The Worldwide Financial Crisis
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Added on 2020-05-16
The Worldwide Financial Crisis
Added on 2020-05-16
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Running head: FINANCEFinanceUniversity NameStudent NameAuthors’ Note
2FINANCEThe worldwide financial crisis that was brewing for quite some time actually began to showits influence during the middle of the year 2007 and thereafter into the year 2008. Due to theglobal financial crisis (GFC) the stock markets around the world dipped, huge financialinstitutions buckled or were sold out, and governments of even the wealthy nations also hadto introduce recovery packages in order to bail out financial systems in their country. Peopleare of the view that the ones accountable for the financial difficulty are essentially the oneswho were being bailed out, whilst contrarily, a worldwide financial crisis might perhapsaffect the living of almost each and every person in an ever more inter-connected earth. Inthis way, the crisis can be said to be closely associated to balance sheets right the waythrough the nation for mainly financial institutions, for every households and for governingbodies. This global financial crisis (GFC) during the yeat 2008 can be regarded as a big eventin the entire history of global economy. Subprime mortgage crisisIn essence this could be easily observed in subprime mortgage crisis. However, in normalcircumstance, subprime mortgage would not be carried out at all. One needs to possessadequate collateral at the time of lending a mortgage in order to shield oneself from anyprobable financial risks in case if the property holder defaulted. Nevertheless, peopleintended to gather more money and entered into the riskier arena of subprime mortgage. Itwas a very risky affair that could straightforwardly go wrong. In its place, it can be observedthat everyone did enter into that risky business (Haas and Lelyveld 2014). There were topical shocks that affected the macro economy that in turn led to the globalfinancial crisis. The first major blow and the macroeconomic shock was the intense decline inthe housing prices. During the decade that led to the year 2006, prices of houses increasedfast by over and above 30% during the next 3 years. Fuelled by the low rate of interest during
3FINANCEthe late 1990s early 2000s, and by ever-loosened standards of lending, this prices enhancedbetween the year 1996 and the year 2006 at a mean rate of approximately 10% every year.Economic gains were considerably larger in certain coastal areas namely Boston, SanFrancisco, Los Angeles as well as New York. Strikingly, the overall national index forparticularly housing prices recorded in the United States decreased by nearly 31.6% duringthe period 2006 and 2009 (Vazquez and Federico 2015). Analysis of this huge rise and fall inthe prices of the housing brings us to the answer and helps in understanding the severefinancial turmoil worldwide. The graph below shows that the sub prime lending sectionsconsiderably allowed mortgages at high level of loan to valuation ratio. Graph: Subprime lending standards(Source: Ang et al. 2015)
4FINANCEWorldwide Saving GlutAttracted by the low rate of interest linked to the worldwide saving glut, huge number ofborrowers went for mortgages, and possibly believed that housing prices would persistentlyincrease. Huge numbers of borrowers however took out mortgages and bought homesbetween the period 2000 and 2006. In essence, these numbers primarily include highernumber of loan applications that did not satisfy the mainstream standards owing to the poorcredit records or else high level of debt to income ratio. However, against this background,after two years of enormously low rate of interest, the Federal Reserve started to enhance thetarget of fed funds and the rate that was charged for basically overnight loans mainly betweenbanks. Primarily, between the period 2004 and 2006, the Federal Reserve increased the ratefrom nearly 1.25% to nearly 5.25% due to concerns regarding rise in inflation (Ang et al.2015). Essentially, this was a reasonable strategy as per the Taylor Rule, the rates of interestwere low in the previous years and the Fed increased them to particularly a feasible stage. Ina specific environment with sub-prime mortgage facing several mortgages where rates weremoving from basically low teaser rates to very high market rates, the impact of the housingprices was even sterner (Bénétrix et al. 2015). The graph below shows the increase in thevalue of the debt to particularly the value of the housing stock.
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