Question

It appears there is a lot of blame to go around for what happened in world financial markets during the 2008 and 2009. After watching the videos listed under the folder "Global Financial Crisis of 2008 and 2009" and reading the other material provided under the module, please write a mimimum 800 word response paper (double spaced, Times New Roman) outlining your understanding of the causes and the culprits of the 2008 Financial Crisis.

In your paper you should answer the following questions:

In your opinion, who is/are the most to blame for the crash? Regulators? Wall Street? Subprime borrowers?

To avoid future crises that can arise from asset bubbles like the one we lived through in 2008 and 2009, what in your opinion can be done? Who should be proactive on this topic? Citizens? Wall Street? The government?

Answer 1

Introduction: -

The Global Financial crisis of the 2000's primarily happened as a result of de-regulation of the financial markets. As a result of which home buyers found it increasingly easier for themselves to avail credit even when their credit scores may not be appropriate for such a loan. In the meanwhile, it is important to know, that the Federal Reserve raised the interest rates in 2004 which led to home buyers being unable to pay off their debts.

The consequential result was that the overall demand for homes shrank since people were sceptical now on purchasing a property and people could no longer sell their property because there was no demand left.

This left a gap between supply and demand. New properties were not being purchased because of higher interest rates and older ones lost value because no one was ready to purchase them.

As a resultant of the above description, the end result was that home buyers would willingly turn over their properties to banks. When this happened the real estate bubble just burst. Bad loans were created and the underwritten property was such that no one would purchase the same.

Consumer demand soon saw a hit and people no longer demanded things. The crash lead to wide spread unemployment and a global crisis which saw deep problems for every small and big country alike. This happened because the United States and its currency and trends are what determine the global mood for demand and supply.

Who is to be blamed?

In my personal opinion, the onus of this problem, lies with the regulators. A developed country like the United States cannot allow loans to be granted without verification and checks and balances. Borrowers or the wall street only analyse the current regulations in place and their decision making may not always be rational.

People buy and sell property based on judgements than financial analysis and thinking in most cases. Due to deregulation, we gave banks the free hand in deciding the amount of loans to be credited and this often did not consider the relative price of the mortgaged assets.

Giving away too many loans without checking the background of the borrowers, would lead to failure of any banking system. The demand and supply are more based on sentiments than anything else.

Solution: -

The key solution to ensuring that such problems do not arise in the future are that financial regulation is strengthened and credit bureaus are placed which can provide relevant background verification of the ability of a borrower to repay back the money.

Further, assessment of a property is essential and banks must ensure that they give away only a proportion of loans and consider depreciation of property prices in areas which may be vulnerable to such trends.

Setting strict laws on reserves can also solve the problem. The Federal Reserve must keep a track of reserve ratio maintenance and whether or not banks are doing verification and background checks before handing over loans to customers.

This will help in ensuring that bad loans are not created in the economy. And even if they are indeed created, they are proportionate to the value of the underwritten property keeping in mind that it may depreciate and the position of supply and demand of the same should also be analysed. The responsibility here is of the regulator to ensure that such things are in place.

Please feel free to ask your doubts in the comments section if any.