Through asymmetric information hence adverse selection, financial crisis was caused by the action and inaction by the government, which created a platform over which both banks taking excessive risks specifically in the mortgage backed security market …
The risks kept building up and through the synergistic effect; they interconnected among the institutions, which in the end undermined the stability of the financial institutions. There were seven main causes that worked together to cause the 2007 financial crisis. Such included the securitization of the mortgages bringing forth to the rise in the shadow banking sector, regulatory arbitrage and conflict of interest, leverage and lower interest rates, outsourcing of mortgage broker function, the suits vs geeks’ problem and finally the bankruptcy law changes. The factors mentioned above worked as follows to cause the “perfect financial storm.” (Mishkin 2004) The securitization of mortgages was the first cause of the crisis given that throughout history it had been a trend that mortgages were issued and serviced by the same bank (Mishkin 2004). The government created Fannie Mae and Freddie Mac although both were eventually spun off as private companies to encourage home ownership by creating home loans, which were issued at quiet lower interest rates. These institutions along with other banks converted loans into securities called mortgage backed securities whereby the money paid by the borrower had to pass through the bank to the holder of the security (Mishkin and Eakins 2012). The banks were therefore able to get more funds to issues more loans by selling the loans. The selling of the loans also made them pass the risks associated by the loans to the buyers of the securities whose impacts both tended to reduce the rates of interest on the mortgages (Casti 2012). The two formally created institutions together with AIG and other financial institutions insured those securities against default through credit default swaps, which are just insurances on cars or houses. Securitization of mortgages itself wouldn’t necessarily be unsafe if only low risk mortgages were securitized but the successive administrations went on to encourage Fannie and Freddie to bundle mortgages so as to expand home ownership. Mortgage backed securities are much profitable when there is no default but with defaults insurance payouts grew and the government had to come in to bail out Fannie and Freddie plus AIG (Lounsbury 2010). Mortgage backed security market is part of the broader trend called the shadow banking where firms run from banks to direct finance due to the better rates they are likely to get (Lounsbury 2010). The participants in this sector take a greater risk as this sector is not regulated like the banking sector. These companies also lack the capital requirement that the banks have compounding the risks further so incase of anything these banks lose a lot. Through regulatory arbitrage, capital requirements reappear (Mishkin and Eakins 2012). This act occurs when financial institutions have a way of undermining the intent of regulation to increase profits like the bizarre risk rankings and the shopping for a regulator. Regulatory arbitrage combined together with the conflict of interest contributed to the growing instability of the financial sector. Poor lending practices caused by the changes within the mortgage market was a cause given that the lending authority was given to the independent contractor who were outsourced and being paid on a fee per loan. They therefore had the incentive for loaning people even without looking at their security, which banks could not do as they securitized the loans (The Guardian 2012). Recent government actions like allowing the investment banks to borrow at lower rates so that they could make profits by purchasing MBSs also contributed to the ...
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(2007 Financial Crisis Essay Example | Topics and Well Written Essays - 1250 Words)
“2007 Financial Crisis Essay Example | Topics and Well Written Essays - 1250 Words”, n.d. https://studentshare.net/finance-accounting/79907-1500-3days.
The disaster left no economies and financial systems unaffected with its drastic and harsh effect. Both developed and under developed countries felt radical effects of recession when the deficit of liquidity/cash elicited in banking sector of United States, thus, begetting the conditions of economic instability and volatility along with the crumple of financial institutions, and the downfall in stock market.
Although other countries were not directly affected by the crisis, they were still significantly affected by the crisis as their economies also crashed, the prices of oil and other commodities skyrocketed, and the banking crisis overwhelmed their economy.
Government bodies all over the world have been hit hard by the 2007 global financial crisis. The UK economy has not been any exception as the condition has become extremely volatile. The economic crisis has proved the enormous monetary loss that is associated with the collapse of the global financial stability, and has enhanced its importance as the stepping stone towards economic growth.
When considering the possible causes for this economic situation, fundamental defect of the free market system is the prominent reason for the crisis. In the US economy, a secure and sustainable economic order is not ensured by the economic regulatory. As a result, banks and financial institutions in the developed countries are not restricted from spending more than what they can afford.
The immediate cause of the crisis was rise in interest rates in the mortgage market so that people with home loans, paying adjustable interest rates, found themselves with spiraling interest payments. This in turn was the result of the liquidity crunch that banks faced as a result of growth in lending to borrowers of the sub-prime category, that is, those who had less than adequate credit worth.
ry Institutions Deregulation and Monetary Control Act of 1980 enabled financial institutions to influence the nature of monetary policies thus making the economy susceptible to non-factual policies, as was the case in 2006.
Thesis Statement: There are several fundamental
The crisis came about due to imprudent and excessive lending by the banks (Chapra, M., 2009). The crisis came about in a chain reaction that started with the mixing of subprime and prime debt and passing the entire risk to the
However, the efforts were not strong enough to save stock markets, which continued to deteriorate all over the world. The financial crisis left many people homeless globally due to evictions catalyzed by the lack of jobs and foreclosures in the
The 2007-2009 Global financial crisis threatened the collapse of some of the greatest financial institutions. The reason the effect was felt by many financial institutions is that they had invested mortgages which lead to deterioration in the balance sheet of the banks as a result of housing bubbles.
3 Pages(750 words)Essay
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