Causes and Impacts of the Global Recession

This assignment delves into the complex reasons behind the 2008 global recession. It examines the role of excessive lending by banks, ineffective monetary policy, avoidable factors such as risky investments and regulatory shortcomings, and the impact of housing market fluctuations. The analysis aims to understand how a combination of these factors contributed to the economic crisis.

Business Skills
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INTRODUCTION
This essay demonstrates the major causes of global recession of 2008. The global recession
was an expansion of banking crisis and financial crisis. Further, great movement from risk-free
securities towards highly risky ventures inspired the credit crunch in the market. Upcoming of
hedge funds and weak monetary policies were the major factors which influenced the Global
recession. On the other hand, banking policies adopted for aggressive lending stimulated the
financial market towards the recession as it encouraged subprime lending and loans to invest in
housing property which was failed due to decreased rate of houses in early 2006. This report
explains in detail all the terms and factors which caused the major recession across the globe.
Financial crisis study brings the world economy under the financial microscope to focus on
information regarding the role or contribution of regulators, governments and banks in the global
recession caused (Buckley, 2011). Every crisis has many causes and their multiplying effects hidden
behind the veil playing their role from backstage. One of the major reasons was sectoral which
paved the way for investments in commodities, energy and housing. There were many such factors
which contributed towards financial crisis such as dollar weakness, rising demand for housing
properties, easy approval from loans, the introduction of currency hedge instruments and much
more. However, the major downturn in US economy caused the whole world to face the devil
effects of global recession. The major cause of global crises was devaluation of the US dollar which
pushed people to invest more money into hard assets which are actually limited by geology such as
oil, gold and properties. Further, this in turn, boomed the US housing prices which were the prime
reason for the whole globe facing the night of recession. Major indication towards the US recession
was a major drop in housing prices of US in the year 2006. As more and more people wished to buy
residential houses, loans were issued by the banks at a lower quality of securities and also with easy
and quick approvals with lower interest rates.
Further, modern phenomenon entered the US market which became popular as
securitisation. Banks mortgaged the securities offered by customers to securitisation companies who
in turn issued bonds to the public. With the high pace of this cycle of loans and mortgage, housing
properties being limited and unexpanded caused the quality of mortgages to lower down. However,
banks were still issuing the loans at the poor quality of securities which was known as Subprime
lending. Loans were issued to the public for the long term for 28-30 years and which carried interest
rates initially as 8%-10% and in future years it rose to 15%-20%. The falling of housing prices in
2006 prevented people from selling the properties and repaying the debt due to banks. In initial
period, people were making profits on trading into housing properties as the property market was at
the boom and was flourishing and therefore happily paying a chunk of interest on loans out of their
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huge earnings. However, when all the housing market property was mortgaged to banks, citizens
were unable to pay the interest leaving the bank facing issues with earning and recovery of interest
difficult. Since, the demand for houses decreased because of unavailability, therefore, its prices
reduced and leaving people unable to pay off the raised interest overdue on the loans. Earlier public
was using their house property as an ATM to generate fast cash. But as the decline occurred people
were left with no money to fulfil their necessities and to maintain the high standard of living which
caused anger and distrust in the economy. Other than these factors, the whole demographic scenario
was normal consisting of reasonable employment rates and respectable GDP growth (Anonymous,
2010). This caused the financial crisis in US economy and influenced the whole world.
Capital requirements of the economy were evaded by the banks which forced the economy
towards recession. Firstly, Banks placed the mortgaged assets to the off balance sheet entities,
securitisation companies which eroded the capital requirement of the banks to balance the two sides
of the balance sheet. Secondly, banks were allowed to reduce the capital requirements if the asset
side consisted of AAA rated mortgaged securities. Therefore, modification or repackaging the
customer mortgages into securitized mortgages reduced the capital and allowed the banks to issue
loans freely and excessively. Further, when the housing sector bloomed mortgage default became
common and left banks kneeling down towards the devastating effects of insolvency. Moreover,
banks being pillars of the financial sector faced major disorder which in turn affected the economy
as a whole in the US as well as the whole globe (Otter and Wetherly, 2008). The working of the
securitisation companies was interesting being complex at the same time. All the collateral debts,
mortgage debts, securitised debts and other derivatives collected by banks from customers are sold
to hedge funds in the secondary money market. Hedge fund bundles all the similar mortgages with
same functions and conditions together. After that, these bundles of such assets were valued by
technical models after considering the creditworthiness of the owner of the property, total amount
borrowed, probability of repaying, monthly scheduled payment, fluctuations in the housing prices
and interest rates etc. Once the valuation was done hedge funds issued securities based on this
mortgaged debt to the investors. These securities were also known as Collateralized Debt
Obligations (COD). These derivative security instruments spread the financial risk all over the
world and caused banking crisis in 2007, financial crisis in 2008 and ultimately leading to the
global recession. The crashing of Lehman Brothers bank crashed the whole economy and multiplied
the effect of the crisis. Every month newspaper was highlighting the failure or applications by
subprime lenders for insolvency.
One of the studies describes that boom in saving opportunities increased drastically in 2007.
As the giant pool of fixed income securities raised highly, with the entry of globally strong and
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developing nations with high growth into the global capital markets. This marched investors with
greed filled in their eyes to switch from US Treasury bonds to various alternatives available
globally. This tempted the investors to put their savings into great use and caused generation of the
bubble after bubble across the globe (Domitrovic, 2012). However, after the saturation, these
bubbles burst out and caused the prices of investments (housing properties, commercial ventures) to
decline thereby raising the suspicion on customers, banks and governments regarding their
solvency. This caused a shortage of money in the economy and thereby affected adversely the
consumption power of customers which hampered the whole economy and snuggled it to settle into
a phase of recession. Further, this lack of money circulation in the economy affected the European
and global markets and caused a credit crunch. As the major effect, business was flattered due to
acute shortage of money in the economy and shrinkage of demand.
Moreover, the reliance on the credit rating agencies which were subjected to the client
pressures for raising loans was a major factor of high leverage in the economy. Credit ratings of the
customer were relied upon by banks in issuing the loans which were due to undue pressure and
several factors which were fictitious. Due to increased competition and hike in hard assets, clients
placed pressure on credit rating agencies to issue good ratings to extract the handsome amount of
loans from banks. Reduced intervention of government to regulate the leverage policies of banks in
the US was the great cause which destructed the whole economy. Excessive lending policies of
banks in want for higher margins and income had the most devastating effect (Grigor'ev and
Salikhov, 2009). The monetary policy of US economy was not effective and was not prepared for
the immediate financial crisis. Lower interest rates motivated the hedge funds, banks and investors
to invest the surplus and borrowed amounts into riskier projects or assets which in turn provided
better returns.
Furthermore, there were factors which were avoidable and caused the global recession that
cursed the whole world. This recession was caused by the failure of federal reserve’s of US which
caused the huge tide of mortgages to flow into the economy, combinations of excessive risk and
borrowings by the household of US, lack of full understanding of the crisis by policy makers,
breaches in ethics and accountability at all the levels of economy. The major role amongst all was of
the financial regulations which were managed unsystematically and their widespread failure across
the economy.
CONCLUSION
Further, it can be concluded that banks were not the only reason, but several factors worked in
combination to this event of a global recession. Weak financial regulations and policies in addition
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to aggressive lending inspired the banks and investors to invest into riskier projects and which in
turn caused the credit crunch. Evolution of credit rating agencies and securitization hedge funds
caused the boom in the economy and later a burst. Furthermore, the study of various factors under
the financial microscope states that fluctuation in housing prices was a great lead which marched
the whole economy towards recession. Financial product innovation in terms of new securities from
hedge fund companies influenced the market a lot to withdraw all the currency supply from the
economy. However, US economy effectively survived the crisis and emerged as one of the strongest
economies in the world.
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REFERENCES
Books and Journals
Buckley, A. 2011. Financial Crisis: Causes, Context and Consequences. Harlow: Prentice Hall.
Domitrovic, B,. 2012. ‘The Weak Dollar Caused the Recession’ .Forbes.189(8). pp.32
Grigor’ev, L, and Salikhov, M. 2009. Financial Crisis 2008. Problems of Economic Transition (51)
pp.35-62.
Otter, D, & Wetherly, P,. 2008. ‘Chapter 9: Growth vs. austerity: The macroeconomy in a
globalizing world.’ In The Business Environment (2nd edition). Glasgow: Oxford University
Press.
Online
Anonymous. 2010. ‘Vatican economist: recession caused by low birth rate’ Catholic Insight. [e-
journal] 18(4). Available through: Anglia Ruskin University Library website
<http://libweb.anglia.ac.uk/> [Accessed on 28th December, 2016]
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