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The global financial crisis that began in mid-2007 soon developed into what became known as the Great Recession. According to Farlow (2013), it began as a typical turbulence in the housing sector in the United States before exploding into a full-fledged recession by the end of 2007. The old adage that anytime the United States gets a cough, the entire planet sneezes seemed to be valid by mid-2008, when major economies such as Japan and other European countries faced the Great Recession. Most economists, politicians, multilateral organizations, and analysts were taken aback by the crisis, and they were chastised for failing to forecast the global economy's disastrous collapse. This paper analyzes the Great Recession in terms of its causes, the effects, and policy responses. It provides a historical perspective of the period prior to the crisis and offers insights into the events that characterized the Great Recession of 2008.
The Financial Crisis inquiry Commission (2011) reveal that the housing market is considered the root cause of the global financial crisis. Beginning late 1990's, the price of houses grew rapidly due to factors such low-interest rates, speculation, and highly leveraged lending by the financial institutions. The crisis began when the house prices started going down and foreclosures went up drastically. As a result, credit rating organizations downgraded their risk assessments for asset-backed securities by mid-2007. The high risk reduced the ability of issuers of these financial instruments to pay the interest rate. The realization of the fact that the credit and housing bubbles would eventually result in losses led to a severe and immediate dislocation of the financial markets. Several other interlinked and complicated factors such as lax monetary policies, risk misperception, global imbalances, and lack of effective financial regulations also contributed to the emergence of the financial crisis. In particular, the collapse of Lehman Brothers financial services firm made investors across the entire world to change their perception of risk.
Despite receiving short-term credit facilities from the Federal Reserve fund and auctions for the mortgage-based financial instruments, financial and mortgage firms' turmoil continued. According to Berberoglu (2016), such actions did not prevent the rapid decline in the prices of assets. To recapitalize their risk-weighted ratios, these firms had to relieve themselves of the financial risk burdens. Many firms were acquired such as the Mortgage Lender Countrywide which was acquired by the Bank of America for 4 billion US dollars. Many other financial institutions especially those that had engaged massively in mortgage-backed securities collapsed while others were acquired (Gup, 2010). As the rise of the default rates and mortgage delinquency continued, the mortgage lenders were also severely affected as the value of their collaterals drastically went down. During the last quarter of 2008, the crisis hit the banking industry. Lehman Brothers investment bank filed for bankruptcy after failing to raise the required capital for underwriting the downgraded securities. This act clearly demonstrated the government's unwillingness to bail out banks, which further increased interbank lending rates.
In response, the financial markets across the world became highly volatile. The investor confidence went down drastically, which was demonstrated by the flight to safer assets such as the US dollar, oil, and gold (Marshall & Great Britain, 2009). Moreover, the demand for risk-free treasury bills rose so high that even their returns approached zero. Overall, the credit restrictions to both companies and households had serious implications to the real economy. Additionally, the automobile industry in the US was severely affected as the sales for cars in October went down by 31% from the previous month. Furthermore, the retail industry was negatively affected because the sales for general merchandise decreased by 2.8% in October 2008. The rate of unemployment also rose from 6.2% to 7.6% for the same period.
In conclusion, the global economic and governance reforms need to promote greater coherence of financial and monetary relations. Strengthening the supervision and regulation of financial markets is inevitable to achieve greater stability and to prevent the occurrence of another Great Recession.
Berberoglu, B. (2016). The global capitalist crisis and its aftermath: The causes and consequences of the Great Recession of 2008-2009. London: Routledge.
Farlow, A. (2013). Crash and beyond: Causes and consequences of the global financial crisis. Oxford: Oxford University Press.
Financial Crisis inquiry Commission. (2011).The financial crisis inquiry report: Final report of the National Commission on the causes of the financial and economic crisis in the United States. New York, NY: Public Affairs.
Gup, B. E. (2010). The financial and economic crises: An international perspective. Cheltenham: Edward Elgar.
Marshall, J., & Great Britain. (2009).The financial crisis in the US: Key events, Causes and responses. London: House of Commons Library.
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