The Financial Crisis of 2007 - Research Paper Example

Prepare a short paper on the mortgage industry and show how it is related to the financial crisis of 2007and its subsequence ramifications up to the current economic situation. The Subprime Mortgage Mess, the Housing Bubble and the Financial Crisis of 2007 Financial crisis is generally described as an abrupt decline in the worth of financial assets and their respective financial institutions. There is number of factors which give birth to financial crisis. The most common trigger noticed behind the occurrence of financial crisis is the negative behavior of investors, which includes panic, anxiety and fear. The most adverse consequence of financial crisis is that they usually have ripple effect, which means that the bankruptcy of a single major financial institution will result in collapse of many other related financial institutes. This happens because nowadays trade barriers are lower than ever before and due to technological advancements, countries are highly interdependent these days than ever before (EconomyWatch). Events Leading to Financial Crisis 2007 The 2007 financial crisis proved to be the worst financial crisis in the history of finance. Nowadays, economies are not surviving in isolation but, actually, they are interlinked and due to this reason a fluctuation in one economy can have significant impact on other countries’ economies as well. Lately, due to this reason some major bankruptcy issues were faced by countries like Italy, Greece and Egypt. In this regard, it becomes essential to get insights about the major triggers behind financial crisis so as to develop some individual backup plans in order to survive in the times of recessions and financial crisis. For each individual, it is imperative to understand the basic criteria of spending and investment during the times of recession. Subsequent paragraphs expansively provide insights about the major triggers behind global financial crisis and events that led to these crises. Major Triggers Behind Global Financial Crisis 2007 The major reason behind the occurrence of global financial crisis 2007 was the crash of the US housing markets. This situation was mainly caused by the issuance of subprime mortgage and subsequent defaults of the U.S. in the beginning of new millennium, the world’s economy faced serious concerns including terrorists’ attacks of 9/11, collapse of dot com bubble followed by recession 2007. Chairman of FED, Alan Greenspan persuaded to lower down the interest rates to just 1%. This phenomenon gave rise to subsequent problems and caused several major economic troubles. In the U.S, advantage of such lowered interest rates was taken by every citizen and mortgage brokers. They started granting loans to millions of buyers who did not have the capability of paying back those loans due to poor credit history and low level of incomes. Lowered interest rates means lowered amount of mortgage payments. These situations created a speculative frenzy of buying houses which continued till 2006. In 2006, Alan Greenspan was replaced by Ben Bernanke, as a Chairman of FED. The situations continued to persist and prices of houses continued to rise in the U.S due to lowered interest rates. Both the former and present chairman of FED, Alan Greenspan and Ben Bernanke negated the alarming sign that this bubble will burst soon giving rise to greater and new economic problems for the U.S economy, as well as the world’s economy. Mortgage brokers took absolute advantage of this condition and allowed mortgages to those buyers who, otherwise wouldn’t be in a position to qualify for home ownership. A large number of these buyers were poor people who did not have the capability of affording high prices of houses due to higher amount of interest rates. They had also not qualified earlier for being granted the loans due to poor credit history and low income. Approximately for 60% of subprime loan, there was no income authentication (Slavin). This situation resulted in loss of confidence of investors which deteriorated the condition of financial institutions and money market. Magnitude of such intense situation would result in two most possible situations: Firstly, people who had acquired loan would default because of their incapacity of paying off mortgage payments and thus, will get misplaced by losing their homes as well. Secondly, there can be a massive decline in real estate industry (Baker). The enormous losses of mortgage was mainly suffered by some major financial institutions which included JP Morgan Chase and Citigroup but besides this, investment banks, hedge funds, unregulated firms and brokerage houses also reported substantial amount of losses. Despite the fact that housing bubble came to an end very rapidly but it resulted in serious financial disturbance across the global economy. Banks reported more than $200 billion losses globally. The main reason behind the losses of such amount was the breakdown of housing bubble. The approximated figure is amounted to be as $1 trillion. The loopholes in the financial institutions and mortgage crisis deteriorated the adverse effects of recession (Baker, 2007). Not only banks, but globally stock markets also started getting fallen down. The lack of confidence of investors compelled them to shift their investments. Due to these financial crises, worldwide the investors switched from investments in equity markets to safe investments which dropped world’s stock market. The older myth of money market funds and Commercial papers considered as safe heavens were no longer the reality. In essence, financial institutions and money markets failed primarily due to lack of proper surveillance and incompatible structures of remuneration. Inadequate transparency in the procedurals of financial policies, instruments and trading resulted in market failure worldwide. After all this havoc, the question that comes to everyone’s mind is what actually triggered these financial crises? Many people argue that it occurred due to the turbulence of mortgage industry and issuance of subprime mortgages, but in genuine it is just a slight aspect of the entire situation. For past few decades, investment banks and financial institutions were speculating that the real estate prices as compared to other investment will keep on increasing. Essentiality, the network of debt crisis spread so rapidly and vastly, that an instance of default of one large firm would have ripple effect on the entire network bringing down the entire financial market. The firms were governed under FED, FDIC and other governmental authorities. None of the institution could have any clue about how much was owed to whom. In real, we may never possible know that (Baker). Government Data Pertaining to Prices of Real Estate From 1953 to 1995, Government data showed that the real estate prices essentially remained stable. Robert Schiller assembled a range of data which demonstrated that preceding 1995, the prices of real estate all over the world had remained stable for the last century. The real estate price suddenly came down by 30%, after 2002. Government’s Response in Dealing with Recession During the recessionary periods, the most important part has to be played by governments. With the help of tools like fiscal and monetary policies, government can make adequate changes in the money supply which can lead to a change in public capacity to undertake a housing loan. The Euro zone and the U.S implemented the following changes in the fiscal and monetary policy in order to prevent the housing industry from a complete collapse which includes: Reducing taxes Reducing interest rates Increasing the amount of borrowings Spending on public works and infrastructure (Shah) At the time of recession, it can be risky to make borrowing but essentially the concept behind it is that the amount of borrowings will be recovered when the economy will be at its boom. It is essential to reduce the level of interest rates so that it will persuade the general public to contribute in financial and economic activities and thus it will encourage spending. Generally, the idea of reducing tax rate is because in this way people will be able to spend more and greater tax rates can cause discouragement in spending by bringing further complications for people. Furthermore, the attempt of investing in infrastructure of the country is encouraged because it stimulates the economy by hiring more people (Shah). There is no rule of thumb in coping up with recession. Every country takes action as per the seriousness of their problem and economic condition (Shah). Globally, the economy has coped to preserve its position back to the previous pathway. The panic of higher inflation rate, shortage of food and fuel has totally outdone the fear of recession in which the developed countries are surrounded including economies of Asia, Latin America and Eastern Europe. Apart from these, many developing countries from Asia and Africa are also encompassed in it because no country has been in a place of surviving or witnessing the developing financial crisis. Global concern and harmonization is imperative since it can enhance the national policies ‘effects. In order to survive the monetary crisis, governments need to evade crafting and implementing those procedural and policies that might portray a picture of beggar-thy-neighbor. Many underdeveloped countries do not possess considerable resources to support such policies so as to endure the financial crisis. In this regard, official assistance is required to provide adequate policies in order to kick start the economy of such countries (UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATION). Concluding Remark The housing bubble started to come down after the prices of real estate industry climbed their greatest point. Thus, the housing bubble came to its end in the middle of 2006. This situation upsurge the default risk of numerous financial institutions that were predominantly related to subprime market. The financial disaster also badly influenced the housing industry. In order to recover the rising turmoil of financial crisis, unique decisions and policies have been formulated by financial experts and policymakers. Trillion of dollars all over the world, have been inserted into the economies to improve the investors’ confidence and release the credit freeze. In this regard, within the U.S deposit insurance nine banks have been publicized. Apart from these severe concerns, those industries which are associated to food and beverage industry reported serious shrinkages globally. Lastly, the consequences of this global financial turbulence amplified weak employment and poverty. Presently, the world’s economies are recuperating gradually from the worst effects of fuel and food crisis. Not only underdeveloped countries, but in fact developed countries are also facing these challenges. Many countries like Italy, Egypt and Greece are being encountered to insolvency issues. Lessons to be learnt from this entire situation is crucial for everyone. At the same time, it is necessary to take actions at economic and governmental level because these areas are beyond an individual’s scope. Financial analysts and experts suggest some strategies that an individual investors can adopt in order to survive the periods of recession. It is recommended that individual investors need to learn about making individual sensible and adequate investments and spendings. These strategies can be beneficial even for a layman to incuring secure investments and making greater amount of spendings during the times of recession. Works Cited Baker, Dean. The Housing Bubble and the Financial Crisis. 2007. Web. 6 Apr. 2012. . Dullien, Sebastian. The Financial and Economic Crisis. New York: United Nations Publications: 2010. Print. EconomyWatch. Financial Crisis, Credit Crisis, Credit Crunch. 2010. Web. 6 Apr. 2012. . Faust, Coronare Modestus. What Caused The Financial Crisis & Housing Bubble? 2011. 6 Apr. 2012. . Greenidge, Kevin. Financial Crisis 2007: What Has Been and Should Be the Nature of the Response by Countries? n.d. Web. 6 Apr. 2012. . Rahn, Richard W. What Caused the Financial Crisis. 2010. Web. 6 Apr. 2012. . Risk and Insurance Management Society Inc. The 2007 Financial Crisis. 2009. Web. 6 Apr. 2012. . Shah, Anup. Global Financial Crisis. 2010. Web. 6 Apr. 2012. . Slavin, Stephen L. Macroeconomics. 9th ed. New York: McGraw Hill: 2009. Print. UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATION. The Global Financial Crisis and the Developing World: Transmission Channels and Fall-outs for Industrial Development. 2009. Web. 6 Apr. 2012. . Read More