Introduction

The Global financial crisis and the 2008 financial crisis have been considered by the world economists to be the worst economic crisis since the Great Depression of 1930s. The financial crisis of 2008 nearly led to the collapse of government controlled financial institutions. Even though, the world markets also dropped. According to Soros (2), this crisis came to a broad light when serious problems became evident in the housing market and mortgage industry and when short term credit markets froze resulting to an intervention by the central banks. During this period, there was rise in the asset price and there was a rash in the economic demand. Back in the United States, the evidence that it underwent a financial crisis in 2007-2008 includes; failure of major financial institutions, the dramatic fall of stock markets, and dramatic widening of treasury securities on different types of loans. This paper examines the causes, effects and solutions to the economic crisis of 2008.

Causes of financial crisis of 2008

There are very many theories about what caused the economic crisis some claiming that it happened because financial institutions were able to make huge sums of money quickly by making loans hence they used it to hike up house prices and speculate on financial markets (Positive Money). Eventually, it became hard to repay the loans and banks were caught in the danger of running bankrupt and the process caused the economic crisis. This became evident when Lord Turner-the former chairman of United Kingdom’s Financial Services said that the crisis occurred because of failure to constrain financial system’s creation of private credit and money.

After this happened, financial institutions restrained their lending capability to businesses and households causing a drop in the market prices. Due to the pending bank loans, these institutions opted to sell some of their properties in order to settle the debts. House prices went down and causing further panic by banks to tighten their nuts. When banks refused to lend due to loss of confidence from their customers, the economy froze as repayments continued to be made. When the rate of lending is lower than the rate of repayment, the money disappears from the economy and is destroyed. It is similar to siphoning oil from a vehicle engine. Bank of England in the article Money Creation in the Modern Economy argues that the repayment of bank loans destroys money the same way taking a new loan would make money a factor that significantly creates and destroys bank deposits in the modern economy.

Additionally, fraud led to the crisis. Borrowing of money by housing institutions with failure of repayment means that there are culprits who converted the loan into their personal accounts (Michael D. Hurd & Sussan Rohwedder, 5-6). Although it is not clear on the legal proceedings upon them but it is clear that they were involved in matters of corruption. By approving the Community Reinvestment Act which encouraged more borrowing, politicians are said to play a role in this issue. They blackmailed banks into giving credit to un-creditworthy borrowers. Similarly, critics mention that bank regulations encouraged unconventional business practices. Government policies encouraged ownership of homes even to the people who were unable to afford. This resulted in income inequality growth and stagnation of wages. Families were not able to live according to their desired standards. This increased the political power of business interests .They used the power to limit regulation of shadow banking systems.

Had the banks increased the importance of shadow banking, they would have made fewer losses. As most of traditional banks failed during the crisis, they have less input on the responsibility for what actually happened. This is because shadow banks caused most of the damage. What they did is to ignore investment banks (shadow banks) causing a thrift that did not fall. Richard Kovacevich- former chairman and CEO of Wells Fargo revealed that about 20 financial institutions were involved in perpetrating the crisis out of which half were investment banks and the other half were savings and loans. He went further and said that Citicorp was the only commercial bank but was operating as an investment bank. His enumeration shows that their failure in conducting business processes have no excuse and a severe punishment is all they needed.

Effects of 2008 financial crisis

The crisis brought a lot of consequences to the U.S. As estimated by the Congressional Budget Office, the financial crisis cost the U.S government billions of dollars because of reduced economic growth. Approximately $5800 of income was lost for each household. The Federal State also estimated that $7.4 trillion was lost in the real estate and stock wealth because of this economic crisis.

According to Dooley, Yan, Srimathy, & Mohan (12-18), the drop in international trade caused unemployment and increase in commodity prices. The government came up with policies to reduce the crisis and one of it was to send home some of its employees in order to cut the wage bill as well as imposing a tax increment which in turn led to the increase in commodity prices. This burdened citizens as the economy was now ‘staggering.’

Michael D. Hurd & Sussan Rohwedder found out that American household had to reduce on their expenditure by 30% because the crisis affected their well-being. The reduction was the highly used in response to the crisis. They reduced their expenditure on food purchases. Expenditure on health care services and prescribed drugs also dropped a lot more than the total spending. This move protected expenditures against future health declines because they could bring long-term negative health impacts (11-17).

The economic crisis of 2008 also caused the number of credit card holders to drop by some percentage (3%).This reflected a tight access of credit due to the tightened access to credit services. It was caused by the credit card holders having debts carried over from one month to another thus resulting in an additional interest payment of almost $1000 annually. Additionally, households who had retirement savings reported that the savings had dropped in value. Some of them relocated the retirement accounts away from stock markets because the economy had affected the stock.

It is even more interesting to find out that banking institutions who were the major players in the crisis were much affected. They lost money on mortgage defaults and interbank lending. There had to be new regulations on the bank and this affected them further. They could not lend money to other banks. The interest rate also increased to a higher percentage and this prevented consumers from accessing credit services easily.

Many people were dissatisfied with their living standards a result of this crisis because their income had reduced yet they had a lot of debts to clear. Some were depressed and had sleepless nights. This affected the overall consumer prices. The amount of export also reduced because of the increase in prices and it led to fiscal unemployment (Mian, Atif and Amir.Sufi, 2197-2223). As a result, the poverty gap widened and there was disparity of income. The level of inflation increased rapidly because of the increased overflow of money in the market. The value of money reduced as a result. According to a research was done by the National Association State Budget Officers, the state was forced to cut down on expenditure thus immensely affecting the education sector. Intake in colleges had to reduce and the class sizes had to be reduced. Transport and public assistant programs were also affected. The crisis affected not only America but also other related countries. It caused a global economic shock.

Solutions to the crisis

In response to the crisis, the U.S government followed a strategy to engage a reverse. The president and the congress made legislation on the Recovery bill. They bailed out the financial institutions that were distressed. Congress helped in financing the failing institution. They made the Troubled Asset Relief Program that invested billions through the Department of treasury. They became part owners and in some cases even bought the real estates that were financially unproductive. More money was also printed and the central bank decided to guarantee value to the institutions with shaky handsets. The banks agreed to offer low interest rates. This encouraged growth of business activities. The stock market also increased as a result.

Conclusion

The crisis that hit not only the United States but also other countries around the world -thus also referred to as The Global Financial Crisis was as a result of the banks giving mortgage loans to consumers. Most of the consumers were unable to pay the loans and this caused the banks to run on debt. The financial regulations also made a high impact on the recession. The government made policies that the consumers could take loans even though they had not qualified. As a result, the consumers were not able to repay the loans. Transactions stopped the flow of money as banks stopped lending money to the consumers. The crisis resulted in unemployment and inflation. The stock market also reduced because people took their money away from the stock market as they lost confidence in the trading and stock industry. Due to the bank withholding money, the consumers had to use their savings on consumption a factor that contributed to the increase in poverty level .The rate of forced or early retirement increased because wage bill was already higher that the output putting companies in a danger zone of closure. The global financial crisis also reduced the rate of exports because of the increased prices of items. The investors lost confidence in the economy and they ceased from investing in the country. However the US government was able to come up with ways to counter act recession. They were able to bail out failing companies by providing them with finances. There after the companies could return them the finances when they were back on their feet. The government also came up with an act so that they could finance companies by being part owners through buying stocks. They could also at times buy the whole company.

Bibliography

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Mian, Atif, & Amir.Sufi. (2009). What explains the 2007–2009 drop in employment? Econometrica 82.6 , 2197-2223.

Positive Money. (n.d). Financial Crisis & Recessions. Retrieved April 29, 2016, from Positive Money: http://www.positivemoney.org/, n.d.

Sussan Rohwedder & Michael D. Hurd (2010). EFFECTS OF THE FINANCIAL CRISIS AND GREAT RECESSION ON AMERICAN HOUSEHOLDS. Cambridge: National Bureau of Economic Research, 11-17.

Soros, G. (2008). The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means. United States: Public Affairs Books, 2.