Each player in the financial system is connected to another. Therefore when one fails, the others are affected. This statement could not be truer in analyzing and understanding the 2008 financial crisis that saw many companies fall to the ground. Economic analysts argue that the crisis was a result of looming debts that grew day by day. However, debt alone is not sufficient in explaining the cause of this crisis. Therefore, this paper analyses the 2008 economic crisis, its causes and how Western nations could have avoided it.
The 2008 Financial crisis On September 15th, 2008, the world woke to a rude shock of the collapse of the Lehman Brothers, the world’s largest stock brokerage and investment firm. By this time, more than 10, 000 companies in the USA had run out of business (Buckley, 2010, p. 274). This wind of crises spread out to the whole world leading to a global economic crisis.
Analysts agree that as much as many factors caused the crisis, one direct and immediate one was subprime loan system in the US. This is a housing loan with a low credit rating because it is believed that these individuals have higher chances of defaulting repayment (Buckley, 2010, p. 275). Initially, people are drawn by the low interest promised but later get hurt by the gradually risen interest. This is the most outstanding feature of a subprime loan and one of the causes of a financial crisis.
Subprime loan became common, especially in America since 2003 when house prices had gone up, and people began having difficulties in purchasing a house. During this period, the rate of delinquency was at 10%. It increased to 13% between 2004 and 2005 (Domitrophic, 2012, p. 32). However, there was a drastic increase because interest went up. As a result, financial institutions that were accommodating subprime lenders started to hold back their money hence creating a drop in housing prices thus making it difficult for delinquency rates to increase (Buckley, 2010, p. 276). This led to a financial crisis for financial institutions offering subprime loans and its borrowers.
Had the financial crisis remained in America, there could not have been a global financial crisis. Instead, it became a global crisis because of the global interconnection of financial systems. This system is security backed up and is spread all over the world. Unfortunately, because of the connection of players in the global financial system, the downfall of one leads to the downfall of another.
For an economy to develop, it has to explore many sources for sufficient financial resources. For example, it may have to use revenue surplus, external aids, increase tax levels or use public borrowing. Nevertheless, taxation and borrowing remain to be the major tools. Financial analysts agree that, at moderate levels, debt can improve the economy (Buckley, 2010, p. 277). However, at high levels, they can destroy to a point-of-no-return.
Meaning, debt is a double-edged sword that makes and destroys at the same time making a nation to stagnate financially. The 2008 financial crises happened because banks in Western Nations created too much money within a short period and used it to increase house prices and speculate on financial markets (Domitrophic, 2012, p. 32). Eventually, high levels of debts became too much to handle, thus creating a global financial crisis.
When so much money is given out by banks regarding loan, house prices go up along with the level of personal debt. But when debt levels rise quicker compared to income, it becomes hard to make repayments (Vatican, 2010, p. 18). This put banks at the risk of running bankrupt.
High debt levels have many negative impacts on a country such as; reducing public investment, low private investment, and limited economic opportunities for citizens and reduced fiscal flexibility. The resultant of these impacts is that it puts the world’s economy in a compromising situation; unable to respond to coming financial crises.
Stock Market Issues
This is one factor that can lead to an economic crisis very quickly. Countries like the US, whose stock market crashed in 1929, 1987 and 2000, have had their share of this problem (Buckley, 2010, p. 278). Stock market crashing can lead to great losses, especially to people holding various equity investments (Domitrophic, 2012, p. 32). Investment firms and banks that had large capital investments in privately owned companies sadly watched their capital vanish.
Currency Fluctuations
A country’s currency is usually compared to other currencies in the global economic environment (Buckley, 2010, p. 278). The value of this currency is determined through current monetary and economic policies (Domitrophic, 2012, p. 32). For instance, countries with rampant inflation create hyperinflation. If a country faces hyperinflation, its currency loses its value making citizens use huge sums of money to purchase goods.
Credit Contraction
This occurs when individuals are not able to purchase goods or services on account. Some of the credit instruments are equity lines of credit, credit cards and other types of traditional banks loans (Buckley, 2010, p. 4). Those who are not able to access credit use personal savings or wealth to purchase goods or access services. Consequently, personal wealth decreases leading to a decrease in spending hence this causes a significant economic crisis (Vatican, 2010, p. 18). Because banks and other financial institutions offering loans depend on the interest, they charge consumers who use credit, those that cannot charge interest find it impossible to nourish in a severe economic environment.
When a bank makes a loan, new money has to be created. Ultimately, large sums of money are created. This leads to huge loans. The huge sums of money are utilized in pushing up house prices and financial markets (Buckley, 2010, p. 280). For example, a small percentage of the trillion pounds created by banks between years 2000 and 2007 was used up in business (Domitrophic, 2012, p. 32). 31% was used in the residential property. 20% was used in commercial real estate like building offices and other business properties. 32% was used in the financial sector which later went down during the financial crisis (Domitrophic, 2012, p. 32).
Low birth rates
According to a Vatican economist, Gotti Tedeschi, bankers should not be the only group blamed for the 2008 economic recession as most analysts have put it (Vatican, 2010, p. 18). In his opinion, low birth rates in Western Nations. He says that the contemporary society does not believe in the future hence have fewer children. The Western Nation’s population growth rate is at 0% (Vatican, 2010, p. 18). Meaning, in every household, one should expect to find at most two children.
Low birth rates imply that fewer people enter the working class hence older adults leave the system of production (Vatican, 2010, p. 18). Therefore, the cost of the collective increases and eventually leads to a crisis. This happens because of an imbalance between the fixed cost of economic and the social structure of the society (Vatican, 2010, p. 18).
Although financial analysts say that an economic crisis is a regular feature of the economic world and just like any other system; it can break down. In most cases, it happens in the peak of business and requires government intervention to bring back sanity. Given the factors that lead to the 2008 global financial crisis, it is possible that it was inevitable.
Governments should not have been to too quick to throw in huge sums of money in bailing out institutions that had been affected. It is under stable that in times of a crisis, everyone looks at governments as a last resort (Buckley, 2010, p. 278). However, this means that the government will have to borrow more money thus increasing the debt levels of the country. If the repayments are not made early enough, it can destroy the system and render it bankrupt. Therefore, moderating the amount of money put into the system could have reduced the debt levels thus making it easier for counties to make early repayments.
Also, the countries should have put more focus on resource allocation to ensure a balance between the fixed costs of economic and the social structure (Domitrophic, 2012, p. 32). Allocating resources in a good way ensures that institutions have sufficient capital to run and in the case of a problem, some strategies ensure that the problems are established and solved using the resources allocated (Buckley, 2010, p. 278). This way, the governments could have to bear the burden of bailing out one institution after another because clearly, the burden became unbearable.
Moreover, had the society and families been stimulated to have faith in the future again and bear more children, there could have been an increase in economic development. More young people could enter the working world (Vatican, 2010, p. 19). Consequently, there could be no drastic changes when older adults left the system of production.
The 2008 global financial crisis hit hard and deep. Up to date, it is not yet clear whether the world has fully recovered from it. If we are not careful, we could be headed to another financial crisis because the players in the financial system are not telling us what they are doing differently to avoid it. One thing is clear though; it is upon the government to regulate or monitor institutions to avoid the cost of outsourcing help during a crisis which eventually causes a breakdown.
References list
Buckley, A., 2010. Financial crisis; causes, context and consequences. Financial Times, 1 March, pp. 274-293.
Domitrophic, B., 2012. The Weak Dollar Caused the Great Recession. Forbes, 7 May, p. 32.
Vatican, 2010. The Church and The World. Catholic Insight, 20 April, pp. 18-19.
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