[ad_1]
Financial crises have occurred repeatedly throughout history, from the formation of early empires and the formation of colonies. His appearance can sometimes be unexpected. Nevertheless, crises can be controlled from escalating into more dangerous and serious conditions such as depression by the implementation of rules and regulations. The global economic crisis of 07–08 resulted primarily from the significant loosening of financial regulations implemented during the Great Depression era with the intention of stabilizing the economy and preventing future economic disasters from happening again. Its origins can be traced to the low interest rate policies implemented by the government to encourage home ownership in the United States and the introduction of a number of risk-taking techniques such as derivatives, which were bets placed on the creditworthiness of a specific company. . Other countries such as Iceland, Japan, Spain, UK and many others also adopted these tactics, resulting in adverse consequences for their economies.
In 1999, Congress passed the “Gram-Leach-Bliley Act” which overturned the Glass-Steagall Act. The Glass-Steagall Act was passed in 1933 to prevent banks from engaging in risky activities such as betting on depositors’ savings and affiliations with other firms. This change in regulations enabled many investment banks to operate widely as they began to enter a new global financial liberalization era. Greed and discontent were the initial stimulants that contributed to undermining confidence that profits would remain at low levels. As a result of deregulation, products such as derivatives were invented and quickly introduced to the market, which Warren Buffett refers to as weapons of mass destruction. Credit default swaps and collateralized debt obligations were the most common. This led to the development of the securitization process, where the lending party is not affected if the borrower fails to repay. This was primarily because lenders sold the mortgages to investment banks. Investment banks then clubbed these mortgages with other debt such as car loans, credit card debt and student loans.
This resulted in the creation of collateralized debt obligations, or CDOs, which were sold to investors around the world. Since all these products received triple A or the highest investment ratings from rating agencies, many investors considered them as risk-free safe investments. Lenders started taking risky loans because they had no liability in case they went bad. On the other hand, investment banks ignored the volatility of the loans because their primary focus was to maximize their profits by selling more CDOs, which ultimately contributed to the high growth in predatory lending. Credit default swaps were another form of derivative. They were insurance for investors with respect to the CDOs they purchased. Insurance companies like AIG were the main service providers and promised to pay investors any losses in case the CDO went to bed.
Another important fact to keep in mind is that other speculators in the derivatives market may also purchase insurance for CDOs that they do not own. This exposed insurance companies to greater risk since more than one party became responsible for covering the loss. Many investment banks began taking bets against their CDOs, indicating they were about to go bad. As a result of deregulation of the derivatives market, insurance companies were not mandated to report the amount set aside to cover losses, if any. This exposed AIG and many other insurance companies to a high degree of risk, which later translated into disaster. In early 2007, the situation escalated and terror began to gain ground on a large scale. As the pressure of debt increased, economic activity began to deteriorate. Large-scale defaults on loans and bankruptcy filings followed lenders’ vigilance and additional lending as many institutions across the world began facing liquidity issues and were unable to pay their obligations. The decline in GDP was rapid in many countries, especially in Europe and East Asia. This was mainly due to a decline in consumer confidence, lower demand for commodities, and a decline in production worldwide. Unemployment was skyrocketing rapidly, as many companies tried to reduce the threat of bankruptcy by laying off large amounts of their employees. The unemployment rate reached an all-time high in some European countries where it crossed the 27% mark.
On the other hand, China, the world’s second largest economy, was mainly affected by the decline in world trade given its high export role. The financial crisis of 07–08 is considered one of the most severe and painful financial crises to strike the world economy in the years following the Great Depression. Currently, many governments around the world have taken pre-emptive action towards regulation and many new policies have been implemented to stabilize the economy and prevent future crisis. The United States, the epicenter of the 07-08 financial crisis, is now following a more regulated approach with the intention of substantially ameliorating the consequences it is currently facing.
[ad_2]