Financial Crisis in 2008

The 2008 Global Economic Crisis

The 2008 global economic crisis began with the bursting of the real estate bubble and the US subprime mortgage crisis. Subprime loans refer to loans to customers with low credit ratings, i.e., customers who have difficulty repaying their loans. Subprime loans were a government initiative to promote affordable housing for low-income earners. This type of loan featured poor collateral, high interest rates and unfavorable terms to compensate for the higher credit risk. Key players in the crisis included governments, lenders, rating agencies and the mortgage market.

Government Regulations and Monetary Policies

The government formulated regulations that promoted growth in the risky subprime mortgages. The enactment of the Community Reinvestment Act required the banks to assist the communities in which they operated. Similarly, the Department of Housing and Urban Development required the banks to extend loans to customers without considering their credit worthiness. The government also loosened the standards governing the down payments in the housing market. Besides, the government adopted poor monetary policies that caused the economic crisis. For instance, the Fed Chairman Alan Greenspan adopted the Keynesian policy which expanded the money supply in the economy. He reduced the federal fund rate to 1% which in turn increased the level of the inflation rate. This weakened the economy as it increased the level of money supply to the economy creating a bubble that went into the housing market.

Increased Demand for Housing and its Consequences

The high returns in the United States mortgage market attracted investors from all over the world. This caused an increased demand for the construction of more houses. On the other hand, availability, if credit to acquire houses, increased the demand for houses too causing the price of houses to go up. It encouraged construction of more houses thus absorbing large volumes of dollars into the mortgage market. More houses increased the supply of houses relative to demand which caused the housing prices to go down. Big financial companies such as Lehman Brothers and Bear Stearns that had invested in the housing market experienced huge losses as the crisis increased and spread to other parts of the economy.

Credit Rating Agencies and their Role

The Standard & Poor’s, Fitch Ratings and Moody’s Investors Service were the three credit rating agencies that were involved in the 2008 financial crisis. They misled the investors by failing to point the deficiencies they found in the assets they were rating. They rated mortgage-backed securities and collateralized debt obligations AAA yet they were of poor quality. They applied a model of rating that was dependent on historical trends that could not contain the decline in house prices.

The Role of Lending Firms and Insolvency

Finally, the lending firms such as Freddie Mac and Fannie Mae held the loans that ultimately led to the financial crisis. When the house prices started to go down and the fact that the collaterals were of poor quality, the lenders could not recover the loans they had extended to the investors. The mortgage holders could not repackage or their mortgages meaning that they did not have means in which they could pay their monthly installments to the lenders. The stock prices of the lending firms went down leading to insolvency. Those that were lucky as Bear Stearns were bailed out and their debtors were protected by the government. Conclusively, the government, lenders, mortgage market and credit rating companies played a significant role in the 2008 financial crisis.