The Global Financial Crisis 2007-2009

Running head: THE GLOBAL FINANCIAL CRISIS 2007-2009 1
The Global Financial Crisis of 2007-2009: Effects and Causes

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THE GLOBAL FINANCIAL CRISIS 2007-2009 2
Contents
Introduction................................................................................................................................................3
Description of the Financial Crisis of 2007-2009..................................................................................3
The Start of the Financial Crisis..............................................................................................................3
The Causes of the Crisis.........................................................................................................................4
Effects of the Crisis...................................................................................................................................4
The Spreading of the Crisis all Over the World....................................................................................5
Conclusion.................................................................................................................................................5
References................................................................................................................................................6
Introduction
Financial crises are a common occurrence and supported by different literature
(Thakor, 2015). Despite being familiar with them, the 2007-2009 financial crisis shocked
almost the entire world. It began in around August 2007 when investors unconfident in
the scrutinized mortgage value in the U.S resulting to crisis in liquidity. As a result, the
Bank of England, Europe Central Bank, and the U.S Federal Reserve injected the
financial markets with huge capital. In 2008, there was a crash in the international stock
markets further deepening the crisis leading to increased volatility that saw the closure
of most financial companies (Thakor, 2015). With the help of affected companies and
other examples, this report aims to discuss the causes and effects of the crisis while
paying attention to how it began.
Description of the Financial Crisis of 2007-2009
The financial crisis began in the U.S due to a break down of the housing market
that resulted into intense contraction of liquidity in the international financial markets.
The international financial systems faced a threat of destruction as failure was noted in
many areas such as commercial banks, insurance companies, associations of loans
and savings, mortgage lenders and other investment platforms. For instance, the
Lehman Brothers investment bank in the U.S filed bankruptcy while the government
bailed out insurance companies such as AIG and other companies such as Wachovia
bank were sold (Greenbaum, Thakor & Boot, 2016). Such financial failures in these
areas abruptly led to a great recession that turned out to be worse than the Great
depression in the 1930s (Thakor, 2015).
The Start of the Financial Crisis
According to Greenbaum et al. (2016), the financial crisis of 2007-2009 began as
a result of ignorance from the banks and the government. The housing prices began
falling in July 2006 with every month turning out to be a bad one for the mortgage
market. It was assumed that the Federal Reserve had increased funding and in January
2007, the prices of homes increased again. However, since things were not progressing
well, in February, 2007, Greenspan predicted the possibility of a recession in the later
months of 2007 but there were still false hopes from the Federal Reserve (Fed) that the
economy would rise. The Fed was ignoring the warning signs of the collapsing stock
market and investment losses from hedge funds. Thus, banks such as Freddie Mac
continued lending money to borrowers until they filed bankruptcy. Yet, the borrowers
were not in a position to pay back but continued acting as preys for the banks.
Meanwhile, the government, in an effort to restore liquidity failed to regulate the housing
market. This led to the entire banking system having loans that could not be repaid with
unmet obligations which later contributed majorly to the financial crisis.
The Causes of the Crisis
From studies, there exists a common agreement that the crisis was majorly
caused by credit boom and housing bubble (Acharya, Philippon, Richardson, & Roubini,
2009). In the first case, the capital markets experienced a mispricing in the sense that it
was believed that the short-term volatility would remain low. The increased growth of
new capitalist societies across the world particularly Eastern Europe, China, and India
brought a global imbalance that facilitated the mispricing. On the other hand, there were
another set of countries that were consumer oriented namely Australia, the U.S and the
Western Europe. Also, there were other nations that were growing fast in terms of
investment and savings. As a result, the capital obtained from the consumer-oriented
countries formed the assets of the capitalists resulting into huge liquidity with low
spreads and low volatility.
In the second case the Federal Reserve (Fed) and some central banks had
made some mistakes in the previous decade before the crisis. Fed decided to lower the
rate of its funds significantly for a longer period. Acharya et al. (2009) report that such a
move led to credit and housing bubble. With low rate of funds, banks availed cheap
loans to people. Yet, Fed and other regulators were not controlling the mortgage
markets requirement standards and supported various financial innovations that
included lack of down payments in accessing houses, no verification, be it of job,
assets, or income among others (Acharya et al., 2009). Thus, in the long run, credit was
widely available with poorer loan qualities.
Effects of the Crisis
Thakor (2015) reports that the effects of the crisis can be categorised into three
parts namely low demand of house-hold credit, low supply of credit and low corporate
investment and increased unemployment. Beginning with the credit demand, it should
be noted that the relaxed regulations on credit access increased the debt of various
households in the U.S. This interfered with the balance sheet of households leading to
eroded net worth which ended up reducing the consumption rate. Secondly, the banks
experienced a decline in the supply of credit. This led to an increase in the credit price
particularly from commercial banks that had huge losses. As a result, it would be hard
for firms to access credit and expenditures such as paying employees became hard
hence unemployment. Thirdly, almost 9 million jobs were lost in the period between
2008-2009due to reduced corporate investment resulting from low credit supply
(Thakor, 2015). This led to industries such as the U.S automobile were hit hard with a
major reduction in the sales of cars.
The Spreading of the Crisis all Over the World
In my opinion, the worldwide spread of the crisis was due to unconventional measures
that banks took. The central banks all over the world collaborated to support financial
institutions with the hope of stabilizing the interbank. But, from a personal point of view,
this never solve the problem since central banks across Canada, China, England,
Switzerland, European Central Bank and Sweden resolved to reducing discount rates.
In the long run banks that would not such as Lehman Brothers and IndyMac Bank
withstand the financial meltdown filed bankruptcy.
Conclusion
The financial crisis of 2007-2009 that just began with the need to see everyone own a
home taught countries many financial lessons. One evident lesson is that it is hard to
restore the confidence of a financial market once it has collapsed. Based on this report,
it is evidently clear that financial institutions can suffer liquidity crisis which can result to
solvency crisis. However, one evident factor is that markets have never lost hope. They
emerge strong after every crisis and establish new begins that take them back to the
ladder of success.
References
Acharya, V. V., Philippon, T., Richardson, M., & Roubini, N. (2009). Prologue: A Bird's‐
Eye View: The Financial Crisis of 2007–2009: Causes and Remedies. Restoring
financial stability: How to repair a failed system, 1-56.
Greenbaum, S., Thakor, A., & Boot, A. (2016). Contemporary financial
intermediation (3rd ed., p. Chapter 14). Amsterdam: Academic Press/an imprint
of Elsevier.
Thakor, A. (2015). The Financial Crisis of 2007–2009: Why Did It Happen and What Did
We Learn? Review of Corporate Finance Studies, 4(2), 155-205. doi:
10.1093/rcfs/cfv001

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Running head: THE GLOBAL FINANCIAL CRISIS 2007-2009 1

The Global Financial Crisis of 2007-2009: Effects and Causes

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