Summary Subprime mortgage bubble The precipitating factor for the Financial Crisis of — was a high default rate in the United States subprime home mortgage sector — the bursting of the "subprime bubble". While the causes of the bubble are disputed, some or all of the following factors must have contributed.
This financial crisis had several negative impacts on banks, financial institutions, households, businesses and the global economy. For instance, many banks incurred substantial losses, and some were even forced into bankruptcy, like Lehman Brothers.
In addition, banks lost a large amount of capital as consumers lost faith in the entire system.
The effects of the crisis are shown in the diagram below. Moreover, one of the consequences was that many non-bank financial institutions such as pension funds, insurance companies and finance companies are now subject to stricter regulatory requirements due to the introduction of new rules and regulations.
Furthermore, the financial crisis affected households significantly as consumer confidence fell, thus this reduced consumption.
Consequently, the profits of many firms fell, meaning that they began to lay people off and hence unemployment increased exponentially.
Households had a lower disposable income or had to sign up for unemployment benefits. Unemployment rose sharply in the US and the Eurozone. In addition, the crisis affected businesses worldwide as the demand for their goods and services fell on account of consumers being reluctant to spend due to uncertainty regarding the state of the economy and job prospects.
Hence, the financial crisis affected the economy globally — the total value of goods and services produced fell worldwide.
Consequently, unemployment rose in many countries and government revenues which partially comes from income and corporation taxes fell during the financial crisis.
To a large the extent, the crisis was caused by selfish interests. First, the world of finance and particularly investment banking tends to attract individuals who are hard working, driven and money motivated.
Therefore, prior to the crisis, there was excessive risk taking by investment bankers, traders and bank executives. At the pinnacle of the financial crisis, the bonus culture was predominant and these groups were not focused on building a long-term relationship with clients but instead wanted to sell them as many financial products, particularly loans known as sub-prime mortgages to even the most poorly rated credit borrowers and other complex financial products and instruments such as derivatives.
Whether the client or borrower defaulted, this was of little interest to banks due to securitisation, a type of financial engineering.
Securitisation is when an asset or group of illiquid assets are transformed to a security which can be sold to investors. When these borrowers defaulted and the owners of these financial assets financial institutions, investors, pension funds, insurance companies realised that these products were essentially worthless, many firms incurred losses, individuals loss their homes and were declared bankrupt and many investors also suffered from losses.
Bonuses Besides, many bank executives were focused on achieving sales and bonus targets instead of thinking long-term performance and sustainability. Hence, different interests by not only investment bankers, traders and other parties, but by bank executives and managers too, led to the financial crisis.
Furthermore, credit rating agencies also had a part in it. Hence, credit rating agencies gave financial institutions and investors information on the riskiness, safety and quality of securities issued. However, these credit rating agencies charge a fee to banks and other financial institutions to rate these financial products.
Hence, during the financial crisis, the incentives for the agencies were to continue to stay profitable and therefore give positive ratings to many of these securities, even though they were high-risk and poorly performing.
Therefore, to a large extent, the crisis was caused by the different interests of investment bankers, traders, bank executives and credit rating agencies. On the other hand, there are several other major causes.
One major cause was a lack of financial education. When interest rates changed, many borrowers defaulted. In addition, many investors and other financial institutions did not fully understand the financial products sold to them. Hence, when the housing bubble burst and many of homeowners defaulted, these securities were of little value.
Another major reason were the monetary policies leading up to the financial crisis, particularly in the US. Monetary policy is the use of interest rates and the money supply via quantitative easing in order to influence the economy and aggregate demand.These are the slides from a revision webinar for A Level economics that looked at some of the major consequences of financial crises.
For example, the Global Financial Crisis in was initially focused on the housing market (an asset price bubble) but then spread into the commercial banking system and onto government debt problems.
The impact of the global financial crisis on the world’s poorest.
Martin Ravallion, Growth impacts of the crisis. The poverty impact of the crisis in a given country will depend on how it affects both average consumption and the distribution of consumption relative to the mean. The World Bank has made projections for average consumption.
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