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2008 Financial Crises Essay

2556 words - 11 pages

The 2008 financial crises
The financial meltdown which happened in 2007-2008 is considered to be a huge financial crises as it led to an economic recession throughout the world. That is the reason why this topic has been chosen for the study. The exposition here will first throw light on the factors that contributed towards the recession. I believe that certain steps could have been taken to avoid the build-up of the financial meltdown and the second part of this exposition would discuss such steps.
Prior to the financial crises that occurred in 2007-2008, the U.S government was moving towards the extreme side of a free market. This approach ultimately led towards the ...view middle of the document...

Such re-packaging and sale to the investors is made through a securitization vehicle. Typically, the vehicle issue multiple CMO classes with each of the class linked with different default risk levels within the specific loan portfolio. The risk associated with different classes of CMO was assessed by the rating agencies.
After the financial crises of 2008, there was huge criticism on the rating agencies in terms of how they assessed the risks associated with some classes of CMO securities. The financial models used by the agencies were criticized to be not conservative enough for assessing the risks of certain CMO securities. This ultimately caused gross miscalculations of the actual risks associated with certain CMOs. It is debated that such a modelling approach by rating agencies misled investors about the true associated risks. In the early part of 2000, the exposure of financial institutions and banks to such mortgage backed securities increased dramatically. For example, Gold Sachs during 2004 and 2006, issued about 318 CMO’s having a value of dollar 184 billion.
Rise in default rate of home loans, breakdown of CMO values, banks’ confidence crises, and the seizing up of the credit markets
The US mortgage markets were stable and well established in early 2000’s. Now as the interest rates continuously increased due to application of deflationary monetary policy, the rate of credit default followed up with the same trend. Once it became evident that the default rate associated with loans underlying securitized loan portfolios was increasing, bond values started falling and caused investors to make attempts for selling their holdings. Such attempts further caused a depreciation in the values of the holdings. As the value of the CMO bonds was dropping sharply, investors were forced to sell them for minimizing the losses. This created a state of panic which caused a further decline in the value of these bonds. As value of the banks’ holdings in such securities started to decrease, they started showing losses on the balance sheets, causing an increase in their capital requirement at a juncture where others were looking to raise liquidity through sale of the securities. This combination of diminished capital and continuous losses caused crises of confidence in banks, which caused wholesale lending markets unwilling to trust the credit of major banks. So this resulted in furthering the credit crises.
The unchecked growth in the securitized mortgage market was among the biggest contributing factors on the crises. The growth within this market was caused by lack of market regulation, and the big rating agencies which miscalculated the true associated risks.
Principal factors behind events which led to the crises
Interest rates
In early 2000, the rate of interests were comparatively low, which along with some specific government policies encouraged house ownership in US. Low rates made borrowing easier, increased property investment and...

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