Introduction
For the United States and the world at large, the occurrence of the global financial crisis in 2008 brought upon the greatest recession that the country has experienced since the Great Depression of the 1930s. This crisis caused a shockwave within the financial world that was barely stopped by the implementation and wide-scale use of government funds to bail out major banking institutions in order to prevent a systemic collapse of the global financial system.
Housing Bubble and the Global Financial Crisis
One of the main causes of the global financial crisis stemmed from the housing bubble that was experienced in the United States. After the occurrence of the tech bubble collapse in the early 2000s and the terrorist attacks on the United States, the Federal Reserve enabled policies that lowered interest rates in order to boost spending within the economy (Bernanke, 2010). This caused a cascading effect in which lending standards were lowered in order to allow consumers of all income levels to be able to purchase homes. Often dubbed NINJA (No Income No Job Or Asset) loans of hundreds of thousands of dollars were given to individuals who would not have been able to acquire such currency by other means (Martin, 2011).
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"Global Financial Crisis in 2008".
The huge increase in loans and drop in interest rates fueled a huge increase in the price of real estate, as investors were in the search of an investment that would be reliable in the face of the systemic collapse of tech investment within the early 2000s. The system was shaken, and investor confidence determined that the housing market would be the best area of investment due to its history of stable prices and long-term value increases in the past 30 years.
The obsession with real estate became systemic as myriad of investors would speculate on home prices. Huge housing projects were funded and created in areas that would not have otherwise supported such a housing boom; such projects raised the prices in a number of neighborhoods which incentivized non-investors to attempt to speculate in the housing market through the use of home equity and other credit lines available to consumers. As the housing bubble popped, many of these individuals with unsustainable loans were left unable to pay their debts due to the dramatic drop in housing prices that occurred.
Credit Rating Agencies
Credit rating agencies also played a significant role in the financial crisis, as they were primarily responsible for the aftereffects of the loans that were given out to consumers (White, 2010). For the vast majority of home loans, the lending institution did not hold on to them, but instead bundled them into securities and sold them off based on their credit rating. Credit ratings were assigned by credit rating agencies, which judged the veracity and reliability of the loan payments that would be made by home owners in order to determine whether the security was investment grade or not.
These agencies, however, did not maintain proper rating standards for such securities and assigned investment grade ratings to bonds that would never have passed inspection otherwise (Sinclair, 2010). By handing out false securities ratings, the demand for securities would have been significantly higher as the risk within these securities would have been obvious, rather than hidden. False credit ratings gave investors a false sense of security, as they were not aware of the significant risk that they were undertaking by investing in these items (Katz, et al., 2009). Furthermore, the rating agencies frequently had conflict of interests when involved within these operations. The investment firms who sold such securities, such as Goldman-Sachs would frequently short the very same securities that they were selling to their customers.
Derivatives
Derivatives were a new method of securitization that was used to shift the risk of an investment between parties. Due to the secretive and private nature of these derivative agreements, they were often used as methods for hiding the credit risk from a third party while protecting the counterparties within these agreements (Crotty, 2009). While this did not cause the financial crisis, it exacerbated the effects of which due to the inability of investors to properly appreciate the risk undertaken through these transactions. The use of derivatives to disguise risk posed a major problem, and significantly contributed to the lack of financial caution experienced in the pre-recession world.
The large scale use of these securities derivatives contracts by highly influential financial institutions poses a significant chance of systemic risk, as this created a culture of institutional interdependence between major firms. Simplified, the crisis within a single institution will spread the crisis throughout the system. The chain-reaction of default and collapse could triggered a systemic crisis as the proper conditions were met (Simkovic, 2010). The risk of a financial crisis was increased by the complete lack of regulation within the derivatives market.
Conclusion
In the overall picture, all three factors were critical to the creating and the occurrence of the financial crisis. Unfortunately, a number of lessons from this crisis were not learned as proper regulation of the financial industry has yet to occur. The impact on the crisis still continues to display its effect on the global economy.
- Bernanke, B. S., 2010. Monetary Policy and the Housing Bubble, s.l.: Speech at Annual Meeting.
- Crotty, J., 2009. Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’. Cambridge Journal of Economics, 33(4), pp. 563-580.
- Katz, J., Munoz, E. S. & Stephanou, C., 2009. Credit rating agencies: no easy regulatory solutions. The World Bank Group
- Martin, R., 2011. The local geographies of the financial crisis: from the housing bubble to economic recession and beyond. Journal of Economic Geography, 11(4), pp. 587-618.
- Simkovic, M., 2010. Paving the Way for the Next Financial Crisis. Banking & Financial Services Policy Report, 29(3).
- Sinclair, T. J., 2010. Credit rating agencies and the global financial crisis. Economic Sociology, 12(1), p. 7.
- White, L. J., 2010. Markets: The Credit Rating Agencies. The Journal of Economic Perspectives, Volume 4, pp. 211-226.
