Global Economic Crisis

Global Economic Crisis

Introduction

The global financial crisis of 2008 is considered the greatest financial crisis after the great depression. It all began in the United States and resulted in countries all over the world being affected. Large financial institutions witnessed a major collapse and had to be bailed out by governments. The housing sector also witnessed a major setback especially in the US and EU. With a downward spiral of prices, companies that had hedged at future prices had to face immense losses which resulted in the shutdown of several companies.

The financial crisis was a combination of several issues resulting in losses worth billions. This could be averted by proper measures were taken in the initial stages. However, financial institutions passing on the risks to other institutions, the prices rose sharply and the situation became such that even a slight lowering of prices would result in major losses. This is exactly what happened which resulted in the financial crisis (Shiller, 2008).

Discussion

There were several factors that led to the global financial crisis. The most notable of the crisis are as follows:

Subprime Lending

During a period when competition was tough among the lenders of mortgage, the supply of creditworthy borrowers was low as and competitors were aiming at larger market share. In order to benefit, riskier mortgages were originated to borrowers who were less creditworthy. Until 2003, the situation was under control with strict measures in place. The market economy was also supportive. However, since 2004, the power of the market shifted to the originator resulting in the undermining of the Government Sponsored Enterprises and the proliferation of risky loans (Claessens, 2010).

A reduction in the mortgage rates resulted in the increase in mortgages. The year 2005 was considered the peak of the housing bubble during which the amount of subprime mortgages doubled. The low cost housing schemes were instrumental in helping the number of risky loans to increase. These loans were subsequently purchased by government sponsored agencies. In 2007, the situation changed because the housing loan rates declines to less than the subprime rates. With interest's rates already low, there was no possibility of a change in the monetary policy that would save the downfall. The result was that people could not pay their losses and it was up to the financial institutions to cover up the loses resulting in a national downfall (Crotty, 2009).

Housing Bubble

During the decade before the economic crisis, housing rates increased significantly. The median house prices ranged from 3 to 4 times the household income. This resulted in home owners refinancing their houses with a second mortgage. Although the pool of investment increased, there was no significant increase in revenue generating investments (Crotty, 2009).

The collateralized debt obligation gave financial institutions an opportunity to get funds in order to finance subprime lending. The result was that the housing bubble further increased. With everything moving smoothly, the housing rates suddenly decreased thus making it difficult for financial institutions to manage their obligations. Secondly, the mortgage securities had been supplied abroad through ...