Main Issues Found Within the International Financial Marketplace Credit Crisis of 2008

Main Issues Found Within the International Financial Marketplace Credit Crisis of 2008

Introduction

The credit crisis of 2008 was a global crisis that rocked the global marketplace. According to many economists and market analysts, it was the most significant or serious crisis to hit the global marketplace since the Great Depression which was experienced during the 1930s. The crisis started in 2007 in the U.S. where there was a huge crisis in the subprime mortgage market. The crisis became full-blown in 2008 when it shifted to a banking crisis with the collapse of Lehman Brothers, an investment bank in the United States (Foo, & Witkowska, 2017). Excessive risks that were being taken by banks such as Lehman Brothers played a critical role in magnifying the impacts that the crisis was having on the international financial marketplace. The world financial system almost collapsed during the crisis and the only solutions that were developed to avert this from happening were massive bail-outs of financial institutions by the government. Other monetary and fiscal measures were also being employed by governments including the United States to try and arrest the situation. Following the crisis, there was economic slowdown something that economists have referred to as the Great Recession. The aim of this report is to assess the main issues that were found in the global marketplace during the credit crisis.

Housing Markets and CDOs

When delving into the financial marketplace credit crisis of 2008, it is important to assess some of the factors that are perceived to have led to the financial crisis. The onset of the financial crisis started when the housing market almost collapsed. The bubble bust led to significant loss of value of various mortgage-backed securities also known as MBSs (Kaur, 2015). The housing market bubble bust signaled the start of significant events in the financial markets that would lead to the crisis becoming a full-blown issue not only for people who were holders of mortgages but to everyone across the country.

The housing market in the United States peaked in 2006-2007 with hundreds of thousands of people benefiting from the growing housing sector industry. When the housing sector peaked, the number of defaulters started to increase sharply. The defaulters were mainly on adjustable-rate mortgages and subprime mortgages. The growth of the housing industry was caused by easy availability of credit in the United States. There were also very huge foreign direct investments from foreigners who had made a lot of wealth during the Asian financial crisis and the Russian debt crisis. Such aspects led to the growth of the industry. Increased access to credit also meant that people could easily buy houses. This increased the cost of houses due to huge demand in the market. Such a scenario led to an enormous debt load that was no longer sustainable.

The housing sector was at the time characterized with many CDOs. CDOs, also known in full as centralized debt obligations are financial instruments that pay investors from a huge pool of sources that generate revenues. Failure of these instruments is what led to the housing market bubble burst in 2007/2008 (Wiethuechter, 2016). These instruments had become very popular and the huge debt meant that the bubble was meant to burst in the long-term. The falling prices of properties also meant that most of the mortgages were of a higher value than the market value of the property. With this in mind, borrowers were provided by an incentive to enter into foreclosure. This was mainly because many homeowners were no longer interested to continue paying mortgages that were of a higher value than the market value of the property in the market.

Lack of Regulation on Disclosures

During the same period, there was a huge increase in the number of defaulters. The credit bubble had led to the weakening of the financial system with it becoming increasingly fragile. Since the 1970s, the federal government of the United States had insisted on the deregulation of the industry with the aim of encouraging the use of market forces which encouraged businesses to expand. Such deregulation meant that there was very little oversight on some of the major stakeholders in the housing market. Financial institutions were also not being regulated in the desired manner. This meant that they were not disclosing their operations and motives. Lack of disclosure about their operations meant that millions of consumers across the country were being misled into entering the housing market before the bubble burst took place.

Following the collapse of some of the financial institutions such as Lehman Brothers, it was noted that the company had concealed a lot of information. If such information had been provided to the public, there would have been a great likelihood that consumers would have been protected from the effects of the marketplace credit crisis of 2008. Policymakers were also unaware of the important role that is played by smaller institutions such as hedge funds. These institutions are part of the shadow banking system. These institutions are critical in regulating the amount of credit that is present within the financial markets and this is something that had not been studied by policymakers and economists. If proper regulations and disclosure requirements had been in place on these institutions, the credit crisis of 2008 could have been avoided with relative ease.

Banks and other commercial lending institutions have also been observed to have been directly involved in creating the crisis. Before the housing market bubble burst, the level of regulation on these institutions was very lax. Many banks had accumulated huge debt burdens that they could no longer service given the increase in the number of people who were defaulting on loans and other instruments. Banks and other lending institutions also did not have any form of financial cushions. Such cushions are put in place to ensure that they can absorb defaults that happen from the loans they have issued to the consumers in the public realm. Such losses meant that when the housing market bubble burst, financial institutions could no longer lend and this led to the collapse of many. Such lack of disclosure has been observed to be caused by lack of accountability and systematic breaches across the financial system.

Strategies to Reverse the Negative Effects

Following the full-blown financial marketplace crisis of 2008, there were many strategies that started to be adopted to correct the situation. Many economists stated that if corrective action was not being pursued, then there was a great likelihood that the whole system would collapse. One of the ways was to provide funds to some of the key financial institutions in the country. The credit crisis of 2008 affected many nations although the United States was one of the most hard-hit (Ting, 2017). Central banks of different countries started to offer funds with the aim of creating confidence in the commercial paper markets. Governments such as the United States also moved to bail out some of the major players in the financial sector. Bail out programs and economic stimulus programs were some of the immediate strategies that were adopted to try and correct the situation.

The short-term responses were also aimed at expanding money supply within the economy. When the money supply within an economy is expanded, there is a great likelihood that the risk of a deflationary spiral can be avoided. A deflationary spiral happens when unemployment and reduced wages reduce the level of consumption within the economy. When this happens, the GDP can decrease the push the economy into further turmoil. The economic stimulus programs that were being adopted were supposed to increase money supply in the economy. Increased money supply leads to inflationary tendencies which stimulated consumption thereby improving the economy. The Federal Reserve also moved to expand the liquidity facilities with the aim of ensuring that central bank would play the role of lender-of-last-resort to financial institutions that were struggling due to the credit crisis.

Regulatory Proposals as Long-Term Responses

Following the financial credit crisis of 2008, the Obama Administration through key economic advisers came up with a list of regulatory proposals that were developed in 2009. The aim of these regulations was to hinder another financial crisis to be observed in the financial markets in the future. The proposals addressed a list of issues that were purported to have led to the financial crisis. They included consumer protection, disclosures, executive pay by financial institutions, financial cushions of banks and other financial institutions, capital requirements, improved authority of the Federal Reserve, and heightened regulation of the shadow baking system. In 2010, Volker Rules were also developed. The rules were developed by Paul Volker and were supposed to hinder or limit banks and other financial institutions from participating in proprietary trading (Kluza, 2011). It happens when a trader trades in financial instruments with the funds of the company. The practice was common in the past and was part of the unethical practices that led to the crisis.

Lessons Learned

Since the 2008 financial crisis, there have been many changes that have been developed in the financial markets to prevent a repeat of the same. The economy has also improved since there has been great recovery not only in the United States but also in the global financial marketplace. However, the recovery has been uneven with many people unable to take advantage of the economic stimulus systems and tools that were developed such as low interest rates and other different types of stimulants (Kassim, 2012). One of the main lessons that has been learned is the need for increased regulation in the financial system of the country. Lax regulations in the shadow banking system led to numerous loopholes which were easily exploited by unscrupulous organizations and individuals within the financial system. Many oversight agencies have also been created offering an indication of the critical nature of the industry and the need to ensure that it is regulated at all times.

The second lesson learned is that there is no financial institution that is too big to fail. The notion was a popular one before the financial crisis of 2008 with some of the organizations being presumed to never fail due to their sheer size (Jaleel, Hui, Virk, & Abdullah, 2015). However, the notion was erased from the minds of many players in the industry following the crisis. Even the biggest financial institutions had to be bailed out by the federal government whereas others such as Lehman Brothers were not so lucky and collapsed following the financial crisis. The collapse of Lehman Brothers could not have been fathomed and was even unimaginable due to the market capitalization of the company and the manner in which it had a diversified portfolio. The lesson is one that calls for banks and other financial institutions to be more accountable in everything that they do in the industry.

Another lesson that was learned was the need to reduce the risk in Wall Street. Before the financial crisis, proprietary trading was very common and rampant across the market. Through the creation of the Volker Rules financial institutions were now not allowed to trade using funds from the financial institution. Doing this helped reduce the resultant risk and also increased the level of accountability from financial institutions. Increased accountability calls for financial institutions to observe a standard of care and caution as they continue in their operations in the financial markets.

The financial crisis of 2008 also offered great lessons on the dangers of an overzealous lending system within an economy. Before the bubble burst of the housing market, access to credit was very easy. Unfit borrowers were able to access any form of mortgage. At the time, easy access to credit was seen by many to be an indication that the economy was on the right track. However, this led to huge disasters when many homeowners could no longer service their mortgages. If another financial crisis is to be avoided in the future, such indicators should be approached with caution since they could easily spell doom for the financial market in the long-term. When the financial market is doing exceptionally well, such as the housing market industry prior to the crisis, regulatory bodies need to be careful to guarantee that another housing market bubble does not burst as observed between 2007 and 2008.

How the Financial Crisis became and Economic Crisis

The financial credit crisis of 2008 gradually turned into a full-blown economic crisis through several ways. First, more than eight million jobs were lost. When people lose their jobs, they lose their source of income and this means that they cannot sustain their livelihoods. When people lose their jobs, they have no income and thereby their consumption decreases to levels that have never been perceived before. The loss of jobs also meant that the unemployment rate in the United States increased by a great margin. The unemployment rate hit 10% following the financial crisis meaning that the economy was suffering due to the huge losses in jobs by the people. The economy was also affected due to the huge number of foreclosures that were happening. More than eight million homes went into foreclosure since the owners could no longer pay their mortgage obligations.

The credit crisis also meant that banks and other financial institutions could no longer offer any lending services. When this happens, investors or people who want to expand their businesses cannot have access to funds. This means that economic progression declined due to the financial crisis of 2008. Lack of liquidity among financial institutions also meant that there was very little money supply in the economy. When there is decreased money supply, the level of consumption decreases and this brings about a full-blown economic crisis. The only solution that was being provided to avert such instances was the economic stimulus programs that were being adopted by the Federal Reserve. Their aim was to increase the amount of money supply in the economy. Increasing the money supply is observed to be a direct catalyst for increased consumption among various households in the country.

Conclusion

The financial crisis of 2008 is one of the worst to hit the global financial marketplace in recent history. It eroded different financial markets and brought about significant regulations in the industry which are supposed to prevent a similar situation from happening in the future. The crisis which started in the United States had ripple effects that were felt in other regions across the world including Europe and Asia. However, economic recovery has been taking place in the last decade. Financial regulations that have been established through various acts or pieces of legislations have been critical towards ensuring that such instances are not observed in the future. Financial players in the market also need to act ethically and increase their level of accountability since lack of these two aspects were some of the factors that led to the crisis.

References

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Jaleel, A., Hui, X., Virk, M. U., & Abdullah, M. (2015). Investigation of causal relationship between trade credit and bank loan during 2008 financial crisis. Journal of Asian Business Strategy, 5(5), 90-98. Retrieved from https://search.proquest.com/docview/1678794336?accountid=45049

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Ting, H. (2017). Financial development, role of government, and bank profitability: Evidence from the 2008 financial crisis. Journal of Economics and Finance, 41(2), 370-391. doi:http://dx.doi.org/10.1007/s12197-016-9356-8

Wiethuechter, M. D. (2016). The contribution of hedge funds to the systemic instability of financial markets: Aspects from the financial crisis of 2008. The Journal of Wealth Management, 13(3), 80-95, 10. Retrieved from https://search.proquest.com/docview/770470667?accountid=45049