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‘Critical Evaluation of the US Financial Crisis - Causes and Consequences’

‘Critical Evaluation of the US Financial Crisis - Causes and Consequences’

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An essay for the 2012 Undergraduate Awards Competition by Stephen McKee. Originally submitted for Accounting at University of Ulster, with lecturer Judith Wylie in the category of Business & Economics
An essay for the 2012 Undergraduate Awards Competition by Stephen McKee. Originally submitted for Accounting at University of Ulster, with lecturer Judith Wylie in the category of Business & Economics

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Published by: Undergraduate Awards on Aug 31, 2012
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05/13/2014

 
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‘Critical E
valuation of the US Financial Crisis -Causes and
Consequences’
 
Contents
Abstract ......................................................................................................................................................... 2I. Introduction ............................................................................................................................................... 3II. Causes of the US Financial Crisis ............................................................................................................... 4i. Financial Institution Causes .................................................................................................................... 4Real Estate Bubble ................................................................................................................................ 4Derivatives ............................................................................................................................................ 5Diversification ....................................................................................................................................... 7Leverage ................................................................................................................................................ 8Credit Rating Agencies .......................................................................................................................... 9Excessive Remuneration ..................................................................................................................... 10ii. US Government Causes ....................................................................................................................... 11Deregulation ....................................................................................................................................... 11Interest Rates ...................................................................................................................................... 12No Repercussions ................................................................................................................................ 13iii. Macroeconomic Causes ..................................................................................................................... 13Chinese Investment and Savings ......................................................................................................... 14Chinese Currency ................................................................................................................................ 14US Deficit ............................................................................................................................................. 16III. Consequences of the Financial Crisis ..................................................................................................... 17IV. Conclusion .............................................................................................................................................. 20VI. Appendix ................................................................................................................................................ 22VII. Bibliography .......................................................................................................................................... 23
 
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 Abstract 
The intended readership of this paper is an individual from a business background whohas at least a basis in basic financial principles. The paper aims to analyse problems contributingto the 2007 US financial crisis and clarify the effects it has had upon the American economy.The causes and consequences of the financial crisis have been well documented in the mediaand academic research has only predominantly studied topics individually. This paper gives aconcise overview of all contributing factors to the recession and concludes the financial crisis of 2007 was an accumulation of events; hence no isolated occurrence was exclusively to blame.The crisis could have been averted had sub-prime lending not spurred an unaffordable housingbubble whilst the derivative markets where allowed to grow unregulated. Unethical anduneducated trading behaviour including excessive risk taking and high leverage transactionsexacerbated these problems further until the liquidity markets effectively froze. Thegovernment played a relatively inactive role encouraging deregulation in an industry which
needed supervision. The Federal Reserve’s lack of interest rate control encouraged risky lending
and an absence of penalties for misgivings in the financial sector set a precedent of leniency.The international scale of business made this a global problem with every country around theworld affected. Recommendations need put forward which will strengthen the financial systemwhilst encouraging entrepreneurship and continued growth. The President and the FederalReserve have taken action, legislation like the Volker rule has been passed and mistakessupposedly studied from, yet this does not and never will guarantee another financial crisis willnever happen again.
 
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I. Introduction
In 2007 the stock market plunged, insurance companies went bankrupt, banks closeddown and people lost their jobs. The financial crisis or the great recession as often referred toin the US has been described as,
“…
the worst economic crisis since the
great depression.”
(Ely,2009, p. 93). In hindsight however the warning signs were there. Raghuram Rajan presented apaper to some of the most powerful people in finance predicting that current marketconditions were increasing the risks in investment trading and a crash was possible (Rajan,2006), nonetheless no-one paid attention.The causes and consequences of the financial crisis have been well documented in themedia but it is far more complex than the general public realises, information has been selectedand manipulated to appease public outrage. This paper researches the causes of the 2007 USfinancial crisis through to the consequences that still affect the economy today. This will beaccomplished by the study of many academic sources as well as mass media publications fromnewspapers to interviews. The academic sources enable an in-depth understanding whilst massmedia publications will give insight into the information the average US citizen was exposed to.

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