Deregulation in the financial sector was the primary driver of the 2008 financial crisis because it gave banks the power to fund trading activities with derivatives. As a result, banks raised their mortgages to cushion the derivatives sales, which brought more profit (Bernanke 251). Similarly, the move encouraged more borrowing by subprime customers because the loans were interested only. In 2007, housing prices began to fall due to the balance between demand and supply failure. This sudden increase in mortgage prices trapped homeowners who failed to service the loans and could not sell their houses (Lane and Milesi-Ferretti 189). Due to the crumbling of the housing prices, the banks delisted each other and stopped lending money which created the financial crisis and later the massive recession.
Deregulation
The financial modernization Act of 1999 repealed the Glass-Steagall Act of 1993, allowing banks to utilize their stock and deposits to invest in profitable derivatives. Bank activists requested a change regarding the financial Modernization Act to compete with foreign firms who had the freedom to trade (Bernanke 340). In return, the lobbyist promised to invest in low-risk securities which would not affect the clients. On the contrary, following the repeal and freedom to trade, big banks became sophisticated with derivatives because they wanted to make more money (Lane and Milesi-Ferretti 220). Big banks bought small banks, which made them grow into a too big monopoly to fail.
Increase of rates to subprime borrowers
At the beginning of the financial decline, the federal government resorted to raising rates on subprime borrowers and lowering their fund rates. In addition, lowering the fund rates reduced the interest rates on adjustable-rate mortgages, making the interest rates cheaper on short-term treasury bills based on the federal fund rates (Zhang and Broadstock 101239). This move delighted homeowners who could not afford conventional mortgages. But, the percentages for the subprime mortgages doubled between 2001 and 2007, and the feds started raising their rates (Lane and Milesi-Ferretti 190). As a result, homeowners were hit by loans they could not afford, and the rates kept rising further.
Effects of the Financial Crisis
Unemployment
The financial crisis led to an increase in unemployment in many countries because it expanded the economic crisis. Some countries such as Germany experienced a steady decrease in unemployment rates because they countered the financial crisis with instant solutions. On the other hand, south European countries experienced more employment crises where unemployed youth rose dramatically (Zhang and Broadstock 101239). Similarly, Baltic and Anglo-Saxon countries were the worst hit because of their constant dependence on the outside countries and high account deficits. According to the European statistics, temporary workers accounted for 44% of people who lost their jobs despite contributing to 14% of the total workforce in Europe (Bernanke 259). The crisis was more challenging on younger workers and those under contracts, as they would always fall the first victims to lose jobs.
Debt Crisis
Popular countries such as Greece, Ireland, Italy, Portugal, and Spain had extravagant fiscal irresponsibility when the economic cycle was favorable, leading to an increase in bond rates to control perceived risks in debts. The rising interest rates became unbearable, forcing the countries into foreign borrowing from IMF and the EU (Zhang and Broadstock 101239). However, the same financial institutions needed government engagement in the authentication of the programs, the liberation of the labor market, restructuring welfare, and bringing order in finances (Lane and Milesi-Ferretti 189). In addition, the countries’ accounts’ imbalances led to currency devaluation, which makes exports cheaper and imports more expensive. Thus, the crisis led to an increase in interest rates which affected the exports and imports, pushing the countries into debts.
Due to the crumbling of the housing prices, the banks blocklisted each other and stopped lending money which created the financial crisis and later the massive recession. Deregulation and increase in fund rates for subprime homeowners are the major drivers that led to the financial crisis. Freedom to trade with the float and deposits led to uncontrolled growth leading to monopolies that affect the financial markets. As a result, the problem led to a higher rate of unemployment and an increase in debts because the affected countries failed to maintain a balance of demand and supply. Thus, the crisis occurred due to irresponsible fiscal accounting and uncontrolled freedom, which led to the exploitation of the poor economies by bigger banks.
Works Cited
Bernanke, Ben S. “The Real Effects of Disrupted Credit: Evidence from The Global Financial Crisis.” Brookings Papers On Economic Activity, vol. 2018, no. 2, 2018, pp. 251-342. Project Muse, Web.
Lane, Philip R., and Gain Maria Milesi-Ferretti. “The External Wealth of Nations Revisited: International Financial Integration in The Aftermath of the Global Financial Crisis.” IMF Economic Review, vol. 66, no. 1, 2018, pp. 189-222. Springer Science and Business Media LLC, Web.
Zhang, Dayong, and David C. Broadstock. “Global Financial Crisis and Rising Connectedness in The International Commodity Markets.” International Review of Financial Analysis, vol. 68, 2020, p. 101239. Elsevier BV, Web.