Financial Crisis 2008 Causes And Effects Pdf
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Policy Brief. The Great Recession devastated local labor markets and the national economy.
- What Really Caused the Great Recession?
- Financial crisis of 2007–08
- Causes of the Great Recession
- What Really Caused the Great Recession?
They created interest-only loans that became affordable to subprime borrowers. Housing prices started falling in as supply outpaced demand.
What Really Caused the Great Recession?
The new international financial crisis: causes, consequences and perspectives. E-mail: flaviovieira ufu. The paper investigates the recent financial crisis within a historical and comparative perspective having in mind that it is ultimately a confidence crisis, initially associated to a chain of high risk loans and financial innovations that spread thorough the international system culminating with impressive wealth losses. The financial market will eventually recover from the crisis but the outcome should be followed by a different and more disciplined set of international institutions.
There will be a change on how we perceive the widespread liberal argument that the market is always efficient, or at least, more efficient than any State intervention, overcoming the false perception that the State is in opposition to the market. A deep financial crisis brings out a period of wealth losses and an adjustment process characterized by price corrections commodities and equity price deflation and real effects recession and lower employment , and a period of turbulences and end of illusions is in place.
Keywords: financial crisis; globalization; advanced and emerging economies. The main goal of this work is to review financial crises on a historical perspective to subsidize the understanding of the international financial crisis of the new century with special attention to the lessons from the crash of and how the subprime crisis is related to previous episodes.
Since the end of we have seen an enormous number of studies on different aspects and dimensions of financial crises, some of them focused on historical issues in a comparative perspective and others trying to understand the specificities and the eminence of a new global financial crisis. The present work tries to summarize some of them as part of two sets of studies, one considered as a broader investigation into the determinants of financial crises and the second pays special attention to issues related to the housing market and the financial innovation derivatives developed in this new financial architecture.
The paper is divided in three sections. The first one focuses on the financial crises literature on a historical perspective. The second one highlights recent studies on the new international financial crisis and pinpoints its specificities. The third section is devoted to evaluate the most important indicators of the U. Finally, the concluding remarks focus on the main lessons from this recent financial crisis episode. The crash of and the following depression of the s was a period of extreme financial and real consequences to the world economy.
The general perception was that the two crucial problems not overcome by monetary authorities at that time were the lack of an active and coordinated monetary policy and liquidity constraints, resulting in a world depression 1.
The current financial crisis is centered on disturbances in the world credit markets and the initial concern was associated to the viability of subprime mortgage loans spread around the financial system. In this situation what we have seen is that the central banks have been forced to increase liquidity in the system to avoid complete breakdown in lending operations 2.
Among the key lessons of previous major financial crises, the WEO listed some of them: globalization has increased the frequency and spread of financial crises, without necessarily increasing their severity; early central bank intervention is considered more effective when one thinks about limiting their spread when compared to old episodes of financial crises; during the financial crisis it is hard to forecast if it will have broader economic consequences; and there is a time discrepancy between financial innovation that can trigger a crisis and regulation measures to prevent it 3.
Bernanke in his work on financial crises argues that shocks to the domestic U. The factors that reduced aggregate demand around the world in the s are associated to monetary shocks and the role they played and how such shocks were transmitted around the world during the Gold Standard era are essential elements. The author emphasizes that the worldwide monetary contraction of the early s was not a passive response to declining output, but instead the result of an interaction of poorly designed institutions, shortsighted policy making, and unfavorable political and economic preconditions 4.
Friedman and Schwartz work on U. Temin , has a different point of view arguing that the contraction in money supply reflected a passive response of money to output and that the origins of the depression is mainly associated to the real side of the economy.
Eichengreen argues that there are some views associating the current international monetary and financial system as new version of the Bretton Woods one. There is a clear division in this new era of globalization where the international system incorporates a core U.
What is definitely not a consensus is the idea that countries like the United States can have current account deficits for a continuous time period given the argument that emerging economies will be glad to accumulate dollars. The author does not agree with this new line of argument and there is no such thing as a widespread collective interest and this new monetary and financial system and it should not be compared to the Bretton Woods system. In a recent paper, Eichengreen develops the argument that the gold standard was crucial to understand why the economy was contracted by the demand side in a historical period where the countries that benefited from the gold standard were the ones engaged in significant international trade and investment and have considerable economic and political power.
In such an environment there was room for the central banks do whatever was necessary to keep the exchange rates fixed. Bernanke and James developed the argument that during this period of crises the central banks adopted policies to increase gold reserves and coverage ratios as security against future attacks on their currencies but the outcome was a decline of the monetary base to reserves ratio.
This process was followed by fears about the banking system soundness and expectations of exchange rate devaluation and after all it started an era where crises are associated to what is called hot money based on short-term deposits held by foreigners in domestic banks. The idea is that the expected devaluation induces outflows of hot-money deposits threatening to start a general bank run and on the other hand there is a fall in confidence in a domestic banking system and a process of short run capital flight with significant impact on international reserves reduction questioning the viability of keeping convertibility and the fixed exchange rate.
The combination of exchange rate and banking crises imposes a dilemma for the monetary authorities since the former asks for expansionary monetary policy while the later requires a contraction of money supply.
The first generation models of currency crises are associated to the passive role played by investors and the bad economic fundaments and how a country can face speculative attacks. Krugman and Flood and Garber are two of the main contribution on such models of financial crises especially when dealing with speculative attacks and balance of payments crises. The second generation models emphasizes a limitation of the first generation models arguing that investors behavior are only relevant in order to determine the time when the speculative attack will happen, but they say nothing on whether the attack will occur or not.
Krugman develops a model where financial crises are associated to the loss of confidence and the essential problem is not macroeconomic management or fundamentals. Governments analyze the cost of keeping the exchange rate versus the benefits of realignment, where the costs depend on agent expectations. Krugman among others developed the third generation currency crises models and the idea is to respond the question of whether financial crises are primarily due to problems in economic fundaments or if they occurred due to self fulfilling investors' expectations and loss of confidence.
The answer is that both factors are relevant to understand such crises. A graphic representation of the set of events associated to the international financial crises of the new century is slightly different from the vicious circle of the currency crises episodes previously verified and associated to the second and third generation models Figure 1 5.
Reinhart and Rogoff develops a historical analysis of financial crises dating from England fourteenth-century default to the current United States subprime financial crisis using a dataset that incorporates a number of important credit episodes.
The authors find that serial default can be considered as a universal phenomenon and that major default episodes are separated by some years or decades, creating an illusion to policymakers and investors that this time is different. After all, they do not consider the U.
Periods of excessive capital inflows and supply of borrowing funds are frequently associated to a future reduction in economic growth and in equity and housing prices, exactly what the U. Kaminski investigates crises episodes in the s where there was a rapid contagion to other countries and the aftermath of these crises was characterized by a loss of access to international capital markets by many emerging economies.
Contagion and sudden stops are more frequently in economies with current account deficits and financial fragility weakness, and increasing the degree of integration to the international capital markets is associated to a higher exposure to sudden stops even in the absence of domestic imbalances and vulnerabilities.
Regarding the current account deficits, Blanchard examines how they have increased in advanced countries over the last two decades and the argument is that these deficits are different from the Latin American deficits of the early s since they are part of high income and industrialized countries and are a result of private saving and investment decisions and not primarily associated to fiscal deficits.
Current account deficits are mainly financed by FDI, equity, bonds emission on their own currency instead of bank lending. There is a common perception that these deficits are too large and one time or another it will be required some sort of government intervention especially when considering the existence of goods, labor and financial market distortions 8. Calomiris analyzes bank failures during crises episodes and the main idea is that they occur due to either unwarranted depositor withdrawals during the event contagion and panic or they are an outcome of bank insolvency problems.
The author arguments that panics and contagion have a small and secondary role in bank failure, during or before the Great Depression of and on the other side the safety net developed to prevent contagion risks reached a specific form and degree of complexity fragile regulation that became one of the main sources of banking systemic instability in the recent international financial crises.
According to Dell'Ariccia et al. Barajas et al. In order to understand the origins of the recent financial crisis one should consider that during the period of the U. When the interest rates started to go up in and , the U.
Other than this, there was a passive and to some extent collaborative role played by monetary authorities under Alan Greenspan administration. Reinhart and Rogoff investigates if the subprime mortgage financial crisis is new and different from other crisis episodes and the conclusion is that there is a significant number of common factors comparing the recent crises with other 18 other bank crisis in the post war period, and among these factors a decrease in equity and housing prices are the most important.
The authors also find that the actual level of public debt and inflation are lower but the current account deficit is high in recent years when compared to old episodes. Gorton investigates the subprime mortgages problems that result in a systemic crisis due to a loss of information regarding location and size of risks of loss in a financial market facing higher levels of default.
The author shows that additional subprime risk was magnified with the use of derivatives. Mishkin develops an analysis on the relevance of the housing market to monetary policy and how to use the adequate set of instruments to obtain price stability and high levels of employment. Among the important channels of housing market to the monetary transmission mechanism the author highlights how interest rates has an impact on the cost of housing capital and future movements in the price and supply of houses.
A secondary impact is associated to the wealth effect of these price movements and credit effects on consumer spending. Mian and Sufi examines the U. Tong and Wei develop an analysis on how a crisis originated in the financial sector of the economy can be transmitted to the real economy applied to the subprime mortgage crisis. Iver e Pury focuses attention on bank run episodes using micro data on depositor level and the effectiveness of deposit insurance to avoid such runs or to deal with them.
The empirical evidence is that deposit insurance has only partial effectiveness to prevent bank runs, and other factors such as length and depth of the relationship between depositor and bank is also important with a negative correlation with the probability of facing a bank run during a crisis. At the end, banks that face a run have difficulty in bringing these customers back after the episode. Diebold and Yilmaz explores issues associated to asset return volatility and macroeconomic fundamentals for a set of more than 40 countries and the results suggest a significant and positive relation among these two issues, where economies with more unstable volatile macroeconomic fundamentals usually have more volatile stock markets 9.
It should be emphasized that within the last two decades the world economy has seen an enormous increase in asset values relative to GDP for most advanced and emerging economies and such assets are collateral for the credit allocation. On the other hand, a significant decrease in asset prices throughout the period where the crises is more severe generally results in bank collapse and followed by credit reduction. This sequence of events ends up shifting a financial crisis into a real economy crisis with significant implications in terms of job loss and a mismatch between supply and demand.
In this situation there is an increase in the risk for credit institutions and the final outcome is a period of credit shortage for firms and consumers, regardless of government policies such as a reduction in compulsory deposits, even though such policy measures should be in place during the initial and most critical period of the crisis in order to minimize the chances of a complete credit collapse.
The main idea of this section of the paper is to investigate the most important housing and global real and financial indicators associated to the recent financial crisis and how these indicators are affecting developed and emerging economies. Housing market indicators: prices, debt service and consumer confidence. Table 1 describes recent past changes in real house prices and there is a clear trend towards a reduction in such prices due to the occurrence of high inflation in the housing market in previous years among most developed economies.
This scenario is associated to an increase in delinquency rates see Table 3 , especially for The indicators of household debt service payments reported on table 2 show an increasing trend as a result of the increase in the degree of indebtedness in the period of where the U. Most of the borrowing at this time was carried out by contracts based on current interest rates and when they started to increase in a significant part of households has faced financial problems and a deterioration in most indicators such as the DSR, FOR and mortgages.
The data for the delinquency rates residential and commercial for all banks in the U. Considering one of the most important indicators for the economy as a whole and for the housing market in U.
For the U. As this work has previously shown Tables 1 to 4 the housing market problem in the U. Examining the emerging market bond index EMBI spreads from to the second quarter of on Table 6 one can see that the spreads were decreasing from to and since it starts to increase for all emerging countries, which was an indication that the market has already started in to price an increase in global risk affecting the emerging markets even though most of them were having a significant improvement in macroeconomic fundaments such as high economic growth and improvements in the current account.
After all, such numbers captures a global perception of increasing risks. Real and financial global indicators. One of the crucial aspects of any financial crises episodes is the impact on the real side of the economies and this section aims to have a better understanding of some early signs of the crises and what are the expected impact on variables such as economic growth, domestic demand and exports.
On the other hand, advanced economies will face higher inflation in 3. Interest rates will be reduced in advanced economies, an outcome already verified by the coordinated interest rate cut adopted by the FED and the Euro Central Bank in September Interest rates will be stale for emerging economies but higher for those with inflation target flexible exchange rate since depreciation of domestic currency can be a source of inflation pressure and monetary authorities will keep interest rates at a high level 7.
Another empirical lesson from previous financial crises is that commodity prices are frequently high prior to the crisis and this is clearly what Table 8 is summarizing. With the recession of the second semester of in advanced economies and close to zero growth rates for , there is trend for decreasing in commodity prices, especially for metals and oil.
An interesting investigation is on the impact of food and fuel prices to inflation since both were having an increasing trend and there is a clear distinction of two groups when comparing such impact Table 9. Advanced economies are those who suffer the most with fuel prices impact on inflation, while emerging and developing countries have a higher impact of food prices on inflation.
Assuming that fuel prices should fall more than food prices during and after the financial crisis, advanced countries will benefit more from deflation in fuel prices, but the problem is that deflation is an expected outcome and the concern is concentrated on how to minimize real effects output and employment.
Table 10 summarizes data for advanced and emerging economies for real effective exchange rate REER and current account.
Financial crisis of 2007–08
Financial crisis of —08 , also called subprime mortgage crisis , severe contraction of liquidity in global financial markets that originated in the United States as a result of the collapse of the U. It threatened to destroy the international financial system; caused the failure or near-failure of several major investment and commercial banks , mortgage lenders, insurance companies, and savings and loan associations ; and precipitated the Great Recession —09 , the worst economic downturn since the Great Depression — c. Although the exact causes of the financial crisis are a matter of dispute among economists, there is general agreement regarding the factors that played a role experts disagree about their relative importance. First, the Federal Reserve Fed , the central bank of the United States, having anticipated a mild recession that began in , reduced the federal funds rate the interest rate that banks charge each other for overnight loans of federal funds—i. Consumers took advantage of the cheap credit to purchase durable goods such as appliances, automobiles, and especially houses. Second, owing to changes in banking laws beginning in the s, banks were able to offer to subprime customers mortgage loans that were structured with balloon payments unusually large payments that are due at or near the end of a loan period or adjustable interest rates rates that remain fixed at relatively low levels for an initial period and float, generally with the federal funds rate, thereafter. As long as home prices continued to increase, subprime borrowers could protect themselves against high mortgage payments by refinancing, borrowing against the increased value of their homes, or selling their homes at a profit and paying off their mortgages.
However, after the large economic meltdown following. Lehman Brothers' bankruptcy in September , it seems that much more was going on.
Causes of the Great Recession
The new international financial crisis: causes, consequences and perspectives. E-mail: flaviovieira ufu. The paper investigates the recent financial crisis within a historical and comparative perspective having in mind that it is ultimately a confidence crisis, initially associated to a chain of high risk loans and financial innovations that spread thorough the international system culminating with impressive wealth losses. The financial market will eventually recover from the crisis but the outcome should be followed by a different and more disciplined set of international institutions. There will be a change on how we perceive the widespread liberal argument that the market is always efficient, or at least, more efficient than any State intervention, overcoming the false perception that the State is in opposition to the market.
There is very little academic literature available about the current economic crisis and its social impacts in France. This report includes some relevant articles from the news media. More literature is available relating to the unrest seen in , and as some of that material may be relevant to the current situation a small selection has been included. Unemployment and financial hardship resulting from the global economic crisis have contributed to strikes, demonstrations, and other forms of protest in France in and French activists have developed strong capacities for action through alliances with a range of groups although there are some concerns about the risk of extreme radical organisations subverting legitimate political protest and have been able to mobilise significant political forces.
Many factors directly and indirectly caused the Great Recession that started in with the US subprime mortgage crisis. The major causes of the initial subprime mortgage crisis and following recession include the Federal Reserve lowering the Federal funds rate and creating a flood of liquidity in the economy, international trade imbalances, and lax lending standards contributing to high levels of developed country household debt and real-estate bubbles that have since burst; U. Once the recession began, various responses were attempted with different degrees of success.
What Really Caused the Great Recession?
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