Causes of the Global Financial Crisis in

The2008 global financial crisis begun in the U.S and then expandedacross the globe. It can be described as a historic event in thefinancial sector because of its devastating effects felt, both indeveloped and developing nations. The global financial crisissignificantly affected the financial systems, government budgets,economic growth and lead to decreased security in the financialmarket, as well as market confidence. Although, the root causes ofthe global financial crisis are debatable, knowledge of these causesis vital since it can help put a stop to such devastating occurrencesin the future. This paper will analyze some of the root causes of the2008 global financial crisis.

Thehousing bubble

Thehousing bubble is argued as the central element that led to theglobal financial crisis. This homemade factor reflected an expansionof the American mortgage market as lending standards had eased.However, regulation failures, growth of the shadow banking systemencouraged the creation of the housing bubble. Mortgage lendersfailed as borrowers defaulted, and some didn’t make even theinitial payment. On the other hand, house prices decreased by morethan 15% in the United States, and this meant lost wealth tohomeowners of approximately $7 trillion an amount equal to almosthalf of the GDP. As a result, many homeowners defaulted on mortgageloans causing banks suffer a liquidity crisis. Consequently, thisloss of wealth normally has extreme financial stress to the economy(Friedman 68).

Low-interestrate and low inflation

Itis argued that low-interest rate policy contributed to macroeconomicinstability, and thus triggered the housing bubbles. The FederalReserve had kept low-interest rates in America for a long time. As aresult, this encouraged financial institutions to deal with riskyassets that contributed to the bubble. Firstly, with low-interestrates housing became more affordable to individuals from all incomelevels, as demand for debt increased. However, this demand did notmatch with the bank deposits. As a result, banks sought funds fromwholesale funding markets and other financial actors. This led tofinancial institutions building up on large scale liquidity risks. Inaddition, Wall Street firms adopted compensation schemes that sawtraders paid short-term profits without considering on theirlong-term performance. No regulatory oversight was exercised by mostbanks and insurance companies when selling insurance contracts. As aresult, this environment led to liquidity issues (Kolb 128).

Lehmanbrothers` collapse, one of the biggest investment banks globally,almost froze the financial markets internationally. Consequently, thecredit crunch developed and this had a huge impact of normal bankingactivities, as investor confidence declined, causing a liquiditycrisis. Additionally, to deal with the credit crunch, the federalbank injected huge amount capital into the financial markets.Unfortunately, the crisis worsened as stock markets became highlyvolatile (Ciro 145).

GrowingGlobal imbalances

Globalimbalances are also hypothesized as one of the causes of globalfinancial crisis in the year 2008. Trade surpluses caused byexport-led growth strategy from East Asian economies, such as Chinaled to the creation of an artificially high trade and current accountsurpluses. Until 2007, the U.S-China current account deficit was in aconstant increase. Specifically, China exchange rate policy isconsidered as the main cause of the global imbalances as the nationtries to boost exports while minimizing imports (Friedman 68).

Securitizationand the subprime crisis

Securitizationmarkets are dangerous, and this practice was among the major causesof the global financial crisis in 2008. Securitization was meant toreduce banking risks through diversification. However, financialinstitutions made huge losses as a result of subprime-relatedsecuritized products, which they held as mortgage-backed securitiesin their portfolios. For example, the American International Group(AIG) was greatly exposed to underwriting credit default swaps (CDSs)(Kawai, Mayes, and Morgan 94).

Over-the-counterDerivatives market (OTC)

OTCderivatives market is also linked directly with the global financialcrisis. OTC derivatives main purpose is to support the economy andfinancial market by improving liquidity, risk pricing and riskmanagement. However, weaknesses in this market catalyzed thefinancial crises. OTC derivatives markets, particularly, creditdefault swaps were not transparent thereby, contributing to thedestabilization, as well as increased risk to the financial marketsince the market regulators were unaware of OTC counterpartiesnegotiations. As a matter of fact, the transactions wereuncontrolled, and it was easy to hide the derivative transaction fromsupervision. The increased development and marketing of new financialinstruments in America dwarfed the real economy growth as financialinstitutions attempted to take on great risks (Ciro 145).

Lackof regulation

Inthe wake of the global crisis, regulation failures marred the USfinancial system. Essentially, regulation was weak as largebroker-dealers used their risky practices due to demolished barriersbetween investment and commercial banking thus, encouraging riskyinvestments. On the other hand, lending standards continued to weakenin the preceding years where large broker-dealers assigned own creditratings to companies. Both the investors and credit rating agenciesdid not fully evaluate the financial risks associated with newderivatives, and financial innovations in the market that contributedto the global crises. As a result, this made the financial systemvery unstable as leverage piled to dangerous amounts (Kolb 128).

Growthof inequality

Thewidening inequality of income and wealth in the American society alsocontributed to the great financial crises. Firstly, inequalities arecaused by economic system of class exploitation. Thus, the wealthysought after opportunities that are most profitable and highly riskyinvestments. As a result, this created an environment that made iteasier for development of the asset bubble. Secondly, may employeesborrowed money against their homes as families struggle economically(Friedman 68).

Insummary, it is clear that several underlying factors caused theglobal crisis. The growing imbalances helped increase the currentaccount deficit. Low-interest rates and failure to address the creditand asset prices by the central banks had a huge impact of theeconomy. Underestimated risks led to the unstable financial systems.Therefore, central banks and government have a huge role to play tomaintain financial stability through regulations of financialmarkets, as well as proper supervision.

Conclusion

Inconclusion, the global financial crisis impacts on the world’seconomies are ongoing. It consequences on the U.S economy, as well asthe globe resulting to a deep recession, include increasedunemployment as people lost their jobs. On the other hand, the fiscalposition in many countries is still strained. It is hypothesized thatthe U.S policies caused the housing bubble, as well as globalfinancial crisis. The global imbalances were a clear indication ofthe policies and structures affecting how people save in the UnitedStates.

Workscited

Ciro,Tony. TheGlobal Financial Crisis: Triggers, Responses and Aftermath.Farnham, Surrey: Ashgate Pub, 2012. Print.

Friedman,Jeff. WhatCaused the Financial Crisis.Philadelphia: University of Pennsylvania Press, 2011. Print.

Kawai,Masahiro, Mayes, David G. and Morgan, Peter J. Implicationsof the Global Financial Crisis for Financial Reform and Regulation inAsia.Cheltenham: Edward Elgar, 2012. Print.

Kolb,Robert W. Lessonsfrom the Financial Crisis: Causes, Consequences, and Our EconomicFuture.Hoboken, N.J: Wiley, 2010. Print.