The Causes of the Credit Crisis - Essay Example

?Insert Insert Grade Insert The Causes of the Credit Crisis Introduction The global economy has been a subject of interest to many people and the previous and current turbulence in the economic front of nations has made this issue as subject of many debates. Many have assigned the year 2004 as the year of the great credit crisis that first had a toll on the United States’ financial sector before other parts of the globe had its impact. However, there are indications that the credit crisis of the year 2004 was just a climax of a historically influenced turbulence in the world’s financial market that began with the end of “the golden age of capitalism in 1970’s” (Kapadia and Jayadev 33). The global north was after this period walking on a financial tight rope. With the resource utilization reaching the maximum limits compounded further by a relatively high wage rate, most enterprises were feeling the pinch in the reduction of their rates of return. There are also indications that the credit crisis began in the developing nations that had began to experience financial turbulence in the early years before it eventually impacted the giant economies like the United States. With respect to these revelations and more, this paper therefore examines the causes of the credit crisis that affected the world and which its effects are yet to be fully mitigated. This essay will closely look at the major influencing factors in the global economy and that of the United States that led to the credit crisis that was experienced in the year 2004. As a precursor, the two major reasons for this crisis were internal policy framework and external influence as discussed below. Deregulation: Shadow Banking and Mortgage Securitization The main internal factor was that of the policy instruments by the government that led to further instability in the financial sector of the economy that was already unhealthy. The period before the crisis was characterized by a highly capitalist tendency that favored lack of regulation in the financial sector. Blundell-Wignall, Atkinson and Lee (3), state that by the year 2004 there were four key crisis-causing factors that came into perspective. First, the then president’s policy of making mortgages cheaper to low-income household. Secondly, the increased restriction of the sole mortgaging authority that made banks venture more into the sector and thereby increasing low value lending. Third was the publication of the Basel II accord that encouraged banks to get involved in other non-trading activities. Finally, the investment banks were given more freedom through ‘consolidated entities program’. In effect, this led to instability of economies mostly in the northern parts of the globe that depended highly on export surpluses. This created some sort of instability as Kapadia and Jayadev (35) indicate. They further state that the creation of a benchmark of currency and the isolation of the United States’ consumption sector as the last in consideration when exporting resulted into instability in the world economy. The effects of deregulation were mostly felt in the banking sector. First, the impact of disallowing the regulations that stated that demand deposits accrued interests. Secondly, the mortgage interests with relation to residential properties were lowered creating a boom in the housing sector through increased mortgage lending. Lastly, the deposit taking institutions were allowed access to the Federal Reserve through a credit window that in turn allowed non-banking institutions into the financial market that was already unstable. It was therefore inevitable that deregulation was bound to create ‘indiscipline’ in the financial sector and that was the case. For instance, lack of proper monitoring of the banking institutions was creating an environment prone to unscrupulous deals that amounted to lose invested funds that created a recipe for future collapse of the whole lending system. Moreover, the mortgage sector was also affected adversely by this situation of inadequacy in regulation. The lowered costs of borrowing or capital acquisition meant that most citizens was on a rush to take advantage of the opportunity for lowered financing that had presented itself not knowing what the pressure they were in turn, creating to the vulnerable financial markets. Further compounding on this was the increased debt the government was continually accruing because of war. It was therefore obvious that the government was becoming ‘helpless’ because on one hand it could not effectively regulate the sector and on the other hand it did not have the financial might to turn around the deficits that were being created in the credit system. Globalization and External Pressure The external forces also influenced the economy of the country as well as taking up the effects of this crisis into foreign countries. Globalization has created highly interconnected and dependent markets in the world. This interconnectivity facilitated by a benchmark currency was obviously a channel for the spread of the crisis into other nations who directly depended on the United States’ financial markets. For instance, Blundell-Wignall, Atkinson and Lee (8) indicate that mostly European countries like Germany, Switzerland and the United Kingdom were impacted because their banks followed the same design since they wanted to retain their market share. This interconnectivity also allowed foreign markets take some form of advantage to the highly deregulated United States’ financial sector especially in the banking industry. In the contrary, globalization may have cautioned countries from the effects of this crisis because of the way it ensured that the risks were spread, especially if it involved multinational financial institutions. Conclusion The financial crisis was majorly as a result of internal rather than external factors. The impact of the crisis that has left the country struggling to make a footing in the world economic front today may have been a more historically motivated consequence than a sudden happening, even though many people may like to refer to the year 2004 (Weinsenthal 2). It is also observable that this crisis was because of indiscipline in the banking and mortgage sector that was mostly encouraged through the effects of deregulation. The three major identifiable areas of both internal and external push factors to this crisis are after this discussion clear. The first was the complexities of the products developed in the financial sector and the associated risks. There was also conflicting interests of market players and finally, the blatant failure by the regulatory bodies as well as the market players themselves to curb the excesses they were indulging in at that time. It is, however, important that the United States as well as the whole world learn from this crisis. There should be proper and relevant regulatory framework to eliminate the illegal and unethical acts of market player who only care about making an extra dollar out of every deal. Moreover, the management of corporate should understand that leaving them at the hands of self-regulation might have disastrous long-term implications on their organizations. Works Cited Blundell-Wignall, Adrian; Atkinson, Paul and Lee, Se Hoon. “The Current Financial Crisis: Causes and Policy Issues.” Financial Market Trends – ISSN 1995-2864 - © OECD 2008. Kapadia, Anush and Jayadev, Arjun. “Global Economic Crisis.” Economic and Political Weekly. Dec 2008. Weinsenthal, Joe. “Financial Crisis: The Complete Timeline.” Scribd, 2009. Web. 14th Dec. 2012. . Read More