Introduction
In 2008, the world began the financial and economic crisis, which manifested in the form of a substantial decline in the leading economic indicators in most countries with developed economies, which subsequently escalated into a global economic recession. The emergence of the crisis is associated with several factors: the general cyclical nature of economic development, overheating of the credit market and the resulting mortgage crisis, high commodity prices, including oil, and stock market overheating. The forerunner of the 2008 financial crisis was the US subprime crisis, which affected high-risk mortgages in early 2007. The second wave of the mortgage crisis occurred in 2008, spreading to the standard segment, where state mortgage corporations refinance bank loans. A 20% drop in property prices left US homeowners nearly five trillion dollars poorer (Berberoglu, 2014). Moreover, the quotes of stock exchanges fell significantly, which affected the stock market. This is how the 2008 global financial crisis unfolded. Economists are still arguing about why it started and ended today, but most of the phenomena have been studied in sufficient detail. However, the main argument of this paper is that the collapse of the banking system caused the recession, while the consequences affected the worldwide economics.
Literature Review
At the heart of the global financial crisis that erupted in 2008 in the United States and spread all over the world at lightning speed is the collapse of the banking system. The starting point, which served as the beginning of turbulent changes, was the so-called “cheap loans”. It is known that the change in the refinancing rate in the United States is the main instrument of the state’s monetary policy. In 2003, the Fed decided to lower the refinancing rate to 1% in order to stimulate the credit expansion of banks and thus ensure a quick exit from the crisis caused by the economic recession of 1995-2001 (Berberoglu, 2014). As a result of these measures, during 2004-2006, economic growth was observed in the United States: GDP increased from 11,797 trillion USD up to 13314 trillion dollars, which amounted to 3% of the annual GDP growth (Berberoglu, 2014). The economic boom was accompanied by full employment of the population, a high investment policy, and the rapid development of high technology industry.
The lower refinancing rate enabled commercial banks to expand their credit by lending at low-interest rates. Cheap loans led to an increase in demand in the mortgage market and, as a result, to an increase in real estate prices. From 2004 to 2006, real estate prices increased by an average of 10% per year, which led to a doubling of house prices by 2007 (Berberoglu, 2014). Insufficient banking system regulation allowed financial agents to create new profit maximization tools by carrying out somewhat risky operations. One such instrument was the subprime mortgage. Subprime loans have a reduced down payment or none at all, are issued without guarantees and guarantees and do not require the borrower to provide documentary evidence of his income and property (Islam & Verick, 2011). In fact, any US citizen can get a subprime loan, regardless of their income, financial condition, and reputation.
The peculiarity of subprime loans is that they are a type of mortgage loan with a floating interest rate. By resorting to this type of lending, banks did not see the great danger lurking in providing this type of loan since, in the event of a default, the borrower could always sell the property at a higher market price and close the loan. Mortgages have thus become a public financial vehicle, a phenomenon that has created new perspectives and controversies property (Islam & Verick, 2011). In order to increase their creditworthiness, banks are beginning to look for new ways to attract financial resources to expand their credit expansion. Securitization is becoming such a new tool.
If previously issued loans were the active part of the bank balance, they are now being used as liabilities, further increasing the money supply. Banks “sell” issued mortgage loans to financial institutions specializing in securitization, thereby replenishing their lending capacity and hedging counterparty risk. Investment banks and other financial institutions buy secured mortgage loans or mortgage bonds, which pool them all and sort or tranche them, depending on risk diversification, into less risky, medium risk, and risky. This type of security is called a collateralized debt obligation.
The reduction of the refinancing rate to 1% meant not only cheap loans but also deposits with a low-interest rate. In search of more good placements of their financial resources, investors begin to buy SDOs, believing that investing in real estate-backed securities is less risky than other securities, such as shares. Demand for bonds backed by debt obligations stimulates an increase in supply from investment banks, which, in turn, creates conditions for issuing more mortgage loans. Thus, the American economy becomes a debt-based credit expansion and a lightning-fast non-cash money supply. This financial model does not lead to sustainable economic development but, on the contrary, is fraught with a real threat of default, which happened in 2008.
Since 2006, real estate prices have been falling. According to Standard & Poor’s, the fall was 20% of the market value of 2006. In addition, after making sure that the US economy is already out of recession and on the path of economic growth, the Fed is changing financial policy in favor of limiting the credit expansion of banks, raising the rate refinancing from 1 to 5.25%, which leads to an increase in the interest rate on loans (Stiglitz, 2010). The change in the economic situation also led to an increase in the interest rate on already issued sub-standardized loans.
All these changes led to borrowers with low solvency being unable to meet their credit obligations. The low market value of the house also prevented them from closing the loan by selling the property. This economic situation led to an increase in the number of defaults and, as a result, to the transfer of real estate into the bank’s ownership. Some solvent borrowers, according to an analysis of the current problem in the real estate market, stopped paying interest on the loan, not seeing the point in paying an amount that vastly exceeds the actual market value of the house. The default of borrowers led to the collapse of not only the mortgage market but also the market for mortgage-backed securities and, as a result, to a drop in investment and the bankruptcy of many financial companies (Stiglitz, 2010). Thus, by 2008, a difficult situation had developed in the United States, a kind of “debt hole,” which led to the most devastating crisis since the Great Depression.
The global financial crisis severely impacted the functioning of the entire world economy. World GDP by 2009 decreased by 5.8% from the level of 2007 (Arpino & Obydenkova, 2020). According to the ILO, the world unemployment rate increased by 0.8% compared to 2008, amounting to 6.6% (Arpino & Obydenkova, 2020). By 2008, the unemployed amounted to about 15 million. Public debt increased sharply due to borrowing to cover the budget deficit associated with the collapse of national currencies, as well as a sharp reduction in income (Arpino & Obydenkova, 2020). The direct consequences of the crisis also include – a decrease in trade volume, volatility in commodity prices, a fall in the value of financial assets, a global fall in real estate prices, an outflow of capital, low liquidity, a current account deficit in the balance of payments, an increase in the cost of loans, a sharp decrease in direct investment, a decrease in profitability from the tourism industry, declining remittance receipts, sharp declines in export earnings, and payments imbalances. According to OPEC estimates, global demand for crude oil fell by 1.3 million barrels per day, which reduced production.
According to the UN, a distinctive feature of this crisis is that, due to the high degree of globalization and integration of national economies, the crisis has equally affected both developed and developing countries. However, the poorest countries, whose economies depend on external financing and international trade, were most vulnerable to the economic downturn. In Europe and North America, growth rates decreased from 3.2% to 0.9% in 2008 to -3.7% in 2009. Only by 2010 did economically developed countries manage to overcome the crisis in the economy and enter the path of economic growth with GDP growth of up to 2.6% (Arpino & Obydenkova, 2020). In most developed countries, unemployment remains reasonably high, averaging around 10%. The highest rate falls in Spain, where the share of unemployed in 2009 was 14%. The lowest unemployment rate is seen in the Netherlands, where it amounted to 2.9% in 2009.
In 2008, ORS accounted for almost 1.5 trillion. US dollars, or more than 76% of the world’s foreign direct investment. In 2009, their total volume almost halved to $780 billion. In 2008, foreign direct investment was sent to the EEC countries in the amount of almost 1.1 trillion USD; this accounted for more than 61% of the world’s inflow of foreign direct investment (Arpino & Obydenkova, 2020). The crisis also had a negative impact on the development of trade. In the US, exports fell by 15% and imports by 17%; in the EU, both exports and imports fell by 15% (Arpino & Obydenkova, 2020). In some countries, such as Ireland, Spain, Greece, Portugal, and Italy, there was an increase in the state budget deficit, which led to a new round of economic recession, but already in the EU.
According to ECOSOC, from 2008 to 2009, in Latin America and the Caribbean, there was a decline in GDP by 1.9% or 3% per capita. The decline in economic growth was reflected in the structure of employment of the population, an increase in unemployment to 8.3% (Arpino & Obydenkova, 2020). Due to the decline in prices for raw materials and goods of material production and the increase in exchange rates in Latin America, there is a sharp drop in aggregate demand and, as a result, a decrease in inflation from 8.3% in 2008 to 4.3% by 2009 (Blanco, 2010). Foreign direct investment decreased by 39.1% (Blanco, 2010). The experts also noted a decrease in business and consumer expectations, which further worsened the investment climate and influenced changes in the demand structure.
Involvement in foreign trade makes Asian countries dependent on the economic situation in the world. A sharp drop in demand in the American market affected the reduction in production in Asian countries and, as a result, negatively impacted the region’s development. There is a sharp drop in prices for agricultural products, in particular, cereals, by up to 50%, thereby undermining the economy of several Asian countries, the main branch of specialization of which remains agriculture (Wan, 2010). The economic downturn caused GDP growth in the region to fall from 6.8% to 4.1% (Wan, 2010). The decline in economic activity led to a sharp jump in unemployment and, consequently, to socio-political unrest in the region. Demonstrations swept through some Asian countries in a wave, further exacerbating the economic situation in the region and undermining state authority.
Analysis
Regarding the consequences, it should be said that the crisis affected a considerable number of countries, especially countries with developed economies. In general, the consequences of the crisis include an actual drop in global economic indicators: a decrease in global GDP, a decrease in world trade, a decrease in production, recessions in many countries of the world, a decrease in economic activity, and a fall in real estate prices. Of the countries of the Eurozone, Greece suffered the most significant losses due to its violation of fiscal policy and the EU member states that were divided and unprepared for solidarity actions.
Measures to overcome the crisis in individual countries differed, but most countries relied on monetary policy to overcome the 104 crisis. As alternative measures to overcome the crisis, the proposal of Paul Krugman was considered, who argued that during a crisis, one should not be afraid of spending; on the contrary, one should spend, not save. However, this view is highly controversial and has been criticized by many leading economists. The global trend after the acute phase of the crisis in 2008 was the weakening of the middle class in the world, while before the crisis, its share in the total volume of world wealth remained stable for a long time.
The main advantages of the crisis, which can positively affect almost all companies, are the following: the possibility of attracting more professional staff on favorable terms; reduction in the cost of certain types of services used by the company; using an ostrich development strategy. The latter assumed global optimization and cleaning because, on the one hand, everyone panics and reduces their marketing activity and works on developing the management system. However, on the other hand, the costs of these activities are becoming less. Therefore, these tasks can be solved at a lower cost during a crisis and improve their competitive position since most companies will not do this.
Conclusion
Thus, the crisis of 2008-2009, which broke out in the United States due to the collapse of the banking system, echoed around the world, leading to a sharp decline in global GDP, an increase in unemployment, a reduction in foreign direct investment, a fall in global currency and stock markets, and an increase in social – economic tension in the world. This crisis showed the vulnerability of national economies and their dependence on the world situation in the context of integration and globalization, thus proving the low effectiveness of the current regulation of financial flows.
References
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Berberoglu, B. (Ed.). (2014). The global capitalist crisis and its aftermath: The causes and consequences of The Great Recession of 2008-2009. Ashgate Publishing, Ltd.
Blanco, L. (2010). Latin America and the financial crisis of 2008: lessons and challenges. Pepperdine Policy Review, 3(1), 8. Web.
Islam, I., & Verick, S. (2011). The great recession of 2008–09: Causes, consequences and policy responses. In From the great recession to labor market recovery (pp. 19-52). Palgrave Macmillan, London. Web.
Stiglitz, J. E. (2010). Interpreting the Causes of the Great Recession of 2008. Financial System and Macroeconomic Resilience: Revisited, 53(1), 297. Web.
Wan, M. (2010). The great recession and China’s policy toward Asian regionalism. Asian Survey, 50(3), 520-538. Web.