The financial crisis of the late 2000s is one of the worst ever crisis occurred on the globe after the great depression of 1930. It occurred due to the liquidity shortfall of the banking sector in the u.s. This crisis has yielded to the bankruptcy of many small and large financial institutions not only in the US but all over the world.
The financial crisis of the late 2000s is one of the worst ever crisis occurred on the globe after the great depression of 1930. It occurred due to the liquidity shortfall of the banking sector in the u.s. This crisis has yielded to the bankruptcy of many small and large financial institutions not only in the US but all over the world.
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The financial crisis of the late 2000s is one of the worst ever crisis occurred on the globe after the great depression of 1930. It occurred due to the liquidity shortfall of the banking sector in the u.s. This crisis has yielded to the bankruptcy of many small and large financial institutions not only in the US but all over the world.
Copyright:
Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOCX, PDF, TXT or read online from Scribd
The financial crisis of the late 2000s is one of the worst
ever crisis occurred on the globe after the great depression of 1930. It occurred due to the liquidity shortfall of the banking sector in the America. This crisis has yield to the bankruptcy of many small & large financial institutions not only in US but all over the world. The first seven years of the 21st century experienced the highest level of economic growth for the last 30years. Due to this the developing countries faced a great boom. In went right till the half of year 2007 but then converted into a bust. However these short lived successes were to be followed by a period of not only instability but uncertainty as well. Causes of the crises:
Economists of the world gave numerous reasons for this credit crunch but most of them came with the same opinion that it started in US b/w year 1996 to 2007 when people started buying expensive houses as getting loans was so easy because of the excess money of the other countries in US on the basis of mortgages and subprime mortgages. This lending of the money was in forms of constructed credit securities allowing hedge funds to banks and creating assets composed of mortgage and corporate backed bonds and selling them to another person so the risks are transferred to the borrowers.
The influence of housing bubble:
During 1996 to 2006 it was seen that the typical price of US house raised by 124%. But houses started falling down as the people were unable to pay the monthly installments of the loans which resulted in the acquiring of the homes by the loan provider(banks), as they start selling the houses for recovering their loans but there were no buyers in the market which means the quantity supplied for the houses exceeded the quantity demanded for the houses resulting the decrease in the prices of houses. Due to this gradual decrease in the prices the people who were paying their monthly installments of their loans came to know that the value of their house is much lesser than their monthly installment so they also stopped paying the installments and sold their house.
$ub-prime lending:
The subprime mortgage is much risky as the loan is given without any security or checking the historical record. In March 2007 the value of US subprime mortgages stood at $1.3 trillion. The level of subprime mortgages remained in all time low of below 10% until in 2004 when it rose to nearly 20% and staying that way until 2005-2006 when housing bubble was at the peak. contributed 40% of all subprime loans in 2007. everage:
The term leverage refers to the usage of the borrowed money to amplify the profits. Leverage is also considered as one of the cause of this credit crunch. It can easily be understood by this example that how it affected the housing bubble. Through leverage, a person may put 20% down payment and get the loan of 80% of the value of the new home. This means if the house costs $1,000,000, the homeowner buys the new house with $200,000 in equity in the house only. Similarly if the price of the house rises by 10%, to $110,0,000. Now he has $300,000 of equity and thus made a 50% gain on his real investment. So the 10% price increase has turned into a 50% gain to the owner of the house and this is just because his is equity investment or original investment is leveraged through the mortgage. Thats the advantage of leverage that when prices are increasing, gain on a house or any other investment can be turned into a huge and big gain on the owners initial investment. But of course there is a drawback or dark side of leverage as well. In the above mortgage example, this dark side can easily be seen: if prices of houses or other assets fall by 10% instead of increasing by 10%, the owner loses 50% of his equity. And similarly if the prices fall by 20%, the entire equity of the owner is lost. Thus it shows that, leverage magnifies both the gains and the losses on equity investments and is much risky as its already understood that greater is the return, greater is the risk. Thus we can say that leverage is just like a genie of the lamp. When prices of the asset are rising, leverage can change a 10% return into a 50% return. In the period leading up to the current crises, the genie was granting wishes to the financial institutions and they earned huge profits by expanding their leverage. When firms take leveraged bets that pay off 9 times out of 10, they can have long runs of seemingly amazing returns. As after getting on the maximum point the down fall started and problem occurred when the genie catches you in a mistake. The downfall in prices of houses since 2006 and the downfall in the stock market have combined with leverage to threaten the solvency of many financial institutions. As the financial systems is so integrated and inter linked - financial institutions borrow and lend large sums with each other every day in normal times-problems in a few banks can create a systematic risk for the financial system as a whole.
#eferences:
1) lobal Financial Crises of 2007-08 By Charles I. Johns. 2) Financial Crises of 2007 by Qayoom Qureshi.