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The 2008 Financial Crash Revisited - Background, Crisis, and Aftermath

This article was written by Ryan Lee, a sixth form student from London.


The 2007-08 financial crisis, also known as “the Great Recession”, is seen as one of the most important economic downturns of all time. It revealed the weaknesses behind the financial system, brought many consumers and businesses to bankrupcy and prompted a re-evaluation of mainstream economic policy practically overnight. This essay will explore the reasons behind the 2008 financial crash, its impacts on industry, and the lessons learnt from this significant event.



The crisis started in the United States of America, specifically in the subprime housing market. The subprime mortgage market is composed of people who have had difficulties paying their mortgage on a regular basis. After the dot-com bubble at the turn of the century, central banks like the FEC had been pursuing a relaxed monetary policy of low interest rates. This, coupled with growing consumer confidence made cheap mortgage loans available to those who had previously never been able to afford them, the subprime market.  The increase of these high-risk borrowers in the market caused house prices to balloon, creating the infamous housing bubble that would lie dormant until 2008.


Investment banking firms, such as Lehman Brothers, JP Morgan, Morgan Stanley as well as other international investment firms invested in a lot of collateralized debt obligations (CDOs), which at the time of 2007/08, looked profitable and low-risk. A CDO is a financial product to pool together a range of debt which can be sold to investors, to make the bank more money and remove risk to the bank. Initially, financial institutions were sure that if one subprime borrower defaulted on their mortgage, their house would simply be put on sale by the bank, but what happens when all of these subprime borrowers default around the same time? The answer is that nobody would, because nobody could. Banks could not get their money back from individuals defaulting on their mortgages because banks could not afford to buy all these defaulted properties back, and there were not enough people to buy these properties in turn. When the housing market bubble finally burst, the banks and financial institutions realised that CDOs and lax mortgage debt, over a trillion dollars which the subprime market could not pay back, was lost. Banks were fooled, willingly or unwillingly, into buying seemingly profitable CDOs which did not properly advertise  the risk associated with the packages of mortgage loans. Many investment and commercial banks around the world suffered heavy losses which sent ripples, or more accurately tsunamis, throughout the world.



The 2008 financial crash led to losses of more than $2 trillion. Many companies filed for bankruptcy due to the massive amounts of debt they had accumulated, with Lehman Brothers representing the paradigm of firm defaults at $691.06 billion in debt. Lehman had too many illiquid assets and lacked sufficient collateral to borrow from the US Federal Reserve and keep it afloat. It caused an estimate of 8.8 million jobs around the world to be lost and around 3.7 million jobs lost in the UK alone. The stock market, dollar and pound all experienced falls in value, consequently lowering the value of retirement savings and pension funds. Consumer and business confidence plummeted, causing a lack of borrowing and hindered investment and consumption. Consumers’ lack of confidence in the economy caused a sharp fall in aggregate demand in the economy, starting a spiral whereby nothing is being consumed, causing firms to struggle, resulting in further job losses, and demand falls even further.


In response to the 2007-08 financial crisis, governments around the world were forced to intervene with massive bailouts to prevent a complete meltdown of the financial system. Almost $500 billion was injected to save the banks and investment firms from failing. There was also regulatory reform in regards to lending, implemented to enhance transparency, improve risk management and avoid future crises. Moreover, some governments implemented mortgage assistance programs to educate and help people, especially in the subprime market, to pay off their mortgages properly. Governments also moved to expand their government spending in the wake of 2008 to counteract the negative demand spiral, by cutting taxes and cutting interest rates. This would ultimately support businesses and consumers to boost economic activity within their country. However, this initiative did not extend to the UK in the same way, where Brits felt the effects of austerity implemented by the coalition government of the Conservatives and Liberal Democrats. 


In conclusion, the 2008 financial crash, triggered by the subprime mortgage collapse, was a turning point in history where economies suffered traumatic shocks and central banks around the world intervened with unprecedented measures. It has led to important changes in financial regulations and highlighted the need for vigilant supervision on the transparency and risk assessment of financial products. This crisis serves as a reminder to maintain a resilient, sustainable and stable financial system that safeguards against systemic risk.


The views and opinions expressed in this article belong solely to the writer and do not necessarily reflect the views and opinions of the Warwick Economics Summit.

 

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