In 2007, the US entered a financial crisis, consequences of which are still suffered by the entire country. Until the crisis began and unraveled in 2008, most economists were optimistic. The US economy was growing, markets were considered to be liquid and employment levels were high. However, within one year, everything changed. According to Reavis, “the collapse of the U.S. housing market triggered the financial crisis” (3). Weak financial regulatory structure, lack of understanding the innovations in the financial sector, over borrowing and securitization of mortgages are seen as main causes of the crisis.
Though already in 2006 the Treasury recognized the need for a stronger financial regulatory structure, the crisis was unexpected. Short run potential financial market challenges together with the long run challenges were discussed by the Treasury staff (Swagel 6). The result was March 2008 Treasury Blue print for a Modernized Financial Regulatory Structure in case of policy changes in the long run (Swagel 6). Possible near term scenarios were considered, with some of them being:
market driven events such as the failure of a major financial institution, a large sovereign default, or huge losses at hedge funds; as well as slower-moving macroeconomic developments such as … a prolonged economic downturn (Swagel 6).
ge – backed securities, because “they added to the liquidity and efficiency of capital markets and made it easier for firms and investors to lay off risk” (8). The policymakers did not have a solid plan to save the economy. Moreover, the US politicians, financial regulators, and monetary authorities did not view any of the risks to be plausible threats (Obstfeld & Rogoff 6). This paper will focus on causes and solutions to the 2008 crisis. Previously mentioned causes of the crisis will be discussed in more detail. It will also be shown how causes interacted and thus also deepened and prolonged the scope and length of the crisis. As also mentioned previously, policymakers were not prepared for the 2008 crisis. Thus, solutions will be discussed as well. Prior to the crisis, the economy was over performing. According to Reavis, the US real estate markets were blooming: From the late 1990s into the mid-2000s, housing prices around the country rose at a compound annual growth rate of 8%. By 2006, the average home cost nearly four times what the average family made. (Historically, it had been between two to three times.) Demand was outstripping supply (Reavis 3). Despite flat incomes, families bought houses whose prices were rising. The Clinton administration enabled them to do so by easing the eligibility requirements (Reavis 3). Risky homeowners and the housing boom from the late 1990’s till the mid 2000’s drove the US economy’s growth through additional jobs in construction, remodeling, and real estate services ( Reavis 3). Families borrowed $2 trillion (Reavis 3). Mortgage-backed securities and credit default swaps (CDSs) became popular. A mortgage-backed security is a pool of mortgages that were bundled together and sold as securities (Reavis 7). They became