Table of Contents
1. Executive summary 2
2. Introduction 3
3. Body 3
3.1 Analysis of causes of the crisis 3
3.1.1 Housing bubble and subprime mortgage crisis 3
3.1.2 Global imbalance 4
3.1.3 Financial Innovation 5
3.2 The impacts of this global financial crisis 5
3.2.1 Impact on the world economy 5
3.2.2 Impact on stock market 5
3.2.3 Impact on manufacturing activity 6
3.2.4 Impact on developing countries 6
4. Conclusion and lessons learned from the crisis 8
5. References 10
The global financial crisis in 2008 has led to one of the biggest recessions spread all over the world. It caused a considerable slowdown in almost all ...view middle of the document...
1 Analysis of causes of the crisis
In fact, there are many different causes which led to this global financial crisis; however the main causes are the US housing bubble, the world imbalance and the financial innovations.
1 Housing bubble and subprime mortgage crisis
The housing bubble is an economic bubble taking place in real estate markets (Bianco, 2008). It is considered as one of the primary cause to the global financial crisis. In fact, the main cause of housing bubble in US was the stock bubble in mid 90s. With the rise up in stock price, people were able to increase their wealth fare, and wanted to spend their new stock wealth on housing. It led to a sharp increase in housing demand in the market (Beker, 2008).
Another reason which resulted in the rise in demand for house was the subprime mortgage. Subprime mortgage is one type of mortgage which granted to individuals with low credit histories (often below 600). The most popular structure of subprime mortgage is adjustable rate mortgage (ARM) in which a fixed interest rate is charged at first, then convert to a floating rate based on the index like LIBOR plus specific margin (Investopedia, 2011). Because the initial interest rate is low, the borrowers are misled that the subprime mortgage is more affordable. However, when the interest is reset to variable rate, the payment for this mortgage would increase dramatically. This is the reason why there was a significant increase in subprime mortgage.
The high demand in housing led to increase in price. With the expectation that the price would continue to increase, the homebuyer did willing to pay far more than the actual price, created a housing bubble (Baker, 2008).
However, this bubble started to burst in 2007, when housing boom resulted in too much over supply that the prices could not hold up anymore. In fact, the prices reached its peak and then started to fall through 2008. After this turning down, there was an increase in the default rates in subprime market. The reason was that, the subprime mortgage borrowers are people with low income, and low credit history; thus when the house price dropped and they did not have ability to meet the payment, they had to default on the mortgages. When the defaults were spread, the valuation of MBS decreased sharply, the subprime mortgage was in crisis; led to the hit to financial market (Baker, 2008).
The US financial market was exhausted with widespread financial panic when the US Government informed the nationalization of Fanny Mae and Freddie Mac on September 7, 2008; and the largest bankruptcy of Lehman Brothers on September 15, 2008 (Naude, 2009). Lending between financial institutions and banks was cut off sharply, and the interest rate was increased rapidly. In order to raise fund, the financial institutions had to sell the assets, which led to price crash for equity and bond (Liefert and Shane, 2009).
Because the financial markets...