Financial Crisis 2007-08: Underlying Factors, Behavior and Future

This report provides a detailed analysis of the 2007-08 financial crisis, examining its origins, underlying factors, and the behavior of financial institutions. The report delves into the role of securitization, subprime mortgages, deregulation, and incentive issues, offering insights into how these elements contributed to the crisis. It also explores the potential for future financial crises, considering factors such as housing prices, mortgage rates, and currency devaluation. The report concludes by forecasting potential future financial instability, particularly in the form of currency and banking crises, and discusses the increasing likelihood of sudden stop crises based on historical trends. The report utilizes data and graphs to illustrate key points and provides a comprehensive understanding of the crisis and its implications.

FINANCE

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
Introduction of financial crisis................................................................................................1
Underlying factors of financial crisis 2007-08.......................................................................1
Behaviour of different financial institutions using more functions........................................5
Will financial crisis arise in the future ?.................................................................................5
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7

INTRODUCTION
The problem and situation in which specific assets of financial are lost up to the larger
extent of their nominal value is considered as the financial crisis. Due to this particular condition,
overall economy and its local community highly influences in negative manner. In the centuries
like 19th and 20th there are many crises of financial occurred in the world which are related to the
banking, financial institutions and recessions. The present study is talking about the financial
crisis 2007-08 which mainly associated with the property and mortgages. Underlying factors due
to which this crisis comes into consideration in year 2007-08 are explained in the present project.
Beside this, behaviour of various institutions are also described which lead to create financial
crisis. Apart from this, it has been forecasted that, in the upcoming times or future financial crisis
will occur or not.
MAIN BODY
Introduction of financial crisis
In the economy when huge part of financial asset lost and create negative impact on its
growth then it considered as financial crisis. Due to such kind of crisis in the country or world,
people unable to gain income and generate profit by which they cannot contribute in growth rate
of the economy. When talking about the stock market then it is also highly affected through
financial crisis. Therefore, return on the investment made by shareholders also reduce up to the
greater level. There are different kinds of financial crisis occur in the country which are like
currency, banking, sudden stop, debt etc. (Garcia-Appendini and Montoriol-Garriga, 2013). The
financial crisis 2007-08 was related to the banking in which commercial banks give huge amount
of loans to the people. There are several kinds of problems which lead to incur condition of
financial crisis in the year 2007-08. One of the major issue by which this situation created is
bank gives huge amount of loans to the people.
Underlying factors of financial crisis 2007-08
Behind creating situation of the financial crisis in the year 2007-08, there is wide range of
factors contributed. When such elements come into consideration within country then lead to
create issue of the crisis. The crisis of this decade is of the banking type in which overall fault is
of the commercial banks. These institutions are created huge money but not able to use in proper
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and equal direction over the few years. Moreover, factors due to which financial crisis arise in
2007-08 are such as follows:
Securitisation of bank loans:
One of the major factor due to which financial crisis arise in 2007-08 is securitisation in
which without mortgages huge loans are provided to the local community. At the time of giving
fund or loan to the people particular asset like property paper, gold jewellery etc. taken by bank.
Before the year 2007-08, commercial banks not take such assets from people behind giving loan
to them (Ntim, Lindop and Thomas, 2013). Therefore, they are not able to securitisation of the
loans in proper way. Further, loan taker or borrower not return amount of loan and become
defaulter. Henceforth, situation of financial crisis arise in the country.
Growth of Subprime Mortgages:
One kind of loan which is given to the individual but nor having better credit or became
defaulter previously and unable to return amount to bank, known as subprime mortgages. In the
2000's decade number of subprime mortgages are increased in the country and after some times
not give back money of loan. Due to this, flow of money reduced in the economy by which
financial crisis arisen in the year 2007-08 (Amadeo, 2017. ). Moreover, because of increasing or
growing mortgages of subprime, the financial crisis came into consideration in 2007-08.
Deregulation:
For every financial institution, it is highly necessary to use all the required rules and
regulations in legal manner up to the better level. Until and unless, all the legal laws and
regulations are not to be followed by such institutions then wide range of issues arisen. The
Glass-Steagall Act, 1933 was modified and replaced by Gramm-Leach-Bliley Act in the year
1999. This allows commercial banks in order to invest in the derivate markets due to which also
financial crisis comes into consideration in 2007-08 (Armantier and et.al., 2015). Further,
various complications arise related to the derivatives which is other cause of arising financial
crisis in the year 2007.
Raising rates of Subprime Borrowers:
Another issue of incurring this particular financial crisis is increased in the rates for those
who are subprime borrowers. Before the year 2001 rate of this particular financial service is 10%
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but as year passes rate raises consistently. After continuously increasing, it reaches up to 20% in
the year 2008 which create huge negative impact on the subprime borrowers. As per their nature,
they are already not capable to return loan amount and after increasing rates capacity not remain
with them for returning loan. Due to this, flow of money in economy declines which lead to arise
financial crisis situation in 2007-08 (Nelson and Katzenstein, 2014).
Incentive issues:
In addition to this, problems regarding to the incentives for different level of managers
and professionals lead to create financial crisis problem. In this compensation system for the
executives and incentives for the accounting firms are included due to which problem of this
particular situation arisen. Apart from this, because of incentives of rating agency also the
financial crisis arisen in the year 2007-08.
Improper use of fund:
According to this, banks create huge money from the year 1969 to 2014 by which flow of
money in economy reduced up to the higher level. After that, such banks not used such huge
amount created in proper direction. Major part of total amount is distributed in mortgages and
secured loans by which financial crisis in 2007-08 arisen (Financial crises & Recessions, 2016).
The data regarding to the fund is represented through graphs which are mentioned below:
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Illustration 1: Money created by Banks
(Source: Financial crises & Recessions, 2016)
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Illustration 2: Money used by UK banks which is created by them
(Source: Financial crises & Recessions, 2016)
Behaviour of different financial institutions using more functions
In the economy or country, huge number of financial institutions operating who provide
various financial services to the people. Some institutes are of those types which perform wide
range of roles and functions at the one workplace. While adopting more than two functions by
one financial institution, it not able to follow all the regulations and mechanisms in proper
direction (Carvalho, Ferreira and Matos, 2015). Along with this, any of the function cannot be
performed by the institution appropriately which lead to create issue in the country. Therefore,
chances of occurring financial crisis are increased in the economy.
Will financial crisis arise in the future ?
Arising situation of financial crisis in the country and world is highly unpredictable but
after considering past analysis it can be forecasted up to some extent. In the future, it may be
possible that, prices of housing and property can be reduce and rates of mortgages can be
increased. After visualising situation of present world economy it can be estimated that, problem
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of recession may be comes within 2-3 years. Due to which it can be said that, in the future
financial crisis will create but after many years or nearby half decade of 2020s.
Illustration 3: Average number of financial crises over Decades
(Source: Claessens and Kose, 2013)
On the basis of the above mentioned graph it can be found that, from decade 1970s to
2000s sudden stops crisis increased continuously. When looking at the currency crisis over 4
decades then it enhanced up to 1990s and then start to decline. Level of debt crisis is very low in
all the four decades which are from 1970s to 2000s. Henceforth, debt crisis will not come
consideration in the future. It can be said that, sudden stops crisis will arise and create major
impact on the overall economy (Will there be another financial crisis?, 2017).
Apart from this, in past two years due to devaluation of “Yen” currency by China
financial crisis in terms of currency war was arisen. Motive behind is that, make the China
currency at the international level of central in the world but it not able to meet with the
objective. In order to make central currency to “Yen”, China can take some steps again by which
financial situation of the world will affect. On the basis of this, it can be said that financial
(currency) crisis will arise in the future.
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CONCLUSION
It can be concluded from the present research is that, there are different kinds of financial
crisis arisen in the country and world over the last four decades. In the year 2007-08, financial
crisis comes into consideration which is related to the banking in which huge amount of loans are
given to the subprime mortgages and borrowers. Major underlying aspects due to which financial
crisis arisen in 2007-08 are like securitisation of loans, growth of Subprime Mortgages,
deregulation, increasing rates of Subprime Borrowers, incentives, improper use of money etc. It
can be forecasted for the next years in terms of financial crisis that, generally currency and
banking crisis can be raised. Moreover, over the last four decades crisis of sudden stops are
increases continuously by which it can be said that, in the future issue of this will be arisen.
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