Financial Crisis Essay

The Financial Crisis of 2007-2009 According to the Federal Reserve Bank of Atlanta, the recession of 2007-2009 was the longest lasting one from after World War II. It persisted for 18 months, while on average a recession normally lasts approximately 10 months. The decline of employment has been much more lasting and brutal in contrast to the post-World War II recessions. Nearly four years after the recession started, the employment decline was still staggeringly high at 4.5 percentage points (Dwyer and Lothian). The financial crisis has had an effect on not just the economy of the United States, but the entire global economy. Looking at this financial crisis, numerous questions need to be answered. What where the causes of the financial crisis; how did the Federal Reserve and federal government respond to it; should either of them have implemented the policies they did to help stem recovery from the crisis; should the government let big companies fail; and what are the advantages and disadvantages to government bailouts? There were various causes of the financial crisis including: financiers losing sight of risk; federal regulators and central bankers standing by and doing nothing; many years of steady growth and low inflation, where risk-taking and complacency became the norm; and European banks purchasing risky securities after borrowing excessively from money markets in America. First off, financiers lost sight of risk. Years before the financial crisis, loans were given to people who had bad credit and would have trouble paying them back (also known as subprime mortgages). Then, financial engineers at big banks would put large numbers of these mortgages together into pools of what were supposed to be low-risk securities. This ... ... middle of paper ... ... were being performed more and more by computers. More stock would be purchased by the computers during which it also sold off stock index futures, when the market increased. Then, when the market went down, investors assumed that the portfolio insurance would shield them from losses. However, this didn’t work because investors should have sold as the market dropped and bought as it went up. Since there was a large number of investors that were doing this, market trends became exaggerated. The 2008 crisis started out similarly to the one in 1987. In the mid-1990’s the bond and derivatives markets took a major hit. Once again, investors wanted to lower risk for themselves while maximizing their returns. Therefore, financial companies came up with an “answer” in the form of credit default swaps. This shielded debt holders from losses from when bonds defaulted