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« on: June 04, 2013, 11:51:04 AM »
Many factors directly and indirectly caused the ongoing financial crisis (which started with the US subprime mortgage crisis). The complexity and interdependence of many of the causes, as well as competing political, economic and organizational interests, have described the crisis differently. One category of causes created a vulnerable or fragile financial system, including complex financial securities, a dependence on short-term funding markets, and international trade imbalances, high corporate and consumer debt levels. Still, others represent shocks to that system, such as the ongoing foreclosure crisis and the failures of key financial institutions. Regulatory and market-based controls did not effectively protect this system or measure the buildup of risk. Some causes relate to particular markets, such as the stock market or housing market, while others relate to the global economy more broadly.
1 The U.S. Housing Bubble and Foreclosures
Between 1997 and 2006, the price of the typical American house increased by 124 %( Wales, 2007). This housing bubble resulted in quite a few homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation. By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak (Wales, 2008). Easy credit, and a belief that house prices would continue to appreciate, had encouraged many sub prime borrowers to obtain adjustable-rate mortgages. These mortgages enticed borrowers with a below market interest rate for some predetermined period, followed by market interest rates for the remainder of the mortgage's term. Borrowers who could not make the higher payments once the initial grace period ended would try to refinance their mortgages. Refinancing became more difficult, once house prices began to decline in many parts of the USA. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default. During 2007, lenders had begun foreclosure proceedings on nearly million properties, a 79% increase over 2006. This increased to 2.3 million in 2008, an 81% increase in 2007. As of August 2008, 9.2% of all mortgages outstanding were either delinquent or in foreclosure (Wales, 2009).
2 Sub-prime Lending
Both government and competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis. Major U.S. investment banks and government sponsored enterprises like Fannie Mae played an important role in the expansion of higher-risk lending. Subprime mortgage payment delinquency rates remained in the 10-15% range from 1998 to 2006, then began to increase rapidly, rising to 25% by early 2008 ( Christian, 2009).
3 Consumer and Household Borrowing
U.S. households and financial institutions became increasingly indebted or overleveraged during the years preceding the crisis. This increased their vulnerability to the collapse of the housing bubble and worsened the ensuing economic downturn.
4. Housing Speculation
Speculative borrowing in residential real estate has been cited as a contributing factor to the subprime mortgage crisis. During 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an additional 14% (1.07 million units) purchased as vacation homes. During 2005, these figures were 28% and 12%, respectively (Lumsden, Koster and Yik, 2009).
5. Corporate Risk-Taking and Leverage
The way the financial institutions took advantage of easy credit conditions, by borrowing and investing large sums of money, is called leveraged lending. Debt taken on by financial institutions increased from 63.8% of U.S. gross domestic product in 1997 to 113.8% in 2007 (Claessens, Dell, Igan, and Laeven, 2010 a). In 2004 SEC decision related to the net capital rule allowed USA investment banks to issue substantially more debt, which was then used to help fund the housing bubble through purchases of mortgage-backed securities. From 2004-07, the top five U.S. investment banks significantly increased their financial leverage which increased their vulnerability to a financial shock. These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007 ( Claessens, Dell, Igan, and Laeven, 2010 b ). Lehman Brothers was liquidated, Bear Stearns and Merrill Lynch were sold at fire-sale prices, and Goldman Sachs and Morgan Stanley became commercial banks, subjecting themselves to more stringent regulation. With the exception of Lehman, these companies required or received government support.
6. Macroeconomic Conditions
Two important factors that contributed to the United States housing bubble were low U.S. interest rates and a large U.S. trade deficit. Low interest rates made bank lending more profitable, while trade deficits resulted in large capital inflows to the U.S. Both made funds for borrowing plentiful and relatively inexpensive.
7. Trade Deficits
In 2005, USA's high and rising current account (trade) deficit, resulting from USA imports exceeding its exports. Between 1996 and 2004, the USA current account deficit increased by $650 billion, from 1.5% to 5.8% of GDP (Muntasir, 2008 a). Financing these deficits required the USA to borrow large sums from abroad, much of it from countries running trade surpluses, mainly the emerging economies in Asia and oil-exporting nations.
8 Commodity Price Volatility
A commodity price bubble was created following the collapse in the housing bubble. The price of oil nearly tripled from $50 to $140 from early 2007 to 2008, before plunging as the financial crisis began to take hold in late 2008 ( Muntasir,2008 b) . Experts debate the causes, which include the flow of money from housing and other investments into commodities to speculation and monetary policy. An increase in oil prices tends to divert a larger share of consumer spending into gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth flows to oil-producing states.
9 Liquidity Crisis
The banks and financial institutions in the USA were facing tremendous liquidity crisis during the global financial crisis because of the following reasons:
Firstly, due to the influence of global financial crisis, many companies have closed their operations. As a result, people became jobless and they did not pay the loan to the banks and financial institutions.
Secondly, the Bush Administration spent a lot of money for continuing the war in several countries like Afghanistan and Iraq.
For the cause of global financial crisis, economy of many large countries was also affected with the American economy. And, all of these countries are taking many initiatives for overcoming these crises. We can show those initiatives by the following table:
Country Initiative taken
USA • Approve $700 billion rescue package for the first time
• At present again approved $1000 billion rescue fund (which will be used to purchase toxic loan or assets).
London • Approved $875 billion rescue package.
Germany • Approved $68 billion for hypo real estate Company (private resident co).
Japan • Approved $18 billion (for retrieved from financial crisis).
Russia • Approved $ 36.4 billion ( for banks)
Ireland • Government of Ireland nationalized three large bank
Mexico • Approved $4.4 billion (for economic development)
Pakistan • Approved 3200 Crore Rupees.
Korea • Approved $24.20 billion dollar
Saudi Arabia • Approved $ 1267 billion dollars
Table1: Initiatives to rescue from global financial crisis (Source: Daily Star, October 30, 20
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