Financial Crisis of 2008
The financial crisis of 2008 was not only an American issue but also a global financial crisis. The 2008 financial crisis is significantly considered by many; mostly economists to have encompassed severe financial constraints similar to those of the Great Depression. Great Depression characterized more fiscal tightening by the government and low provision of liquidity value by the central bank to the public. However, it is true that in addition to the fiscal tightening in liquidity facilities, the later innovations and developments in regulation responses had significant roles to the financial crisis of 2008. The crisis is commonly associated with the collapse of the Lehman brothers and meltdown of subprime mortgage owing to the adverse effects it had in the market of financial-backed securities.
The Bankruptcy of the Lehman Brothers
The bankruptcy of the Lehman investment bank can be stated as the most prominent event to the expansiveness of the crisis worldwide. The Lehman’s was a primary investment bank and its collapse brought about significant impacts to the economy since it owned many debts in the sub-prime mortgage market at the time of its fall (BBC n.p). Lehman’s collapse was a major impact to the global economy because it influenced significant deterioration in the market capitalization of equity markets globally.
The fall of the Lehman’s was associated with varied factors. For instance, the U.S government lacked the authority to add in the investment bank into its conservatorship like the Treasury had previously incorporated the Fannie and Freddie Mac to facilitate their functioning (BBC n.p). Moreover, it is true that the bailout of Bear Steams signaled the expansion of the government safety network from the banking system to investment institutions not only in U.S but also internationally. For that reason, the Treasury and also the Federal Reserve had much concerns on the need to increase morality of hazard incentives on excessive risk taking in a saturated market of financial borrowing. However, the Lehman’s was reluctant to disclose its leveraging systems thus the Treasury and Federal Reserve allowed its failure to serve as an example when addressing the need to regulate risk taking to other financial institutions.
Subprime Mortgage Crisis
The disturbance of the credit markets in the crisis of 2008 started in 2007 when BNP Paribas bank suspended clients from redeeming shares which were in its money market funds due a reduction of the collateral value (BBC n.p). Prior to the downturn, in 2005, the U.S registered a boom in the housing prices and as the housing prices through 2007 into 2008, so did the mortgage-backed financial securities. The variety securities especially of residential subprime mortgage started experiencing huge losses. The period characterized systemic decline of financial institutions where it had higher impact on shadow banking than on the classic bank. This was facilitated by the fact that the shadow banking system uses short-term borrowing, like, repurchase agreements as its short-term liabilities and long-term assets, like in this case, mortgage-backed products as collateral. Subsequently, the value of collaterals (mortgage-backed products) declined whereas uncertainties regarding chances for retrieval of their value increased.
What followed was that the shadow banking was forced to sell off the collaterals to support less loaning at a deleveraging value. Further, the value of the mortgage-backed securities continued to lower with high levels of uncertainties to stability while increasing the collateral requirements for further borrowing and so, the financial institutions responded by deleveraging and selling off more mortgage debts.
THE AGE OF RISK
The history of the crisis begins by the decline of securitized financial products, particularly, subprime mortgage market and consequently, expanding to the entire banking system worldwide. The development of the crisis from the mortgage market to the banking sector is actually noted by the bankruptcy of the Lehman Brothers. The crisis underlines the role of risk management in the baking system, through which, imperative concepts on the primary causes to the spread of this crisis are deduced. Notably, the specific reason that facilitated its pervasiveness globally is associated with the huge risk taking on common financial-backed securities by banks including Lehman’s investment bank.
It is arguable that the macroeconomic factors of the global markets and U.S monetary policy influenced a series of adverse effects on the financial system. The two intermediaries created an environment where financial organizations enjoyed increased profitability and development and in due cause facilitating systemic risks in the banking market. The privileges elevated perceptions on risk management along the financial and banking sector, confidence, and allowed financial innovation. Advancements in information technology were inaugurated to characterize financial innovation where it was used to perform all marketable securities. The innovation enhanced practices within the Subprime mortgage markets while facilitating the linking of banking to markets. In return, the innovations on security management increased risks in the financial landscape and finally the threats imposed higher unpredictable evasions, which were relative to the failures in investments thus developing an enormous financial crisis.
The most significant underlying concept of the crisis defines the enormous failure of social risk management, triggered by a long-period of profitable growth within the banking sector thus creating an unreasoned sense of financial security. The idea that banks were able to endure the busting of technological innovations further validated the false belief that they had the potential to regulate threats while maintaining continued profitability. Subsequent to the belief, policies were enacted by politicians allowing further ownership of universal homes and so, encouraging banks to allow excessive borrowing by leveraged consumers. This was the cause to reduced capital in the banking system since the banks were giving out extended loans to huge groups of leveraged consumers, underestimating the real long-term risks whereas motivating investors to apply for idealistically low risk premium.
Back from the Brink
The beginning of this crisis was the investor’s withdrawals and escalation of risk premiums and collateral requirements counter to secure loaning. These developments were indicators of expanded liquidity crisis which triggered the initial regulatory and also, government initiatives to stabilize impacts of the crisis. The movements employed expanded bailouts of liquidity facilities for different institutions and other unsecured investor agencies. The bailouts of the institutions influenced declines in various markets including the stock market. Importantly, the rescue response reduced credit amounts whereas expanding borrowing requirements since financial institutions, particularly; the banks sliced back their short-term and also long-term credit facilities to both individual customers and investment groups. As a result, there were slow and less developments in the real sector, facilitated by reduced consumer loaning and low investment credits; linked to the downturn in revisions of the credit value of subprime mortgages and other debt-backed collaterals.
LEARNING CONCEPTS ABOUT THE CRISIS
Responding to the risk events that influenced systemic decline in the banking system and investment market, it is arguable that there were less complex alternative regulatory initiatives that may have minimized the impact of the crisis on the financial system. For instance, there was need to raise the capital requirements in both the financial and private banking systems during the prior years of increased profitability. Moreover, there was need to enact appropriate regulatory mechanisms, preferably, absolute prohibitions or price-based inducements, which would have enabled creating and inspecting mortgages only for creditworthy borrowers in regards to equity sufficiency.
Easily persuaded, the 2008 commercial crisis exemplifies the times of the Great Depression and lengthily, revealing newer growths within the financial system. The two crises, that is, the Great Depression and the 2008 crisis reveals that financial crises follows a recurrent pattern with two variables; high balance sheet leveraging of financial intermediaries and thriving capital price. However, the 2008 crisis notes inaugurates the preference of common causes including financial innovation that depends on continuous improvement of economic conditions for its returns, and unreasoned generosity and limited regulation of financial systems.
Bankruptcy and risk concerns between real banking system and the shadow system appear to be the primary causes of this crisis since the closeness of counterparty inclines to have influenced a series of risk defaults along the financial system. High leverage in the financial system facilitates occurrence of systemic risk and more influential when it engages a simultaneous trend of both consumers and financial institutions on the balance sheets. Limited regulation of depository agencies weakens regulatory measures in the shadow banking system especially in a highly complex controlling structure thus enhancing risk expansiveness. In addition, it is true that state and also federal regulators had significant roles to influencing the spreading of the crisis by implementing similar regulations through varied methods thus the uncertainty of the regulations to facilitating compliance. Also, compensation processes together with the factors of corporate culture within the financial sector may have fueled the impact of the crisis.
Work Cited
BBC, News (2009). Timeline: Credit crunch to downturn. BBC.
