One of the most common examples of financial crisis is banking crisis. Banking crisis is defined as the situation when the bank is facing bankrupt due to the insufficient of cash flow. Banks usually gain their profit by providing deposit accounts to users, and uses those deposits to provide loans that are paid in a long period of time and gain profit through interest. Try to imagine that if all of the depositors wishes to withdraw their money at the same time, the bank will not be able to return all of the money because part of the money has been used to give out loans or investments. This situation is known as a bank run.
It pointed out that failure in different financial institutions including the Federal Reserve accelerated the crises. Lehman brothers; one of the three largest investments banks in the United States has been cited in the financial crises in 2007. The bank went bankrupt and it had to be sold in September 2008 (Currie, 2010). The other two banks Morgan Stanley and Goldman Sachs had to become commercial banks where more regulation was done. The collapse of large and significant financial institutions like the Lehman Brothers propagated the economic crises.
However, once the housing bubble burst, investors began to question the value of MBSs; there was a huge write down in their value, prompting huge losses in the financial sector. The long held myth that house prices do not decrease was found to be catastrophically inaccurate, and with the collapse of Lehman Brothers in September 2008, The Era of The Great Complacence was well and truly at its end.
Conflicts of interest were created when they sold pre-packaged mortgages as securities to investment banks at a profit. Complications arose when borrowers began defaulting on their loans, and the investment banks faced little or no consequences. Next, the lenders used predatory practices to attract potential borrowers. The types of loans made available included: originate-to-sell, adjustable-rate, NINJA, and interest-only. Borrowers were either not completely informed of all the potentially harmful terms and conditions of their mortgages, or they were informed, but not in a way they could fully comprehend.
By 2008, due to the failures of large financial institutions, there were severe liquidity problems within the US banking system. When the housing bubble peaked in late 2007 the values of securities linked to U.S. real estate pricing began to plummet (Stiglitz 55). This was a critical hit to financial institutions across the globe. Questions began to arise amongst consumers and members of government alike in regards to the solvency of banks due to poorly performing loans and mortgages, which in turn led to declines in the availability of credit. The complete loss of investor confidence impacted stock markets globally.
What Is Subprime Crisis Subprime crisis, also regularly known as the mortgage meltdown is a financial crisis that occurred between the years 2008 to 2009. It is a result of excessive borrowing to numerous homebuyers who have poor credit scores. This act of lending is called subprime lending. During this period, loads of homebuyers defaulted on their monthly payments as their interest rates increased with time. With that, there was a sharp upsurge in mortgage foreclosures.
These high risk mortgages were processed as securitisation; this is a financial practice of combining mortgages into one large pool. Most of the pools became mortgage – backed security (MBS) and were traded on the financial markets by firms such as Fannie Mae and Freddie Mac. These MBS delivered high rate of return for the traders increasing their bonus but were not sound investments for the bank. This careless disregard of the compan... ... middle of paper ... ... to guarantee these banks & their debts, economies & Countries would collapse. Society as a whole could have collapsed.
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.
The Global Financial Crisis and its Impact on EU Governments Summary Despite the efforts of the Federal Reserve and Treasury Department to prevent the collapse of the U.S banking system, the Global Financial Crisis (GFC), also known as the Financial Crisis of 2007-2008, since the Great Depression in the 1930s, was considered to be the largest and most severe financial event, which reshaped the world of finance and investment banking. During this period, Millions of Americans lost their jobs; millions of families lost their homes; and good businesses shut down . The main cause of the GFC was the Subprime Mortgage, high risk mortgage lending, of financial institutions, such as investment banks in the United States. However, there were other factors, which contributed to the GFC, such as regulatory failure, inflated credit ratings, and investment bank abuses. As a result, the 4th largest bank, Lehman Brothers, filed for Chapter 11 bankruptcy, stock-broking firm and Merrill Lynch, an investment bank, were taken over and Goldman Sachs and Morgan Stanley sought banking status in order to receive protection from bankruptcy .
Among the more recent ones are Black Monday (October 19, 1987), when the New York Stock Exchange experienced its biggest single-day loss in history, losing nearly 26 percent of its value; the dot-com bubble of 2000; and the subprime mortgage (housing bubble) crisis of 2007-2009. The Gramm-Leach-Bliley Act passed in the US in 1999 allowed financial services companies to engage in multi-segment transactions, but brought in stringent regulations for protecting the customer and ensuring solvency. But the industry came under strict government scrutiny following the collapse of the Enron Corporation in 2004 and accusations of fraud against top executives of JP Morgan Chase and Merrill Lynch and the bankruptcy of the financial services firm Lehman