Factors that led to financial crisis in the United States in 2008

Factors that led to financial crisis in the United States in 2008

Introduction

The USA experience a severe financial crisis in 2008 this crisis almost led to the collapse of the United States economy.The cause of the financial crisis and possible solutions, monetary and fiscal policies and also the role of the government in safeguarding the economy. The following factors as suggested by the economist, financial experts, and government decision makers led to the financial crisis in the United States; they include the financiers, central bankers, European banks, the great moderation, saving gut among others(Schularicket al 2009).. This article will discuss such factors and the role they played in USA economy. Research shows that European banks had borrowed in American money markets, and this led to the crisis the funds were used to buy risky securities.

Economists disagree on the cause of low-interest rates, were unable to identify whether it was the result of central bankers or change in the world economy. The incentive for banks and other investors to hunt for assets which are more risk that offered the little interests created higher returns(Schularicket 122). Central bankers showed concerns about America’s big deficit and the offsetting capital inflows from Asia’s excess savings.  Greater gross capital flows from European banks was affected.  America’s loose credit conditions before the crisis were in global banking and not in world economies.

In the USA lending of mortgages rose from approximately 8% to20% before the crisis. Resulting to lower lending procedures (Taylor, J. B. 254).Eventually, the crisis emerged and evolved and was caused by among them the housing sectors which borrowed mortgages and failed to recover their indebted loans. The debt levels increased leading to inadequate government regulations. This crisis set the United States in a recession that saw a massive loss of approximately 9 million jobs between 2008 and 2009. Unemployment reduced 6% of the workforce. By, currently the level of unemployment has already gone back to the peak, but the housing sector remains at their low prices(Taylor, J. B. 202).The mortgages as collateralized debt obligations (CDOs) into tranches. Investors, come up with the safer tranches by practicing triple-A credit ratings assigned by the Moody’s. T a big mistake, since the agencies were paid by the banks that created the CDOs and in that matter, they were lenient in assessing them.

Investors both citizens and immigrants started looking for the products securitized because they knew that the products were a little bit safer and at the same time provided a higher amount of returns at low rates of interest (Schularicket al 345). Investors sought out these securitized products because they appeared to be relatively safe while providing higher returns in the world of low-interest rates.  Some economists were not satisfied by Fed keeping the short-term rates too low and hence pulling along longer rates of mortgage down with them (Taylor, J. B. 133). .The Fed’s defenders blame were blaming to the savings glut the surfeit of saving over investment in emerging economies, That capital flooded into safe American-government bonds, driving down interest rates.

In Tax rebate, it is evident that. The financial crisis in 2008 brought about prompt and aggressive actions by the monetarists and also the policymakers (Diamond, 456). The politicians increased government spending and reduced taxes to balance money circulation in the economy. During the financial crisis, the rates are lowered which gives firms an opportunity to invest and gather profits widely.

Combining excessive monetary expansion and irresponsible behavior from government sponsored agencies contribute to the speculative bubble in housing.  What is not apparent is how monetary and fiscal policies contributed to the current crisis. In response to this slower growth in money, current-dollar GDP also slowed.  The dollar spending dollar spending slowed to a 4.0% rate from a 5.9% rate in as a result of the financial crisis 2008 but currently it is at normal.

The first line of attack for mitigating the impact of the economic crisis is to have the Fed reversing restrictive monetary policy (Taylor, 211).  To make this current Bank reserves have increased by hundreds of billions of dollars. This led to the reduction of the impact of additional bank reserves on the creation of money. Fed adopts an expansive monetary policy, the damage from “fiscal stimulus” remains. (Diamond, 134)Extra money help to boost spending this will make it difficult for the economy to increase productivity?  Since 2008 productivity has risen by 40%.  The current destructive fiscal policy mix makes it impossible to repeat that performance in the future. Any policy mistake takes a problem in the housing market and spread it to the rest of the economy (Schularick, 280 ). Such that policymakers understand the damage they cause; it is best to remain defensive and avoid investing in stocks. Government moves to boost the economy by huge borrowing of the limited funds available for capital projects.

TARP improves the liquidity of assets by using secondary market mechanisms to buy assets. Participating institutions to stabilize their balance sheets and avoid further losses. TARP expect, prices to support and increase in value, resulting from banks and the Treasury(Schularick, 265).The United States is an example of a state with the good history, and any other state can use these concepts to overcome any future financial crisis.

Cause of Financial Crisis

Many firms relied on short-term credit market to fund products. However, when many prestigious institutions declared bankruptcy in 2008, the media spread the news rapidly, resulting in a sudden decline in confidence from investors, and less capital flow. Investors’ sensitivity to shock and panic led to a sudden decrease in liquidity, which firms heavily relied on. The failure of one company offset the risk of contagion and led to failures of many other firms.

Another cause of the crisis is the quality of financial assessments and securities. Credit-rating companies, issuers, and investors were all too optimistic about investments. Many firms held securities containing highly positively correlated risks and failed to diversify their portfolio to decrease risk. Thus, their operations ran on very risky investments that were incorrectly evaluated by credit-rating companies. As a result, these toxic financial assets are an important cause of failure of many firms.

The influence of foreign investments led to financial crisis. Countries have a large trade surplus with the US, like  China, preferred safe investments. They bought huge treasure bonds and pushed the rate of yield down. As a result, foreign investors started to invest in mortgage market-related securities. This huge amount of foreign investment gave US mortgage firms more money to lend out; thus, raising the price of housing. In response to the abundance of investments, lenders became overly optimistic and loaned money to individuals that were not able to pay back the loan. Then, the large number of foreclosures drove down the real estate value as well as these mortgage-related securities. These foreign investments gave American mortgage firms false optimism, which led to over lending and the downfall of the housing market.

The Fed realized that one of the leading causes of the crisis was the decrease in liquidity due to the decline of short-term debts. In response, the Fed improvised liquidity programs to increase liquidity. They practiced quantitative easement by purchasing mortgage securities, long-term assets, and lowering interest rate. Also, Fed Funds target rate was decreased to nearly 0% to encourage short-term lending.

Solutions

The first line of attack for mitigating the impact of the economic crisis is to have the Fed reversing restrictive monetary policy (Taylor, 100).  To make this current Bank reserves have increased by hundreds of billions of dollars. This led to the reduction of the impact of additional bank reserves on the creation of money. Fed adopts an expansive monetary policy, the damage from “fiscal stimulus” remains. (Diamond, 175)Extra money help to boost spending this will make it difficult for the economy to increase productivity?  Since 2008 productivity has risen by 40%.  The current destructive fiscal policy mix makes it impossible to repeat that performance in the future. Any policy mistake takes a problem in the housing market and spread it to the rest of the economy (Schularick, 480). Such that policymakers understand the damage they cause; it is best to remain defensive and avoid investing in stocks. Government moves to boost the economy by huge borrowing of the limited funds available for capital projects.

TARP improves the liquidity of assets by using secondary market mechanisms to buy assets. Participating institutions to stabilize their balance sheets and avoid further losses. TARP expect, prices to support and increase in value, resulting from banks and the Treasury(Schularick, 229).The United States is an example of a state with the good history, and any other state can use these concepts to overcome any future financial crisis.

Reference

Diamond,D.W.,&Rajan,R.(2009). The credit crisis: Conjectures about causes and remedies (No. w14739). National Bureau of Economic Research.

Schularick, M., & Taylor, A. M. (2009). Credit booms gone bust: Monetary policy, leverage cycles and financial crises, 1870-2008 (No. w15512). National Bureau of Economic Research.

Taylor, J. B. (2013). Getting off track: Howgovernmentactions and interventions caused, prolonged, and worsened the financial crisis. Hoover Press.

Diamond,D.W.,&Rajan,R.(2009). The credit crisis: Conjectures about causes and remedies (No. w14739). National Bureau of Economic Research.

Schularick, M., & Taylor, A. M. (2009). Credit booms gone bust: Monetary policy, leverage cycles and financial crises, 1870-2008 (No. w15512). National Bureau of Economic Research.

Taylor, J. B. (2013). Getting off track: Howgovernmentactions and interventions caused, prolonged, and worsened the financial crisis. Hoover Press