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To: Jacob J. Lew, Treasury Secretary, United States
From: Annika Verseput
Subject: Avoiding Another Global Financial Crisis
Date: 28 March 2018
The global financial crisis of 2008 is one to be taken very seriously. There were many
factors that led to the cause of the crisis however, it possibly could have been avoided. The
impacts that it had not only in America, but also abroad, are not to be taken lightly. Other
countries economic statistics, gross domestic profit (GDP), employment, and national debt were
all hit hard while trouble was unfolding in the United States as well. The policy makers of the
time enacted several things and responded to the crisis in a timely manner, but even that could
not stop the detrimental effects that were soon to be felt by the entire world.
As previously stated, many factors led to the cause of the 2008 financial crisis. But,
probably the biggest, was a combination of “excessive borrowing, risky investments, and lack of
transparency” among the five major global investment banks. These five were Bear Stearns,
Lehman Brothers, Goldman Sachs, Morgan Stanley, and Merrill Lynch. These banks were
looking for a low risk high return investment opportunity and they decided to put their money in
the Unites States housing market in hopes to “get rich quick” on the interest rates that were
associated with the mortgages on these homes. Many of these banks took their investments and
split them up into several thousand mortgages which they grouped together, and these were
known as “mortgage – backed securities”. Banks then sold shares of these securities to
investors. In the eyes of the investors, this looked to be safe and would provide a great rate of
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return because of the rising home prices. They believed there was very little risk because if the
homeowner defaulted on their loan, the investors could just turn around and sell the house for
more money, because of the rising home prices. Lenders also continued to lower the credit
standards and many homeowners with terrible credit, often with scores under 600, received these
loans. These are known as subprime mortgages. The banks thought this would be a good way to
earn more money from the interest rates on the loans they were handing out. After this, many
households in America could not keep up with their payments and eventually defaulted.
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With
so many people defaulting on their loans, this left the banks with an incredible supply of homes
for sale but the demand for these homes was non – existent. As this started happening, the big
banks stopped distributing the subprime mortgages and were stuck with the bad loans they
handed out in the past and eventually several big – name banks declared bankruptcy such as
Lehman Brothers. Other banks had no other options other than to merge with other banks or be
bailed out by the government.
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The reason this problem escalated so quickly was because credit
rating agencies such as Standard & Poor’s, Moody’s, and Fitch Ratings, were reporting that the
mortgage – backed securities were safe investments. They gave these securities AAA ratings,
which is the highest rating possible.
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With the investors and banks being told that what they
were doing was a smart move combined with the fact that it made them lots of money very
quickly, the problem grew quickly and the effects of it hit hard. According to the U.S. Financial
Crisis Inquiry Commission, “the crisis was avoidable and was caused by: Widespread failures in
financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages;
Dramatic breakdowns in corporate governance including too many financial firms acting
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Conclusions of the Financial Crisis Inquiry Commission.
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Fratianni, Michele U., and Francesco Marchion. "The Role of Banks in the Subprime Financial Crisis."
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"Causes of the Recent Financial and Economic Crisis." Board of Governors of the Federal Reserve System.
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recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by
households and Wall Street that put the financial system on a collision course with crisis; Key
policy makers ill prepared for the crisis, lacking a full understanding of the financial system they
oversaw; and systemic breaches in accountability and ethics at all levels.”
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Because of the size and power of the banks that were involved in this terrible and chaotic
event, the entire country felt the repercussions. First, the effects were incredibly significant. The
gross domestic product (GDP) of the nation began to shrink in Quarter 3 (Q3) of 2008 and did
not come close to gaining traction until Q1 of 2010.
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The Congressional Budget Office (CBO)
predicted in 2013 that the GDP would not return to normal levels until 2017.
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When it comes to
the citizens, the unemployment rate before 2008 was 5% or 7 million people. Within a year, it
was up to 10% or 15 million individuals and did not start to decline until 2013 where it was
reported at 7.3% or 12 million people.
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,
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In terms of the economy and national debt, the S&P
500 reported that stocks fell 57% from the peak in October 2007 where they were at 1,565 to 676
in March 2009. The stock prices did not reach any sort of significant levels until April 2013
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