Economic Crisis of 2008-2009

Economic Crisis of 2008-2009

Introduction

The reason the central bank buys own currency or currency of other nations is to control the exchange rate. This is done when there is an excess circulation of money in the market. This excess circulation of money in the market reduces the value of the currency. The exchange rate of the country also affects by this. The central bank thus buys back its own currency in order to reduce the amount of money in circulation, in order to increase the value of the currency. Furthermore, the process of buying currency of another country carried out in order to back your own currency that is in circulation, and it also reduces the value of the currency of that country, and in turn adjusts the value of the domestic currency, in relation to the currency bought by the central bank. Recent recession created a disastrous change in global economies. Nearly all sector of the economy were affected by the economic crises. This paper examines the factors that lead to the economic crisis of 2008-2009, and the policies implemented by the key actors responsible for rescuing the U.S. economy.

Roots of the Crisis

There were many factors that resulted in escalating the crisis situation which emerged in 2007-08. These factors vary in their dimensions; however, having significant impact in worsening the crisis situation. This includes low real interest rates, high credit outflow, apparent excess liquidity, sub-prime mortgages, and unreliable assessment of future risks associated with lending in consumer markets (Krugman 2009, 30). Hype in the market made the banks to focus on short-term earnings and an abrupt high-scale change was observed in lending without properly assessing the risk on liquidity position (Stiglitz 2010).

Risk-taking culture is observed in US banks as considerable incline in sub-prime mortgages were observed. Unexpected turn in economy resulted in credit crunch situation, as majority of people withdrew their deposit money banks characterized as “bank run” condition. Simultaneously, banking panic situation occur due to lack of trust by people in the banks ability to handle liquidity crunch. It signifies the impact of banking strategies developed in early years, without assessing the critical risks associated with consumer banking (Cable 2009). A major turnout was observed in consumer financing, especially real-estate and automobile. Banks placed more concern on their expected revenues instead of balancing the risks of lending; large sums loans that were provided to people having weak credit history mainly for commercial property deals (Rasmus 2010). As a result, increase in the financial fragility occurred.

Causes of the Crisis Ignition

The crisis ignited the economic recession in mainly four ways. Banks emphasized on increasing the financial product portfolio with high leverage that was sustainable only if conditions of increasing asset prices and investor confidence were met. Banks indulge heavily in sub-prime mortgages for real-estate industry. This resulted in uncontrolled creation of liquidity that was based on collateralized lending such as securities lending, margin lending etc, irrespective of analyzing the counterpart risk. Third cause that underpin the economic recession ...