatever caused this, Asia or the Fed’s policy, the market conditions made banks and hedge funds hunt for riskier assets that promised higher yields. As the rates were stable, investors were ready to take the risk of buying securities with longer maturity and higher yields.
In 2006 America started facing huge house-price slump. Housing market collapse reflected problems in the financial system. Investors received no protection when CDOs that were supposed to be safe turned out to slump in value. Operations of selling pooled mortgages and using them as collateral fell in number. Trust that is so important in financial relations started to disappear. Banks wanted their borrowers to pay. The Lehman bankruptcy was a result of an enormous burden of credit-risk protection represented by credit-default swaps it had sold. And its bankruptcy was the most dramatic mistake made by regulators. It provoked panic and killed trust. Spending was frozen because nobody lent anybody. The real economy stagnated. The existing problems of the housing bubbles and the global current-account imbalances contributed on the background. Central banks could take prompt and decisive actions, but they failed.
We discussed problems that were encountered by the financial market players and regulators, but the most interesting part is to find out how this financial collapse influenced lives of mere Americans. “Now, a reduction in the supply of mortgage credit is putting additional downward pressure on the housing market and threatening to prolong the worst housing slump since the Great Depression,” Kirk Shinkle says. The decline in home prices was about 30% after the housing bubble collapse. The global credit freeze created a situation when big loans to people with perfect credit history are getting more and more expensive though the fixed mortgage rate remains low. The majority of banks confirmed that they tightened their lending standards. Now, even responsible consumers face higher rates and less access to credit. Immediately after 2008, 20% down mortgages may become norm because one can hardly found 5 or 10% mortgages. Some experts said that this tightening could make the situation worse than it otherwise would have been. Shortage of money in the economy means decline in spending, thus decline in production. All these credit freezes could possibly make the mess on the Wall Street less catastrophic, but hardly could back real economy. That is why, now we all are paying for the unwise policy and panic that overwhelmed bankers and regulators’ minds when the crisis struck.
In my opinion, it is easy to judge and to find more and more mistakes now, after more than 5 years passed. The situation in 2008 was going to repeat the worst scenario that the U.S. has already survived in 1929, but we managed to avoid this fate. Perhaps there were too little good advises and policy measures combined together with radical steps, but today the U.S. demonstrates slight stable growth. Anyway, I think that this crisis again demonstrated that money, assets and securities must be backed up by real goods otherwise we are blowing another bubble.

Works Cited

“Crash Course”. The Economist, 13 Sep. 2013.
‹http://www.economist.com/news/schoolsbrief/21584534-effects-financial-crisis-are-still-being-felt-five-years-article›.
Shinkle, K. “America’s Credit Catastrophe.” USNews.com, 3 Oct. 2008.
‹http://money.usnews.com/money/business-economy/articles/2008/10/03/americas-credit-catastrophe?page=2›.