Global Financial Crisis: Causes and Impacts

This assignment delves into the complex issue of the 2008 Global Financial Crisis (GFC). Students are tasked with examining the various underlying causes that led to the crisis, including factors related to financial deregulation, excessive risk-taking, and housing bubbles. The analysis should also encompass the significant economic consequences of the GFC, such as recessions, job losses, and global market turmoil. Furthermore, students need to evaluate the regulatory reforms implemented in response to the crisis and assess their effectiveness in mitigating future risks.

Running head: CORPORATE FINANCIAL MANAGEMENT
Corporate Financial Management
Name of the student
Name of the University
Author note

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Introduction:
Financial crisis is one of the economic phenomenons that seem to occur in a cyclical
process. With ever-increasing connectivity among the different economies, effect of the financial
crisis now a days have far reaching effect more or less on every economies. It not only affects
the epicentre of the economy, moreover spreads like an epidemic throughout the various other
economies leading them towards a dwindling situation (Bénétrix, Lane and Shambaugh 2015).
Among many economic crises, Global Financial Crisis (GFC) of 2008 is a remarkable one,
owing to its magnitude, range and effects. It not only crippled the economy of the United States
(US) moreover, affected almost 8 countries from European Union (EU) along with Mexico,
Egypt, South Africa, Japan, Australia, New Zealand and several other countries worldwide
(Dijkstra, Garcilazo and McCann 2015). GFC is acknowledged as the second largest global
economic crisis next to Great Depression of 1929 due to its magnitude and far reaching effect.
This essay is going to analyze the effect of GFC on the various countries and trace out the reason
for its occurrence. Besides this, it will try to find out the whether there is any possibility to occur
GFC again or not. To conclude, the essay will analyze various reforms taken by the government
to control the GFC and proposed reform to make the world economy better.
Possible causes of Global Financial Crisis:
GFC is one of the largest economic disasters that shook the whole world gradually. Since
2006, there were various signs that entailed the US economy regarding the occurrence of this
financial disaster; however, government authorities deliberately overlooked them (Claessens, and
Kodres 2014). Once the effect of recession started to phase out, there were various studies
regarding the possible caused of GFC. Most of them have similarities to some extent; however,
each research came up with different theories regarding the possible reason of GFC.

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According to the Harvie and Van (2016) one of the main reasons for the global financial
outbreak was real estate bubble of the US economy that deliberately brought in the subprime
mortgage crisis into the economy since 2006. Back in 2004, Federal Reserve enhanced the Fed
Funds Rate and it effectively decreased the housing prices. This reduction in prices of the houses
made it affordable to the US citizens and the demand started to rose gradually, which ultimately
forced the price of the affordable houses to go up. Community Reinvestment Act aided the
realtors to enhance the supply of the house and grabbing the opportunity, lenders started to
provide loans at 100% or more than the real value of the new houses. Besides this, banks of US
found that it is more beneficial to sell derivatives than providing loans. Capturing the opportunity
of unregulated derivative market, US banks sold derivative in a large amount overlooking a
major concern; if the derivative business needs to be continued, then the banks required
continued flow of mortgages (Kapan, and Minoiu 2013). Once the prices of the houses started
to fall, supply suppressed the demand, which trapped the owners into the cobweb of mortgage
and the flow of newer mortgages started to reduce. In order to check this, banks reduced their
lending standards; however, the breaking down of the mortgage framework already has been
started. Once the boom in the mortgage sector ended back in 2006, cost of the derivatives started
to decrease. Everyone now wanted to cash their securities; however, banks did not have that
much cash during that time leading to a chaos in the economy.
According to the researches of Treeck (2014), income disparity among the US citizens is
one of the main reasons that lead the economy towards this vicious cycle. With rise in Fed Rate,
houses become cheap, however, excessive demand lead to higher price. One the other hand
realtors provided loans to the house buyers at a higher rate and invested all the money into
derivatives that become plumped, once the economy started to cripple. Income disparity lead to

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discrimination among the citizens and it constrained the US citizens to afford the house at higher
price.
Claessens and Kodres (2014) argued that, main reason for GFC is Gramm-Rudman Act,
which allowed the banks to engage themselves into trading. Post the Gramm-Rudman Act, banks
started to sell their profitable derivatives to the investors and the greed for more profit started to
increase. Overlooking various important parameters bank relied upon the Mortgage Backed
Securities to safeguard their derivatives. However, once the economy started to break down it did
not came to any help, rather it lead to too many of toxic assets in the banking framework. As the
rumours of economic system breakdown started, stock market also started to cripple. The
Repercussion effect of the fraud activities of the mortgage agencies of US and the banks lead US
into a largest financial crisis and the financial disaster has been spread to various economic
systems worldwide.
According to the researcher of this essay, besides the above-mentioned factors,
Commodity Futures Modernization Act is another reason that allowed the GFC. It allowed credit
default swaps that overruled the state laws regarding gambling. It allowed the banks to trade in
energy derivatives that aided to the growth of subprime crisis.
Examples of effect of Global Financial Crisis:
Subprime mortgage crisis is one of the largest effect that brought in GFC, which not only
affected the US economy, moreover hit hard several other economies over the world. Subprime
mortgage being a mortgage backed security, collateral, which essentially need to be home loan.
This derivate introduced an insatiable demand in the market for mortgage leading the derivatives
impossible to price. Besides this, Credit Default Swaps can be treated as another example of
effect of GFC that lead the US banks resold the mortgages in tranches. Moreover, Libor rate also

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rose up and intra-banking lending stopped that lead the bankers to panic and absorb the
respective losses due to lack of money to support the Credit Swap.
Impact of Global Financial Crisis in Australian economy:
Australian economy is connected with US economy well. US economy depends upon on
the Australia’s mineral resources largely and thus, the financial crisis of US has affected the
country too. Signs of distress started arise, when two US financial companies, who deal in the
Australian market, displayed serious problems with their holdings of Mortgage Backed
Securities (Reinhart and Rogoff 2009). As the result, Australian banks refused to provide loans
to the US banks. Besides this, export gradually reduces to some extent and it increased the
interest rate in the Australian market. However, according to the assessment of the Australian
Bureau of Statistics the financial crisis did not affect the Australian economy largely owing to its
strong domestic economy that efficiently absorbed the shock in the market. However, according
to the Reserve Bank of Australia, Australian stock market faced largest ever reduction in the
equities during the period of GFC. During November, it reduced almost 54 percent, which is the
highest reduction in the chart of Australian equities and it recovered sharply during the January
to march of 2008. However, if compared with the equity market of other countries, then the
reduction is the lowest among all and it portrays that Australian economy is potent enough to
absorb any external financial shock. During 2008 to 2009, share prices of Australia dropped by
3% and there were high volatility in the market (Ravenhill 2017). Though there was a reduction,
in cash rate during 2008 to 2009, overall interest rate was high at that time and bond pricing of
the Australian banks has been reduced substantially. Considering this, it can be stated that
Australian market is more resilient compared to the other economies that deal with the US.
Chances of Global Financial Crisis repetition:

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GFC had taken place back in 2008 in the US economy, which affected almost every
economy more or less, that are attached with the US through trading. According to the economic
cycle, as shown in the figure 1, Global financial crisis returns after 7 year once an economy
survives through recession and reaches to peak, suppressing the recovery stage (Xu and Couch
2017). Considering this, if US economy can be contested, then it will be found that the economy
has gone through recession back in 2008 and now it is under the recovery stage. It is expected
that economy will reach to peak by 2020 and later that, according to the economic cycle theory,
GFC can arise again (Rey 2015).
Figure 1: Economic Cycle
Source: (Diaz, Theodoulidis and Dupouy 2016)

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US Federal Reserve Chairman Janet Yellen has recently said that there will be no more
GFC ever again with strong governmental holdings on the market and economic reform plans.
However, according to Richard Sylla, there is 70% to 80% chance that GFC will repeat in
coming years again. Main reasons for his statements are as follow (Rousseau and Wachtel 2017):
Interest rate is still lower that influence the prospect buyers to take loans for new houses.
High yield rate in free market is at an alarming rate. With 8% yield rate, US possess the
highest yield rate. It portrays that government is manipulating the economy and
transferring almost 2.4 USD every year from the US savers to borrowers.
Taxation rate is much higher than the natural rate, same as the taxation rate of 2008.
According to the thought of the researcher of this essay, scope of occurrence of GFC is
considerably low. Though private debt bubble is attractive to the investors; however, they need
to abstain them from the trap again. Debt to GDP ratio of US is considerably lower than the other
developed nations like UK, China, Australia, Korea and Belgium that aids the economy to
sustain in long run (Minsky 2015). However, it can be seen that private debt rate of the country is
growing higher, which is an alarming situation.
Reforms to control Global Financial Crisis:
Back in 2006, alarm bell has already been raised regarding the incoming of GFC in the
economy; however, negligence of the US Federal Reserve and greed of the US banks, mortgage
firms lead the economy towards the financial crisis (Corbo, De Melo and Tybout 2015). Term
Auction Facility from the Federal Reserve back in 2007, in order to pumping in liquidity in the
US monetary market in order to raise the growth has made the final blow.
To control the deteriorating situation, the US government has introduced various
packages. One of the main bailout packages was of US$700 billion that was aimed to safeguard

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the US banks from bankrupted. Besides this, Economic Stimulus Package was also introduced by
the then US President Barrack Obama. Along with this, there were unemployment benefit of
$224 and $275 for public works. Moreover, the government tried to aid the economy with a
college tax cut of $2500 and $8000 for homebuyers (Or and Aranda 2017). In 2009, government
brought in the Homeowner Affordable Refinance Program (HARP) that was aimed to provide
affordable home to the homebuyers, without moving into the mortgage trap again. By this time
unemployment rate was as high as 10% and to control this US government introduced American
Recovery and Reinvestment Act (APRA) as a stimulus package to the economy (Duffie 2017).
Moreover, it has been proposed by the government to amend the Dodd-Frank Wall Street
Reform Act properly, then it will be beneficial for the economy. Republicans of the US senate
proposed plan to let the economy become capitalist market, where deregulation can be beneficial
and it will do its work to ensure GFC does not happen again.
Conclusion:
This essay has studied the Global Financial Crisis and tried to trace out its possible
reason of occurrence. From the analysis, it has been found that fraud activity of the US banks
and mortgage firms has been one of the main reasons that took the economy towards the crisis.
Besides this, subprime mortgage risk along with disparity in income is the different factors that
caused the economy to face financial crisis. The essay has found that, crippling of financial
condition not only affected the US market, moreover brought devastating effect for the other
economies too. As the measure to control the crisis, there has been various stimulus package and
proposed plan. Most of them have successfully triggered the economy to bring in a favourable
condition by the end of 2009. With rising GDP of the country and reducing unemployment, the
essay suggests that, there will be no GFC again like 2008

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Reference:
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