Financial and Credit Crisis

This essay covers the 2008 financial crisis, the causes of changes in demand and supply of funds, and the reason for the major decline in demand for funds in the future.

Running head: FINANCIAL AND CREDIT CRISIS 1
Financial and Credit Crisis
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FINANCIAL AND CREDIT CRISIS 2
Financial and Credit Crisis
Introduction
The cost of borrowing funds is referred to as interest rates. It’s the form of compensation to the
fund providers for risk bearing in lending the funds. The rates are dependent on supply and
demand for funds. In uncontrolled economies, demand and supply balances at a price referred to
the real interest rate. During the high supply of funds, interest rates are lower than the real
interest rate, and when funds are limited in supply, the interest rates rise above the real interest
rate. The rise of interest beyond the normal rates is termed as the credit crisis and can cause the
economy to come to its knees (Fernando, 2012). The economy faced one of the biggest financial
crises in 2008 which caused the credit market crash. This essay will cover the 2008 financial
crisis, the causes of changes in demand and supply of funds and the reason for the major decline
in demand for funds in the future.
In 2008 the world experience one of the worst financial crisis in history. The major causes of the
crisis were deregulation and the growth of subprime mortgages due to easy access (Chodorow-
Reich, 2013). These are mortgages to individuals with not very good credit ratings resulting in
increased defaults during repayments. The increased borrowings resulted in what appeared as a
rise in property price, but later a crisis arose when borrowers could not repay. Most of the
borrowers with mortgages were squeezed on repayment when properties were unavailable for
sale due to low prices.
The defaulting by mortgage borrowers caused a serious financial problem to banks. Deregulation
occurred as banks were allowed to invest in derivatives using deposits leading on the promise of
investing in low-risk securities (Fahlenbrach, 2011). As the number of mortgage defaulters rose,
and bank deposits utilized on derivatives, banks had inadequate cash leading to a shortage in

FINANCIAL AND CREDIT CRISIS 3
cash supply. This caused the fall of some of the biggest institutions an example being the
Lehman Brothers an investment bank in Wall Street who were forced to file for bankruptcy.
Most people lost their jobs making the crisis skyrocket. Intervention by the then US president
George W. Bush and the federal government saved the economic recession situation
(Fahlenbrach, 2011). The rescue was meant to save financial institutions mainly banks and
insurances companies being saved from bankruptcy through a rescue plan worth 800 Billion
US$.
The credit crisis has made most lending institutions conservative on credit lending. The
regulations on the industry have been tightened as well to protect investors and ensure economic
stability (Fernando, 2012). By controlling fluctuations in major sources of finance, contracting or
increasing bank credit as well as reducing the net public debt has solved the credit crisis that was
putting the world economy under recession. Governments, as well as the central banks, have
developed policies to pull their economies from recess. In conclusion institutions and
governments should work on credit crisis prevention as a financial can pull down even the
biggest financial institutions as seen in the case of Lehman Brothers.

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References
Chodorow-Reich, G. (2013). The employment effects of credit market disruptions: Firm-level
evidence from the 2008-9 financial crisis. The Quarterly Journal of Economics, 129(1),
1-59.
Fahlenbrach, R. &. (2011). Bank CEO incentives and the credit crisis. Journal of financial
economics, 99(1), 11-26.
Fernando, C. S. (2012). The value of investment banking relationships: evidence from the
collapse of Lehman Brothers. The Journal of Finance, 67(1), 235-270.