Financial and Credit Crisis

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