The causes of the Financial Crisis of 2008 in the United States and in EU

The Causes of the Financial Crisis of 2008 in the United States and EU
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Some assets suddenly losing a larger portion of their nominal value has occurred in the past. While the financial crises led to direct loss of paper wealth, they may not particularly cause substantial changes in the real economy. One of the crashes that had the greatest jolt to the world’s financial system the financial crisis of 2008. The banking systems of the world almost collapsed. Some of the largest banks in the U.S. like 2008, Lehman Brothers went bankrupt within a few weeks of September. The U.S. government announced that there would be no bail-out for the bank. The 2008 financial crisis was as a result of reduction in the federal funds rate by the Federal Reserve, rise to mortgage-backed securities (MBS) and the inability to anticipate volatility due to the previous economic stability.
The 2008 financial crisis was due to a combination of several factors. While experts agree that these factors played a critical role, they disagree regarding their relative importance. One of the causes was the reduction in the federal funds rate by the Federal Reserve and the Central Bank of the U.S. (Carmassi, Daniel & Stefano, 2009 pg. 987). In 2001, the two institutions anticipated the possibility of a mild recession and hence started putting measures to combat it. The interest rates that banks charge one another for overnight loans of federal funds reduced drastically (Baily, Litan & Johnson, 2008 pg. 30). As a result, commercial banks could extend loan facilities to customers at a lower prime rate. The clients who were initially considered high-risk, or “sub-prime” could access loans, although it was at high-interest rates. The availability of credit facilities prompted led to a surge in borrowing and acquisition of houses (Bernanke, 2018 pg. 3). The demand for houses increased since now many people had access to loans and mortgages. The result was a rapid increase in the prices of houses. The excess speculation by the people prompted houses to surpass their intrinsic value.
Additionally, changes in baking laws in the 1980s enabled banks to lend to subprime clients mortgages. Individuals with excellent credit scores and a history of dependability can qualify for lender’s interest rates (Prentzas, 2014 pg. 61). Hence, subprime mortgages were created to meet the needs of these categories of people. Individuals who are approved to receive subprime mortgages tend to have a history of low credit scores and challenges with debt (Beachy, 2012 pg. 19). Such individuals cannot access mortgages at the prime rate. While there is no exact number for the category, a FICO score between 620 and 680is considered subprime for a loan like a mortgage (Gerardi, Lehnert, Sherlund & Willen, 2008 pg. 79). Since advancing loans to individuals in subprime categories are termed as riskier, hence the interest rate tends to be higher. In the early 2000s, the recession had caused more people to struggle for credit. Hence, more qualified for the subprime mortgages because of their credit score.
At the same time, the Federal Reserve decided to spur economic growth, hence lowered the Federal Funds rate. The move suddenly increased subprime mortgages as people who could not initially qualify for homes could get approvals for loans. Homeownership hence increased considerably. As more individuals rushed to purchase homes, the prices increased. While the prices continued increasing, the subprime borrowers would protect themselves against the high mortgages via getting refinancing (Gorton, 2009 pg. 15). They would get the refinancing against the increased value of their homes. Others could sell their homes at the current market value, get a profit and pay any outstanding loans. If the borrowers defaulted, the lenders could repossess the homes and sell them at higher amounts than the loan. Hence, subprime lending was lucrative to both the lenders and borrowers. Banks ventured into subprime lending in an attempt to make more money. They consistently marketed loans to clients with poor credit, knowing that such borrowers could easily default on payment. Towards 2008, many began fearing that a housing bubble was inevitable. The Federal Reserve, in an attempt to prevent a bubble, increased the interest rate but this did not assist much (Obstfeld and Rogoff, 2009 pg. 6)
Furthermore, the practice of securitization, which gave rise to mortgage-backed securities (MBS) contributed to the finical crisis. The concept of securitization came about as banks bundled together subprime mortgages and sold them to as securities (Daumal, 2018 pg. 9). The purchasers of the MBSs were required to pay interest to the underlying loans. Having subprime mortgages as MBS was critical since it ensured that banks had the liquidity needed to continue operating. At the same time, MBSs were an effective way of shielding banks from exposure to risky loans. Banks also used MBSs to diversify their investment and hence earn money to their investors. While the prices of homes were skyrocketing, MBSs became even more popular (Beachy, 2010 pg. 8). However, more subprime borrowers started defaulting their loans. The MBSs based on subprime continued to lose their value. This had adverse effects on the financial institutions that had invested in them. The steep decline in the value of MBSs meant massive losses to the banks that had invested in them (Goldstein and Fligstein, 2014 pg. 7). The inability to fund subprime loans using MBSs meant that these clients could no longer access credit facilities. The same MBSs that were once valued began to be downgraded by the same credit-rating agencies that had earlier approved of them (Yeoh, 2010 pg. 52). Some of the subprime lenders had to option other than seeking mergers with healthier companies while others filed for bankruptcy. The sale of houses declined since m...