Causes of the Global Financial Crisis
After the Great Depression of the 1930's, the global financial crisis is considered among the worst in the world. The major causes of this crisis were:
- Credit market imbalances contributing to the popularity of subprime lending
- The unregulated nature of financial developments
- Weak lending by Fannie Mae and Freddie Mac
The document also notes that "overdose" is not a viable solution to the financial crisis, since lower interest rates in the first place contribute to the same issues that generated the crisis; credit becomes too inexpensive. One major cause of the current financial crisis is the global imbalances. The global financial flows have been characterized recently by the unusual unsustainable system/pattern whereby some countries including China, Japan, and Germany runs large surpluses every year while others like the United States and the United Kingdom run deficits. United States of America external deficits have been mirrored by internal deficits in the government and the household. Its borrowing cannot continue indefinitely resulting in the underlying current financial disruptions.
Bad computer models
Bad computer models are also a source of financial crisis. These bad computer models betrayed the expectation of the performance of complex structured products linked to mortgages which were based on only a few decades worth of data. In the case of subprime loans, only a few years of data were available (Mayer & Pence, 2008) and sophisticated systems were not confined to historical experience.
Lack of transparency and accountability
Lack of enough transparency and accountability in mortgage finance (Chtourou, 2015) is also another cause of the financial crisis. In the housing finance value chain, many participants contributed to the creation of bad mortgages and selling of bad securities feeling secure that they would not be held accountable for their actions. Lenders could sell exotic mortgages to homeowners without fear of repercussions if those mortgages failed and similarly a trader went sell toxic securities to investors without fear of personal responsibility if those contracts failed. It was the brokers, realtors, individuals in rating agencies and other participants each maximizing his or her gain and passing problems on down the line until the system itself collapsed. Due to lack of accountability, the originate to distribute model of mortgages finance with its once major promise of managing risk, became itself a massive generator of risk.
Financial innovation
Financial innovation is another cause of the global financial crisis (Boz & Mendoza, 2014). The new instruments in structured finance developed so quickly that the market infrastructure and systems were not prepared when those systems came under use. Others proposed that the market in the new instruments should be given time to grow before they are permitted to attain a systematically significant size. This means giving rating agencies, regulators, accountants, and settlement systems time to catch up with this financial innovation. The tax policy was also a major factor that fueled the housing bubble. Tax deduction from a home mortgage is one of the most items for taxpayers that remained unmoved when other deductions for interest like car loans and credit cards reduced. This policy has led to increasing in the number of financial institutions offering home equity loans as an option for lending off high, nondeductible consumer debt. House bubble was fueled by the Clinton administration which passed a tax bill which gave house owners the right to take up to $500,000 tax-free profits. This policy fueled house bubble and caused a significant increase in home values.
Low-quality lending
Low-quality lending's at Fannie Mae and Freddie Mac is another cause of the financial crisis (Crawford & Forsyth, 2015). The government of United States of America urged both government-sponsored enterprises- and private financial created by Congress to increase the asses to credit for borrowers by buying and guaranteeing low-quality loans. In connection to this, Fannie Mae eased credit to give mortgage lending to increase home ownership among those who did not qualify for a conventional loan. Therefore, millions of borrowers whose credit was unworthy were extended loans for which they did not qualify for the interest rate they could not afford.
Structural changes in the banking industry
The structural changes in the banking industry is another cause of financial crisis experienced. The banks have increasingly discarded their traditional mode of financing loans and investment with deposits they correct and have become brokers for loan origination. The banks began setting free-based conduits-pools float investment options to issue commercial papers to investors and companies seeking relatively safe and short-term investments. Originally, these conduits assets from one company or bank increasingly consisted of subprime mortgages and subprime mortgage securities. Unlike the other structured investment vehicles (SIVs), the conduits were off balance sheet and therefore went unreported, and these SIVs began to collapse when the subprime-mortgage crisis hit. This shadow banking system or off-the-balance-sheet process outside of the regular banking system has contributed to the recession.
Financial institutions holding more debts than capital
Financial institutions being allowed to hold much more debts than capital is another cause of financial crisis. A leverage ratio is a way of measuring the finance of a company's debt to a capital inflow formulated as Average of Total Assets/Average of total equity. For instance, by the closure of 2007, the leverage ratio of the reported assets of Morgan Stanley was 32.6 to 1, and others found themselves in the similar situation. The problem of holding more debts than the capital stemmed from April 2004 meeting between bank executives and U.S government official. They agreed to allow five of the largest investment banks to increase their leverage ratios, and in return, they agreed to additional monitoring of the financial companies.
Corruption and poor performance at bond rating agencies
Corruption and poor performance at bond rating agencies are another cause of financial crisis. The three largest bond rating agencies, the Standard and Poor's, Fitch and Moody's took significant payments from firms that packed and sold risky mortgage based securities leading up to the financial crisis. Due to this, these agencies gave AAA ratings to many low-quality assets which enabled financial institutions to see them at a good price in the global market. This corrupted rating process also got experienced in the U.S multinational insurance corporation (American Insurance Group). Other causes of the financial crisis were the corrupt banking. The banks started manufacturing money and lending it to people at interest. This led to increasing financial crisis due to counterfeit money produced by the banks instead central bank.
Growth in lobbying
Another cause of the financial crisis is the growth in lobbying. Many financial institutions including Citigroup, Wells Fargo, Countrywide and the Mortgage Bankers Association spent heavily on lobbying and gave millions in political donations in their fight against state lending restrictions. President Bush and members of Congress received donations totaling to $ 200,000 and $645,000 respectively from Ameriquest and other big subprime lenders. The contributions of these institutions won the way and the lobby increased which led present financial crisis. Another cause is the lack of trust in the market. Evidenced by Ann (2008) the United States of America suffered from the lack of confidence in the system rather than a shortage of liquidity as claimed by Federal Reserve. This crisis emerged because of lack of faith in the ability of borrowers to repay their debts. The primary problem for the market involved the uncertainty that the balance sheets of financial firms were credible.
Off-balance sheet finance
Off-balance sheet finance is another cause of financial crisis because many banks established off-the-books special purpose entities to risky speculative investments which allowed the banks to make more loans during the expansion. Other institutions were exempt the banking system built up financial status concentrated on borrowing short and lending long. They underwent vulnerable to liquidity risk in the form of non-bank runs. This means that they could fail if the markets lost confidence and refused to extend or roll over short-term credit.
Overdose as a tool for the global economic crisis
Overdose in the economy means the governments are lowering interests' rates so that everyone can afford to get a loan. It means that when world's financial bubble blew, a solution is to lower interest rates and pump trillions of dollars into the imperfect world banking systems (Ciro, 2016). When things do not go as planned by the government, it goes ahead to promise the public the biggest financial stimulus package and pumps trillions into the banking systems that was already in trouble. This is like having the solution being the problem, and that's why there is a problem in the first place. It's like giving money for nothing. Overdose is the attempt of the governments by all means to save the banks, but another question emerges out on who can save the governments?
Overdose will not be the solution to the almost collapsing world economy. It is like seeking people seeking strong leaders and simple solutions in times of crisis. This is because money is not merely a tool of oppression. Overdose means giving people money for nothing, and it should get noted money itself cannot, for instance, compel oil to pour forth from the ground. Neither can it refine that oil or transmute it into refined products ready for use by the final consumers. A better solution would be maximizing on the natural resources to extract them to the maximum. This significantly will lead to more gross domestic output increasing the county's production and exports respectively.
References
Mayer, C. J., & Pence, K. (2008). Subprime mortgages: what, where, and to whom? (No. w14083). National Bureau of Economic Research
Chtourou, H. (2015). The US home mortgage market during the financial crisis. International Journal of Computational Economics and Econometrics, 5(4), 392-405
Boz, E., & Mendoza, E. G. (2014). Financial innovation, the discovery of risk, and the US credit crisis. Journal of Monetary Economics, 62, 1-22
Crawford, P., & Forsyth, J. (2015). Was there a regulatory approval market for mortgages?. Journal of Financial Economic Policy, 7(4), 354-365
Ciro, T. (2016). The global financial crisis: Triggers, responses and aftermath. Routledge
