GLOBAL FINANCIAL CRISIS 2007–2008
.jpg)
INTRODUCTION :- The mid-2007 to early-2009 era of high stress in the world's banking institutions and financial markets is referred to as the global financial crisis (GFC). A decline in the US home market during the GFC served as the impetus for a worldwide financial crisis that expanded from the US through connections in the global financial system. Many banks experienced significant losses and needed assistance from the government to stay afloat. As the major industrialised economies went through their biggest recessions since the Great Depression in the 1930s, millions of people lost their employment. Additionally, compared to other recessions that were not accompanied by a financial crisis, the recovery from the crisis was much slower.
WHAT WAS THE CAUSE OF GFC ?
As with all financial crises, a variety of factors explain the GFC and its severity, and people are still debating the relative importance of each factor. Some of the most important aspects are as follows:-
1. Taking excessive risks in a favourable macroeconomic environment
Economic conditions in the United States and other countries were favourable in the years preceding the GFC. Economic growth was strong and stable, and inflation, unemployment, and interest rates were all low. House prices rose dramatically in this environment.
Expectations that house prices would continue to rise led households, particularly in the United States, to borrow excessively to buy and build houses. A similar expectation for house prices led European property developers and households (including Iceland, Ireland, Spain, and some Eastern European countries) to borrow excessively. Many mortgage loans, particularly in the United States, were for amounts close to (or even greater than) the purchase price of a home.
Investors looking for quick profits by "flipping" homes and "subprime" borrowers (who have higher default risks due mostly to their income and wealth being relatively low and/or they have previously missed loan repayments) accounted for a significant share of such hazardous borrowing.
For a variety of reasons, banks and other lenders were prepared to issue growing numbers of riskier loans:- Individual lenders competed more fiercely to offer ever-larger housing loans, which at the time appeared to be quite profitable given the booming economy.
- Many lenders who offered mortgages did not carefully examine the applicants' capacity to repay their loans. This also demonstrated the popular expectation that the favourable circumstances would persist. Lenders also had little motivation to exercise caution when making loans because they did not anticipate suffering any losses. Instead, they offered investors a sizable number of loans, typically packaged into securities known as "mortgage-backed securities" (MBS) and made up of thousands of different home loans of variable quality. MBS products grew more complicated and opaque over time, yet external organisations maintained to rate them as being extremely safe.
- Investors who bought MBS products believed they were purchasing a very low risk asset because it was believed that most mortgage loans in the package would be repaid, even if some of them were not. Large US banks as well as international banks from Europe and other nations that desired larger profits than could be attained in their home markets were among these investors.
2. Increased borrowing by investors and banks.
Up until the Great Financial Crisis, banks and other investors in the US and overseas borrowed more money to increase their lending and buy MBS securities. Leverage increases when money is borrowed to buy an asset, which can increase both potential gains and losses. [1] As a result of taking on so much debt, banks and investors suffered significant losses as housing values started to collapse.
In addition, banks and certain investors borrowed money for longer and longer periods of time, even overnight, to buy assets that were difficult to sell. As a result, they were forced to depend more and more on lenders, including other banks, who provided new loans as old short-term loans were returned.
3. Errors in regulations and policy
Economic conditions in the United States and other countries were favourable in the years preceding the GFC. Economic growth was strong and stable, and inflation, unemployment, and interest rates were all low. House prices rose dramatically in this environment.
Expectations that house prices would continue to rise led households, particularly in the United States, to borrow excessively to buy and build houses. A similar expectation for house prices led European property developers and households (including Iceland, Ireland, Spain, and some Eastern European countries) to borrow excessively. Many mortgage loans, particularly in the United States, were for amounts close to (or even greater than) the purchase price of a home.
- Individual lenders competed more fiercely to offer ever-larger housing loans, which at the time appeared to be quite profitable given the booming economy.
- Many lenders who offered mortgages did not carefully examine the applicants' capacity to repay their loans. This also demonstrated the popular expectation that the favourable circumstances would persist. Lenders also had little motivation to exercise caution when making loans because they did not anticipate suffering any losses. Instead, they offered investors a sizable number of loans, typically packaged into securities known as "mortgage-backed securities" (MBS) and made up of thousands of different home loans of variable quality. MBS products grew more complicated and opaque over time, yet external organisations maintained to rate them as being extremely safe.
- Investors who bought MBS products believed they were purchasing a very low risk asset because it was believed that most mortgage loans in the package would be repaid, even if some of them were not. Large US banks as well as international banks from Europe and other nations that desired larger profits than could be attained in their home markets were among these investors.
2. Increased borrowing by investors and banks.
Up until the Great Financial Crisis, banks and other investors in the US and overseas borrowed more money to increase their lending and buy MBS securities. Leverage increases when money is borrowed to buy an asset, which can increase both potential gains and losses. [1] As a result of taking on so much debt, banks and investors suffered significant losses as housing values started to collapse.
In addition, banks and certain investors borrowed money for longer and longer periods of time, even overnight, to buy assets that were difficult to sell. As a result, they were forced to depend more and more on lenders, including other banks, who provided new loans as old short-term loans were returned.
3. Errors in regulations and policy
MBS products and subprime loans were subject to too little regulation. Particularly, there was insufficient regulation of the organisations that produced and offered investors sophisticated, opaque MBS. Not only were many individual borrowers given loans that were too big for them to manage, but fraud was also becoming more prevalent. Examples include exaggerating a borrower's income and misleading investors about the security of the MBS products they were being offered.
Additionally, many governments and central banks failed to properly comprehend the extent to which subprime loans had been extended during the boom and the numerous ways in which mortgage losses were spreading throughout the financial system as the crisis developed.
HOW THE GFC BEGAN?
US home prices dropped, and borrowers failed to make payments
Falling US home values and an increase in the number of borrowers unable to service their loans served as the GFC's drivers. When the supply of newly constructed homes in some places began to rise quickly in the middle of 2006, house prices in the United States reached their pinnacle. The percentage of borrowers who defaulted on their loans started to increase as housing prices started to drop. Because the share of American households (including owner-occupiers and investors) with huge loans had increased significantly during the boom and was larger than in other countries, loan repayments were particularly sensitive to housing prices in the US.
Tension in the financial system
Around the middle of 2007, the financial system's stresses started became apparent. Because many of the homes they confiscated after the borrowers missed instalments could only be sold at prices below the loan total, some lenders and investors started to suffer significant losses. In a similar vein, investors actively sought to sell their holdings and became less eager to buy MBS securities. The value of MBS and, consequently, the net worth of MBS investors decreased as a result of the reduction in MBS prices. In turn, investors who had acquired MBS using short-term loans discovered that it was much harder to refinance these loans, which increased MBS selling and price reductions.
Effects to other nations
As previously mentioned, foreign banks actively participated in the US home market during the boom, buying MBS (with short-term US dollar funding). There were sizable activities by US banks abroad. These ties made it possible for issues with the US housing market to spread to the financial and economic systems of other nations.
Financial firms failing, panic in the markets
Following the collapse of the US financial institution Lehman Brothers in September 2008, financial tensions reached their height. This, along with a number of other financial institutions that failed or came close to failing at that time, caused a panic in financial markets all around the world. Due to uncertainty over who would be the next financial institution to fail and the exposure each institution had to subprime and other troubled loans, investors started to withdraw their money from banks and investment funds all around the world. As a result of everyone trying to sell at once and many institutions being unable to secure new financing, financial markets became chaotic.
POLICY REACTIONS
Up until September 2008, central banks' interest rate cuts to boost the economy after it slowed in late 2007 were the primary policy reaction to the crisis. However, with Lehman Brothers' demise and the slowdown in global development, the policy response accelerated.
Decreased interest rates
Once policy interest rates were close to zero, central banks quickly reduced interest rates to extremely low levels, frequently near zero, lent large sums of money to banks and other institutions with strong assets but no access to the financial markets, and bought a sizable quantity of financial securities to support broken markets and boost economic activity (a process known as "quantitative easing").
Expenditure increases by the government
Governments increased spending to support employment across the board and boost demand; they also guaranteed bank deposits and bank bonds to boost public confidence in financial institutions; they also bought stock in some banks and other financial institutions to avoid bankruptcies that might have exacerbated the panic on the financial markets.
Despite the greatest contraction in the world economy since the Great Slump, a global depression was avoided thanks to the governmental response. Nevertheless, countless numbers of people lost their homes, jobs, and substantial amounts of money. Additionally, compared to prior recessions without a financial crisis, many economies recovered from the Great Financial Crisis significantly more slowly.
UPCOMING :- INFORMATION TECHNOLOGY CRISIS
copyright : ABHISHEKSARDA - Fintechstock48
.jpg)
