2008 financial crisis

Last Updated on 02/10/2023 by Sophia

The 2008 financial crisis is one of the worst financial crisis in the world since the great
depression that had occurred in the year 1929. It occurred despite the efforts that were put in
place by Federal Reserve and Treasury Department to prevent it occurring. This crisis was
experienced when the most influential and richest US investment bank, went broke. This
financial crisis led to the collapse of banking systems in the world. It resulted to Great
Recession, this was the time when the housing prices fell by 31.8 percent, more than the price
distress when Depression had occurred. Two years after recession ended the unemployment rate
was still higher reaching at 9 percent. This deterred workers who had already given up looking
for an employment opportunity.
What happened?

It was on 15 th September 2008 when Lehman Brothers filed for bankruptcy. This is
usually considered to be the day the financial crisis begun in earnest. The US government
refused to bail out Lehman Brothers which was found difficult to roll over its borrowings in the
markets. It was as a result that the wall street bank went broke.
That failure of an organized financial institution with some $700bn of liabilities created a
huge impact to the whole global financial system. The global money markets froze, banks and
insurance companies in most of the developed countries, also quickly found they could not
borrow money.

Ben Bernanke the chair of the Federal Reserve, afterwards called it “ the worst financial
crisis in the history of the world”.
This financial crisis compelled the central banks to lend to banks on a large scale with an
intention to prevent financial sector bankruptcies of institutions even in a greater extent than
Lehman Brothers that could become disastrous.

Causes

The first sign that the economy was in deep trouble was experienced in the year 2006.
The housing prices had started to fall. In addition, the real estate agent expressed their approval.
They thought the overheated housing market would return to level that can be sustained.The first
signs of the financial crisis appeared in 2007. Banks panicked when they realized they would
have to absorb the losses. They stopped lending to each other. They wanted to prevent other
banks from giving them worthless mortgages as collateral. Nobody wanted to get stuck holding
the bag. As a result, interbank borrowing costs, called Libor, rose. This mistrust within the
banking industry was the main cause of the 2008 financial crisis.

Real estate agent didn't realize there were too many homeowners with questionable
credit. Banks had allowed people to take out loans for 100 percent or more of the value of their
new homes. Many started to blame the Community Reinvestment Act. It pushed banks to make
investments in subprime areas, but that wasn't the implicit cause.

The Gramm-Rudman Act was the main cause. It allowed banks to engage in trading
profitable derivatives that they sold to investors. These mortgage-backed securities needed home
loans as collateral. The derivatives created an insatiable demand for more and more mortgages.

The Federal Reserve believed the subprime mortgage crisis would remain confined to the
housing sector. Fed officials didn't know how far the damage would spread. They didn't
understand the actual causes of the subprime mortgage crisis until later.

Hedge funds and other financial institutions around the world owned the mortgage-
backed securities. The securities were also in mutual funds, corporate assets, and pension funds.
The banks had chopped up the original mortgages and resold them in tranches. That made the
derivatives impossible to price.

Why did stodgy pension funds buy such risky assets? They had thought an insurance
product called credit default swaps could protect them. A traditional insurance company known
as the American International Group sold these swaps. When the derivatives had lost its value,
AIG didn't have enough cash flow to honor all the swaps.

The Consequences
By year’s end, all of the world’s major economies were in recession or struggling to stay
out of one. In the final four months of the year 2008, the U.S. had lost nearly two million jobs.
The unemployment rate rose to 7.2% in December from its recent low of 4.4% in March 2007,
and it was almost likely to continue rising into 2009. Economic output shrank by 0.5% in the 5 third quarter, and announced retrenchments, layoffs and severe cutbacks in consumer spending
suggested that the fourth quarter of 2008 saw a sharper contraction. It was doubtful that the
worldwide economic picture would grow brighter anytime soon. Forecast after forecast showed
sluggish global economic growth for at least 2009. “Virtually no country, developing or
industrial, has escaped the impact of the widening crisis,” the World Bank reported in a typical
year-end assessment. It forecast an increase in global economic output of just 0.9% in 2009, the
most tepid growth rate since records became available in 1970.
Measured by its impact on global economic output, the recession that had engulfed the
world by the end of 2008 figured to be sharper than any other since the Great Depression. The
two periods of hard times had little else in common, however; the Depression started in the
manufacturing sector, while the current crisis had its origins in the financial sector. Perhaps a
more apt comparison could be found in the Panic of 1873. Then, as in 2008, a real estate boom
(in Paris, Berlin, and Vienna, rather than in the U.S.) went sour, losing a cascade of misfortune.
The ensuing collapse lasted four years.
Conclusions
In a nutshell, The financial crisis of 2007-08 has taught us that the confidence of the
financial market, once shattered, can't be restored quickly. In an interconnected world, a seeming
liquidity crisis can very quickly turn into a solvency crisis for financial institutions, a balance of
payment crisis for sovereign countries and a full-blown crisis of confidence for the entire world.
But the silver lining is that, after every crisis in the past, markets have come out strong to forge a
new beginnings and recovery.