The 2008 Financial Crisis
The first indication that the economy was shaky came in 2006, when housing prices began to fall. Realtors were pleased with the scenario because they believed the housing market would eventually return to a sustainable level; nevertheless, they were unaware that many homeowners had suspect credit. As security, financial organizations such as banks permitted citizens to borrow up to 100% of the value of their new homes. The Gramm-Rudman Act was the primary culprit, as it permitted banks to deal in profitable derivatives offered to investors (Hubrich & Tetlow, 2015). Mortgages were used as security. The Federal Reserve thought that only housing could face the negative side of the mortgage crises; they did not know the expected damage extents. Hedge funds together with other global financial institutions owned the mortgage-backed securities which were also in corporate assets, mutual resources as well as pension funds. Derivative pricing became impossible when banks reduced initial mortgages and sold them again in tranches. Stodgy pension funds chose those unsafe assets because they thought credit default swap insurance protected them. However, AIG, a traditional insurance firm sold those swaps but later found that it did not make enough money to honor all exchanges after the value loss of derivatives. Most banks panicked after realizing that they had to take the deficits and resulted in a stoppage in lending to each other. They did not believe in other banks giving valueless mortgages as collateral because nobody wanted to get stuck holding bags and as a result, LIBOR as an interbank borrowing cost rose. The increased mistrust of banks was the primary cause of the financial crisis in 2008.
What Are the Results of Financial Crises Worldwide?
The global activities start to soften especially at the intense phase of the financial crises and eventually dampen the global economy at a significant level. Some few countries find a growth opportunity while the rest become seriously injured (Claessens et al. 2014). At the position of extreme uncertainty, investors and customer's confidence grows severely affected, and household reduces their spending particularly on manufactured products. Dept maturity, as well as leverage, declines because of finance providers and firms' adjustments to higher risks, uncertainties, and lower profits (Carvalho et al. 2015). A sharp reduction in industrial production and GDP in most of the giant economies rises. Moreover, fear concerning a reduction in long-term financial availability develops which eventually creates adverse effects on the small firm's performance and also hamper most of the fixed investments. However, policymakers argue that the fear would sound terrible if developing nations become unable to sustain growth rates. The long-term financial reduction may not be optimal because it can result in a profitable fixed investment decline as well as lover productivity development.
What is Systemic Risk?
It is the risk of disintegration of the whole market or the fiscal system; it is the system instability catastrophically caused by idiosyncratic situations in budgetary intermediaries. A condition created by interdependencies and inter-linkages in a market or the economic policies and the failure of one causes cascading shortcomings to the other, eventually forming bankruptcy or destroy the entire entity (Allen & Carletti, 2013). It is erroneously referred to as systematic risk. An example is the Lehmans' size and the integration of the US economy which later became the source of the threat. When it collapsed, it caused problems in the entire financial system and the economy as well. The capital markets stopped, and customers could not access loans, or they could get it after a proof of extreme creditworthiness to help in posing less risk to the lender.
References
Allen, F., & Carletti, E. (2013). What is systemic risk?. Journal of Money, Credit and Banking, 45(s1), 121-127.
Carvalho, D., Ferreira, M. A., & Matos, P. (2015). Lending relationships and the effect of bank distress: evidence from the 2007–2009 financial crisis. Journal of Financial and Quantitative Analysis, 50(6), 1165-1197.
Claessens, S., Kose, M. M. A., Laeven, M. L., & Valencia, F. (2014). Financial crises: Causes, consequences, and policy responses. International Monetary Fund.
Hubrich, K., & Tetlow, R. J. (2015). Financial stress and economic dynamics: The transmission of crises. Journal of Monetary Economics, 70, 100-115.
