Causes and Effects of the Global Financial Crisis

This assignment delves into the causes and lasting impact of the Global Financial Crisis, which began in 2008. It examines factors such as the housing bubble burst, Lehman Brothers' collapse, and global market dumping. The effects of the crisis are analyzed across multiple economic indicators including GDP, unemployment, trade (exports and imports), and national debt.

Running head: THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
The main causes of the Great Recession in the USA
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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
Executive Summary
This paper will highlight the main causes of Great Depression in the USA. The crisis was caused
due to several factors such as housing market bubble, credit default, stock market fluctuations,
Lehman Brothers and dumping from China. This had an effect on the GDP, growth, inflation,
unemployment rate and other indicators in the economy.

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
Peak
Growth
Recession
Trough or Depression
GDP
Time
Recession refers to a significant decline or massive contraction in the economic activities.
In such a situation, income, real GDP, a manufacturing, employment and retail sale declines
drastically. As the rate of unemployment increases, the purchasing power of the consumer’s
declines and it also affects businesses. Such a situation also leads to bankruptcy. The main
reason of financial crisis is that banks were able to create too much money in a very short time.
This has also pushed the price of houses and thus it became easier to speculate the financial
market. The financial crisis of 2007-2008 is known as global financial crisis and it was regarded
as the worst financial crisis since the Great depression of 1930s. The crisis initially affected the
subprime mortgage market in US and later on affected the entire banking system. This paper will
highlight the main causes of great recession in the USA (Barro and Ursúa 2017).
Fig-Business Cycle

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
Source-Author’s Creation
The average housing prices in US has declined by 20% from 2006-2008. The easy credit
and the belief of the people that the housing price will appreciate have encouraged the borrowers
for adjustable mortgages. The borrowers could not make huge payments because the interest
rate was drastically falling and thus they try to refinance their mortgage. In such a situation,
refinancing also became difficult because the housing prices have been falling drastically. Thus,
the borrowers in such a situation found it difficult to escape from the high amount of monthly
payments which they had to pay through refinancing and thus they were in default (Dimitriou et
al. 2013). The event of housing bubble will affect both the consumers and the investors in the
later periods. This has also affected many developed market and thus there was fiscal detoriation
in the fiscal position. The most important factor which affected housing market bubble in US
was the deregulation of the market and the favourable terms of trade which affected the
government and the individuals to apply for different mortages. This has affected the prime loans
which were adhered to sustainable standards of lending (Kumar and Singh 2016).
The housing market has experienced steady growth rate during the period of 1995 to
1999. In case of stock market crash in 2000, there was huge shift of dollars from the stock
market to the housing sector. Moreover in housing market bubble there was availability of cheap
money for availing new loans in the period of economic recession. The banks and the federal
reserve’s has appreciated the housing market for the creation of wealth and provision of secured
assets which has helped people to borrow money and thus this has led the economy to grow
further. There were also many financial innovations which was included in different types of

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
lending processes such as zero down loans and interest only loans. The total sum of derivatives
which was held by the financial institutions thus exploded and as a result it affected the cash
reserves and thus it became very small (Babalos et al. 2016).
The stock market crash was a kick start to recession. Moreover, the confidence of the
investors for the future can be predicted in stock market. Corporate earnings are dependent on
the economy of US. A massive crash resulted in loss of confidence in the economy. The stock
market crash in US led to recession. However, in certain cases, it can be said that stock market
crash does not always lead the economy to recession. The financial companies knew that they
will be forced to make losses and thus sustain the subprime mortgage crisis (Tan and Cheong
2016). When the values of the financial stocks fell, the companies knew that they hard time
rising new capital to cover the losses and thus apply for new loans. Thus has led to decline in the
stock market and thus put the bank out of businesses. Moreover, the banks do not have sufficient
time to cover the downturn in the businesses. Thus, this has led to recession in the US economy.
This crash destroyed the intention and interest of the investors in business investment. This has
happened because the banks had used the money of the depositors to invest in Wall Street.
However, this was not the only reason of Great depression. There were many instances where
people did not buy a single stock but has lost all their savings. This has led the economy in the
path of financial crisis (Taylor 2014.).
The credit default rates of the consumers fell to a very low level since the beginning of
economic recession. The credit default rate of the bank has increased from the previous years.
The bank card default rate also increased and this has led the economy to recession. The
consumer credit default ahs dropped for the new loans while the default rate of the bank card has
been increasing steeply. Since then the consumers have started to pay more attention to their

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
debts especially in case of financial commitments such as car and home loans (Kouwenberg and
Zwinkels 2014.). The bank card rate, mortgage default rate and auto loans were lower in pre-
financial crisis. But in certain cases, it can be said that the bank card rate was volatile and thus it
was more sensitive to consumer spending. The credit default swap included the insurance
coverage and the contracts on the loans. This contract has to face several losses in case of certain
securities. In such a situation, the buyers of the default credit insurance had to pay the premiums
for longer period of time. Te banks and the insurance companies were regulated and thus it had
led to credit market swap. This has led to swapping or trading of the contractors from different
investors and thus it has also ensured the buyer to cove r the losses in case of security defaults.
Moreover, in such a situation the investors flock to the swaps in the hope that such big
corporations will help in flourishing the economy (Luciani 2015).
Another factor that caused the financial crisis in USA was the downfall of Lehman Brothers,
which is considered one of the largest investment banks in the USA. The bank was involved in
some of the biggest investment project of the economy. It was involved in investment business
with the other firms. It did business in investment, banking, equity and trading activities. The
company was operational in these activities for the past 158 years before its downfall begun.
However, 2008 saw the downfall of the Lehman Brothers due to their bankruptcy. As it was a
financial firm serving globally, the downfall the firm was the main cause of the global financial
crisis. The bankruptcy was due to the drop in the 500 points of Dow Jones in 2008, which was
one of the biggest falls the past few years. Moreover, at that time the company has an asset of
$639 billion and $619 billion. The crisis was also known as mortgage induced financial crisis
due to the increasing debt of the company and the inability of the customers to repay back the
loan. The beginning to the end of Lehman Brothers was the credit crisis that hit the economy in

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
2007 (Keyes et al. 2015). The company experienced a loss of $2.8 billion in June 2008, which
worsen their situation. However, the company was able to raise an amount of $6 billion from its
investors, which helped the company to reduce the negative effect of the crisis and gain some
confidence of the public. The company filed a petition for their bankruptcy for the protection
against such bankruptcy in future. In September 2008, Nomura Holdings Inc. acquired the
company. The collapse of Lehman Brothers had a detrimental effect on the financial market of
US for many weeks, as the company was huge and spread all over the economy. The bankruptcy
resulted in $46 billion market value of the company to be wiped away (Subrahmanyam et al.
2014).
Dumping in other words means predatory pricing that the country charges for exporting
their goods to another country. The country involved in the trade exports its goods to the other
country in a comparatively low price. The process of dumping is done by the economy just to
increase their share in the market. However, in such type of trading both the price and quality of
the product is degraded by the source country. This had a lot of negative effect on the USA
economy as the Chinese dumped their goods in the US market at a very low price. This is
because China was exporting their goods the US market at a very low price. This caused the US
market to import many Chinese gods into their market. Thus, it affected the domestic industry in
US producing those goods as all the people stetted consuming the imported goods from china.
Thus, there was shrinkage in the international trade due to the leakage of US currency from the
economy. This in turn affected the financial reserve of the country causing the financial crisis of
2008 in US. US currency on the other hand became week because of this dumping, which was
the biggest reflection of the shrinking economy of US and financial crisis (Albert2015).

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
The event that took place in US economy such as dumping from china, housing market
bubble, Lehman Brothers, stock market crisis and others. These factors has caused global
financial crisis in US affecting the economy in various ways such as GDP, unemployment,
trading partners of the company and aggregate demand. Even though the recession ended in 2009
, the effect of this crisis was for a longer period of time. The recovery was difficult ad extremely
disappointing. Economic growth began to fell at the time of the recovery and the economy
started taking steps to slow down the recession effect by reducing the gap between real GDP and
potential GDP. On the other hand, the crisis has put a negative effect on the GDP of the US
economy especially due to the shrinking credit rate during the bankruptcy of Lehman Brothers.
Further, due to the dumping activity from China on the US economy has increased the demand
for imported goods and reduced the aggregate demand for domestic goods(Ang and Longstaff
2013). This put a detrimental effect on the domestic industries resulting in their shrinkage. The
dumping activity by China also caused an increase in unemployment rate in the economy, as
most of the population that was engaged in domestic industries is no longer employed due to
huge import. Unemployment rate seemed to be at 10.1 percent in the year 2009, which is just
after the crisis. This showed that about 15.4 million worker got unemployed at that moment.
Rising unemployment has a long-term effect on the economy as production will reduce and
economy will shrink both in the domestic market and trade market. The recession also affected
the inflation rate of the economy, which increased at a considerably high rate. The credit squeeze
caused by the fall of the Lehman Brothers caused a price of risk, as there was a drop in the equity
prices and there was an increasing volatility in the exchange rate. The effect of the financial
crisis has put a threat among the economy that the emerging market will be affected badly.

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
However, the effect was controlled by the foreign invention in the equity market, banking system
and others (McInerney et al. 2013).
From the above discussion, it can be concluded that US has faced a global financial crisis
in 2008 followed by a recession in the economy. The crisis was due to various reasons that
affected the economy in a great way and resulted in their downfall. Some of the effects took
place in the economy and others were due to the activity of the foreign market. The crisis was
mainly caused due to the housing market bubble, the Lehman Brothers failure, dumping from
China and others. The crisis has left a long term on the economy affecting various variables such
as GDP, unemployment, export and import, national debt and others. Thus, the causes and affect
of the crisis were both detrimental.

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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
Reference List
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Barro, R.J. and Ursúa, J.F., 2017. Stock-market crashes and depressions. Research in Economics.
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THE MAIN CAUSES OF THE GREAT RECESSION IN THE USA
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