Causes and Consequences of Financial Crisis Essay


The universe is said to hold encountered the most terrible fiscal daze of all times. The present fiscal recession was initiated by the American economic system. However, the whole universe came under the trickledown consequence. Therefore, the recession of 2008, could be competently called a “ Global Recession. ”

The betterments in communicating and information engineering have merged the universe into one whole unit. Trade among different states has been facilitated. Furthermore, fiscal minutess can take topographic point between two states oceans apart. Therefore, the whole universe got entangled up into the fiscal crisis along with United States of America.

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Features of Recession

A recession is normally represented by concern rhythms. The concern rhythm incorporates three periods throughout the rhythm. It includes recession followed by recovery and so trough (extremum) . This rhythm repeats and the trough decelerate down finally ensuing in a recession.

The recession period is characterized with really slow economic activity. An economic recession neglects the economic construct of the Philip ‘s Curve and the indirect relationship between rising prices and unemployment. Alternatively, the prevalence of high rising prices rate and a high unemployment rate makes the state of affairs worse.

During this period there is low consumer demand which is chiefly due to two grounds:

Lower Buying Power due to high rising prices and low income

Uncertainty about the economic conditions

The consumers tend to salvage ( if they have adequate income ) for future intents every bit high uncertainness prevails in the economic system.

The extent of recession may change from state to state and so does the period from where it would get down recovering.

The Great Depression ( 1930 )

The construct of recession of fiscal crisis is non fresh for the universe. America in 1930 experienced the greatest recession which was termed as “ The Great Depression. ” This is referred to as the darkest period in the history of America.

The American economic system was sing a roar in 1920s. Industrial end product was increasing in malice of the non really high demand from the consumers. Ford Motors launched its auto that was low-cost by ordinary people as good. The makers were encouraged to avail credits for their production which in the other manus did non hold demand to that extent. Furthermore, there was a relentless crisis in the agricultural sector. This might hold contributed towards the low demand. The economic system was besides inflated due to the recognition roar which was due to the aid provided to UK whose economic system was confronting relentless deflation accompanied with high unemployment.

On October 29, the celebrated Black Tuesday, the stock market crashed gnawing the assurance of people. An ambiance of uncertainness rose and consumer demand fell down well.

In 1930, several Bankss went insolvents. Some called in for the loans they had rendered besides when the people did non hold the fiscal strength to pay. This force per unit area accumulated with uncertainness of declaring bankruptcy, people started roll uping their nest eggs from the Bankss. The relentless autumn in nest eggs resulted in low investings.

The combination of low end product high unemployment was terrible. Furthermore, reduced economy and therefore, low investing posed a negative multiplier impact on the economic system. Therefore, recession got terrible and transformed into a Depression.

Some step were taken by President Roosevelt to rectify the deep crisis but the release of the U.S economic system is credited to the World War II when there was a immense demand for ammos and arms from the European World.

Fiscal Crisis of 2008

The recent fiscal crisis is most normally attributed towards the house loans/mortgage market and the recognition crunch. However, this is non the lone cause of the recession that is predominating today. There are several other background causes that led to this lay waste toing fiscal place of the universe.

Causes of Financial Crisis

Harmonizing to Marxian School of thought the autumn in the rate of net income from about 22 % to 12 % caused the duplicate immorality of high unemployment and rising prices ( Moseley, 2009 ) . This resulted in low existent rewards which meant lower nest eggs and a diminution in the investing of the state. The solution that was adopted were the expansionary financial and pecuniary policies which did consequence in higher employment and end product but at the same clip exacerbated the rising prices.

In order to raise the net incomes capitalists focused on cost film editing techniques. These chiefly related to cutting the rewards of workers by presenting acceleration techniques, take downing down wellness premiums /health benefits and retirement benefits ( Moseley, 2009 ) .

This overtime did consequence in the expected net incomes for the American capitalists who had extra money in their custodies. However, investing did non increase that greatly as the earned net incomes were non invested in any kind of ventures. The net incomes were distributed and conspicuous and luxury oriented ingestion was done.

The chief job that arose was that the capitalists had money to impart but there were no borrowers. Therefore, they decided to concentrate upon the general populace and introduced the construct of mortgage loans. This led to a revolution in the recognition market and bank loaning to families increased from 30 per centum in 1970 to 50 per centum in 2006. The entire value of place mortgages tripled between 1998 and 2006. And the ratio of family debt to disposable income increased from 60 per centum in 1970 to 100 per centum in 2000 to 140 per centum in 2007 ( Moseley, 2009 ) .

With clip and tonss of money at manus the recognition worthiness of borrowers was given a back place and NINJA ( no income, no occupation, and no plus ) loans were granted. It was believed that the monetary value of houses would increase persistently and so ab initio loans were granted at a teaser rate ( low rate ) . It was believed that when the monetary value of houses would lift, the mortgage could be renewed by paying the old one.

Mechanism of the Crisis

The lodging market clang was the focal cause of the fiscal crisis. By 2006 the house monetary values started to worsen. The existent estate market crashed. The job arose due to the securization of the house mortgages.

Commercial Banks in the United States started selling these mortgaged loans as securities to investing Bankss non merely in USA but all over the universe. The securities were rated as low hazard AAA securities and passed on. The commercial Bankss and the mortgage companies avariciously passed on loans without proper look intoing the recognition worthiness. Investing Bankss besides gained from this. However, the concluding receiving system of the mortgage security was contented on the AAA evaluation, unknowing that the evaluation companies were private and welcomed income. Therefore, the evaluation companies had a roar period during this clip.

By 2007 the monetary values of the houses fell badly. The NINJA borrowers failed to pay back their loans. This triggered the beginning of the recession as the Bankss had no money left. The defaulters on loan grew twenty-four hours by twenty-four hours. Due to a deficiency of liquidness the Bankss stopped loaning and hence, people who needed loans from the bank for their concern operations had nil to make. The recognition crunch required care capital to loan ratio by cut downing loaning.


The planetary impact has been terrible. Consumer assurance has been thrashed. There is low aggregative demand in the economic system. The involvement rate in U.S has fallen down to about 1 % and therefore, consumers are non willing to salvage. Bank adoption is minimum. The low liquidness in the economic system is bring forthing a negative multiplier due to low investings in the economic system.

Retrenchment has been at its extremum with unemployment rate being 9.4 % in December 2010 ( Bureau of Labor Statistics ) .The Consumer Price Index has been 0.4 which has been greater than the old old ages ( Bureau of Labor Statistics ) . Workers are being laid off from occupations and some are working overtime without excess wage. Furthermore, the filing of bankruptcy under Section 11 by several market leaders such as Lehman Brothers and General Motors resulted in loss of occupations to many. This has farther added to the inability towards non-payment of loans.

The crises have had spillover effects over the whole Earth such as the Greece Crisis.

Role of Government

The function of the authorities has been utile but non to a great extent. Harmonizing to Richard C. Cook,

“ Everything the Federal Reserve and the U.S. Treasury Department are seeking to make to stem the tide of the self-destructing U.S. fiscal system is a makeshift. They are locking the barn door after the horse-many horses-have already escaped, and they know it. ”

The authorities tried to follow expansionary policies. Not merely this but the Fed realized its function and for the first clip in history, leant to investing Bankss. It besides bailed out Lehman Brothers and the Insurance Company AIG.

The Democrats coming into power realized the huge catastrophe financially. They have introduced wellness reforms which would be increasing authorities disbursement and might function as a stimulation to increase demand and cut down the effects of the negative multiplier.

Corporate Finance

Corporate Finance trades with the strategic fiscal issue in order to add value to firm/country. Soon, the U.S Bankss are loath to supply loans to the populace. Although the authorities did slightly demo a willingness towards the loans to be given out. But the Bankss are in no place to make so.

The corporate investing in the field of Real Estate had been huge. The existent estate bubble has said to be unreal by many analysts. Harmonizing to Michael Burry ( 2010 ) , “ ” It ‘s an unreal market. The private mortgage market is practically nonexistent ; 96-97 % of mortgages are fluxing through Fannie and Freddie now. I think Fannie and Freddie are exerting a enormous sum of power over the market by keep backing belongingss from sale and non forcing foreclosure, the foreclosure procedure ( Burry,2010 ) .

The investing at this phase is dead. Previously there has been great investing. Today nest eggs are non existing due to downsizing. Furthermore, people are loath due to the uncertainness in the market. Therefore, in order for the corporate finance to boom and investings to take topographic point some important stairss are indispensable.


It is a fact that consumers are risk averse. The prevalent conditions would non emerge as really demand giving up. The authorities needs to take some important stairss.

Demand side stimulation is the demand of the economic system at this clip. The authorities needs to increase its disbursement, merely like President Roosevelt did during the 1930 by proviso of occupations for the people. The Real Estate Market should be regulated.

Houses in my sentiment are a necessary good. Like wellness and instruction, the authorities should pick up duty of supplying it. The mortgages if administered through authorities loans could hold been more feasible and comfortable.

Social Conventions and societal duty fall upon worlds. Therefore, the citizens should recognize their civic duties towards re-payment of loans.