Essay On Causes Of Global Recession Of 2008

Added on -2020-02-05

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INTRODUCTION This essay demonstrates the major causes of global recession of 2008. The global recessionwas an expansion of banking crisis and financial crisis. Further, great movement from risk-freesecurities towards highly risky ventures inspired the credit crunch in the market. Upcoming ofhedge funds and weak monetary policies were the major factors which influenced the Globalrecession. On the other hand, banking policies adopted for aggressive lending stimulated thefinancial market towards the recession as it encouraged subprime lending and loans to invest inhousing property which was failed due to decreased rate of houses in early 2006. This reportexplains 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 oninformation regarding the role or contribution of regulators, governments and banks in the globalrecession caused (Buckley, 2011). Every crisis has many causes and their multiplying effects hiddenbehind the veil playing their role from backstage. One of the major reasons was sectoral whichpaved the way for investments in commodities, energy and housing. There were many such factorswhich contributed towards financial crisis such as dollar weakness, rising demand for housingproperties, easy approval from loans, the introduction of currency hedge instruments and muchmore. However, the major downturn in US economy caused the whole world to face the devileffects of global recession. The major cause of global crises was devaluation of the US dollar whichpushed people to invest more money into hard assets which are actually limited by geology such asoil, gold and properties. Further, this in turn, boomed the US housing prices which were the primereason for the whole globe facing the night of recession. Major indication towards the US recessionwas a major drop in housing prices of US in the year 2006. As more and more people wished to buyresidential houses, loans were issued by the banks at a lower quality of securities and also with easyand quick approvals with lower interest rates. Further, modern phenomenon entered the US market which became popular assecuritisation. Banks mortgaged the securities offered by customers to securitisation companies whoin turn issued bonds to the public. With the high pace of this cycle of loans and mortgage, housingproperties 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 Subprimelending. Loans were issued to the public for the long term for 28-30 years and which carried interestrates initially as 8%-10% and in future years it rose to 15%-20%. The falling of housing prices in2006 prevented people from selling the properties and repaying the debt due to banks. In initialperiod, people were making profits on trading into housing properties as the property market was atthe boom and was flourishing and therefore happily paying a chunk of interest on loans out of their2
huge earnings. However, when all the housing market property was mortgaged to banks, citizenswere unable to pay the interest leaving the bank facing issues with earning and recovery of interestdifficult. Since, the demand for houses decreased because of unavailability, therefore, its pricesreduced and leaving people unable to pay off the raised interest overdue on the loans. Earlier publicwas using their house property as an ATM to generate fast cash. But as the decline occurred peoplewere left with no money to fulfil their necessities and to maintain the high standard of living whichcaused anger and distrust in the economy. Other than these factors, the whole demographic scenariowas 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 economytowards 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 sidesof the balance sheet. Secondly, banks were allowed to reduce the capital requirements if the assetside consisted of AAA rated mortgaged securities. Therefore, modification or repackaging thecustomer mortgages into securitized mortgages reduced the capital and allowed the banks to issueloans freely and excessively. Further, when the housing sector bloomed mortgage default becamecommon 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 economyas a whole in the US as well as the whole globe (Otter and Wetherly, 2008). The working of thesecuritisation 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 soldto hedge funds in the secondary money market. Hedge fund bundles all the similar mortgages withsame functions and conditions together. After that, these bundles of such assets were valued bytechnical models after considering the creditworthiness of the owner of the property, total amountborrowed, probability of repaying, monthly scheduled payment, fluctuations in the housing pricesand interest rates etc. Once the valuation was done hedge funds issued securities based on thismortgaged debt to the investors. These securities were also known as Collateralized DebtObligations (COD). These derivative security instruments spread the financial risk all over theworld and caused banking crisis in 2007, financial crisis in 2008 and ultimately leading to theglobal recession. The crashing of Lehman Brothers bank crashed the whole economy and multipliedthe effect of the crisis. Every month newspaper was highlighting the failure or applications bysubprime 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 and3

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