Macro Economic Policy And Financial Crisis Finance Essay - Free Essay Example

Sample details Pages: 3 Words: 909 Downloads: 8 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? The history of the world has witnessed many economic crises. It is a common fact that the basic reason that economies plunge into recession is due to debt. This paper aims to review the Financial Crisis of 2008 in the world and analyses its causes and analyse the different types of measures have been taken by the US government. Don’t waste time! Our writers will create an original "Macro Economic Policy And Financial Crisis Finance Essay" essay for you Create order According to US national bureau of economic research, recession is a period of general economic decline, characterized usually by a contraction in the gross domestic product for six months or longer. The share markets have crashed, huge and massive financial institutions have collapsed and some of them got financial support from government. The typical features of the recession are high levels of unemployment, lower wages and a drastic fall in retail sales. According to the bureau of labour statistics, the level of US unemployment was 4.5% in 2006 and in 2008 it rose to 6.7% How it affects worlds economy? Various countries at various times have run high current account surplus, reflecting an excess of saving over domestic investment (Max, 2009). This saving will reduce worlds real interest rates. it is obvious that worlds total export of capital must be equal to worlds total imports of capital. As a result of this total current account surplus will be equal to total current account deficit. The US current account deficit rose since the year 2002. It had the opposite effect on the world real interest rates, tending to raise them. The investments made by the countries such as Japan, China, Germany, oil exporters countries and other countries affect the US deficit policy. In 2007 approximately half of the total world deficits belonged to the US because of the cheaper borrowings and readily available. US economy is 30 percent of the world economy; that is sufficient to explain why any effect in US is likely to be relatively in the world (Max, 2009). The collapse of Bear Stearns in 2007 has made it clear to the consumers that the recession is unavoidable. Causes of the Global financial crisis:- USA:- The growth of housing bubble: The housing bubble was the major cause not only for the subprime crisis but also for the global economic crisis. Total US mortgage market is approximately $10 trillion out of this the subprime loan is the fastest growing segment. The common belief that the prices of the real estate always raise year after year create a scenario for the lenders and financial institutions to lend risky loans. The real estate market was in boom during the year 2000 and onwards after the dot com bubble busted in the end of the century. From the year 2000 the interest rates were low, that made an Americans to invest money in the safe industry i.e. real estate sector. Easy credit conditions: During boom period in the US real estate sector, the mortgage lenders lend mortgages to the low income workers. From the year 2000 the money lenders became very liberal and they provided mortgages on liberal condition such as interest only loans and option adjustable rate mortgages (ARMs). In the year 2003 these A RMs accounted less than 1% of all mortgages but in the year 2006 it rose to near 15%. In many us communities, however, option ARMs accounted around one of three mortgages written in past few years (Der Hovaneasian). These option ARMs have high rate interest so it became highly profitable for the banks. Many brokers promoted that option ARMs because they earned a massive amount of commission. Securitisation of mortgages: The practise of bundling mortgages into new securities is called securitisation of mortgages. These highly risky mortgages converted into new security and the banks sold it to the investors. The financial institutions sell these securities to convert long term debt into liquid asset so they can earn profit from the investors and on the other hand investors get long term high return. Generally hedge funds are the main investors to get high returns. Securities of the mortgages have been in the practise since the real estate boom in the 1990. The number of securitise d investments grew nearly 300% between 1996 and 2007 reaching $7.27 trillion (Kantz2008). When the mortgage holders could not able to pay their instalments, this loss have to suffer by the investors and these investors includes hedge funds, investment banks, pension funds and the commercial banks. However it should be noted that they can detain the properties but if the number of defaulters is high then the prices of the properties decrease so the lenders cannot recover their money. This led them to instability in liquid assets. Repeal of the Glass Steagall Act: The Glass-Steagall Act was enacted in the year of 1933 by the former US president Roosevelt administration committee after having The great depression in1929. Commercial banks could not merge with the other financial institutions which were engage in mortgage securitisation, real estate, insurance companies and investment banks. That act separated the commercial banks from the investment banks and the insurance company. T his act was repealed by the Bill Clinton in 1999. Europe:- Spain Ireland:- After the adoption of euro as a common currency in Europe, the countries such as Spain and Ireland had experienced a lending boom. The reason was euros negligible interest rate. At the time of real estate boom, Spain built more houses than Germany, France and United Kingdome. That led them for the growth of banking and construction industry. At the same time in Ireland, 110 percent mortgage loan without any down payment was very popular. United kingdom:-