Introduction
The 2008 financial disaster was a severe international economic disaster in the early twenty-first century. It led to the Great Recession, which proved to be the most serious global recession after the Great Depression. Furthermore, it was followed by the European debt crisis, which began with a deficit in Greece and the Icelandic economic issues from 2008 to 2011. The latter involved the failure of three major financial institutions in Iceland, resulting in a loss of over $2 trillion to the global economy. The essay aims to demonstrate that the 2008 financial crisis was primarily a banking crisis and could also have been influenced by the business cycle and lessons learned.
Analysis
Causes and Effects
The 2008 financial crisis was primarily a banking crisis, as many financial institutions globally suffered significant damage and were unable to fulfill their short-term and long-term obligations. The rapid development of predatory fiscal products targeting low-income home purchasers belonging to racial minorities is believed to have been the key contributor to the problem (Amadeo, 2020, p. 1). Regulators failed to monitor the issue, and it continued until it became apparent that a serious economic crisis had arrived.
For instance, in June 2008, then-California Attorney General Jerry Brown sued Countrywide Financial for fraudulent business practices and deceitful promotional practices. He claimed the company used dishonesty to push homeowners into complex, risky, and costly loans. Their main goal was to sell as many loans as possible to third-party investors. Subsequently, in 2009, the Bank of America chose to modify more than sixty thousand loans offered by the firm (Amadeo, 2020, p. 1).
When home prices were reduced, the owners of adjustable-rate mortgages lacked sufficient incentive to make their monthly payments due to the disappearance of home equity. Thus, the organisation’s fiscal condition deteriorated, leading to seizure. It is true that, according to the origin and effects of the financial crisis, the event could have just as well been a business cycle. The term refers to the cyclical growth or decline of a country’s economy, determined primarily by its gross domestic product. A government can attempt to manage it by adjusting interest rates.
Following the 2001 Dotcom bubble and subsequent recession, the United States Federal Reserve reduced interest rates to the lowest level, intending to sustain economic stability (Weinberg, 2013, p. 1). With federal guidelines aimed at promoting homeownership, the rates led to a significant boost in real estate and financial markets, as well as a substantial expansion of total mortgage debt volume (Weinberg, 2013, p. 1).
Financial innovations, such as novel types of ARMs, ensured that borrowers received reasonable home loans, anticipating that rates would remain low and house prices would increase. However, between 2004 and 2006, the Federal Reserve slowly increased interest rates to maintain steady inflation rates in the economy (Weinberg, 2013, p. 1). As market interest rates rose, the new credit flow moderated.
Additionally, the rates on available ARMs and exotic loans began to reset at significantly higher rates than most borrowers had anticipated. This resulted in the bursting or damage of the housing bubble. During the mid-2000s, when the U.S. housing boom occurred, banks had already been promoting mortgage-backed securities and expensive derivative products at unprecedented levels. Following the 2007 collapse of the real estate market, the securities’ values dropped significantly (Hlaing & Kakinaka, 2018, p. 227).
Furthermore, as the credit crisis emerged, the markets responsible for funding the housing bubble experienced a downturn. Over-leveraged financial institutions immediately lost their ability to fulfil their long-term financial obligations, for example, Bear Stearns in 2008 (Hlaing & Kakinaka, 2018, p. 228). Later in the year, Lehman Brothers, one of the top investment banks, declared bankruptcy, which became contagious to other countries worldwide.
Recovery Efforts
To achieve recovery, the British government developed and implemented effective economic policies. After the crisis, it announced a package worth more than $800 billion to rescue the banking sector (Wiß, 2019, p. 508). After two weeks of instability leading up to September’s end, the first week of October saw significant drops in the stock market and serious concerns about the stability of banks in the United Kingdom.
The plan restored confidence and helped stabilize the banking sector. Additionally, it provided various short-term loans to the taxpayer and guaranteed interbank lending (Wiß, 2019, p. 509). The government purchased shares in some financial institutions, which have been sold and are profitable to the taxpayer. These methods helped the country’s economic situation and, thus, were effective.
Conclusion
Even though it has been more than ten years since the 2008 financial crisis, there are various lessons individuals can learn from the event. The first lesson is that risk comprehension is vital across every part of the financial system. Spreading the insured banking system’s risk and utilising insurance policies did not increase risk diversification as anticipated. Another lesson is that lending to borrowers who may be unfit to repay is a poor business decision. For example, banks tried to offer adjustable-rate mortgages to parties who could not afford them.
Reference List
Amadeo, K. (2020). 2008 Financial Crisis, pp. 1. Web.
Hlaing, S.W. and Kakinaka, M. (2018). The financial crisis and financial policy reform: Crisis origins and policy dimensions. European Journal of Political Economy, 55, pp. 224-243. Web.
Weinberg, J. (2013). The Great Recession and its aftermath. Federal Reserve History, pp. 1. Web.
Wiß, T. (2019). Reinforcement of pension financialisation as a response to financial crises in Germany, the Netherlands, and the United Kingdom. Journal of European Public Policy, 26(4), pp. 501-520. Web.