The financial crisis of 2008 is also known as the subprime mortgage crisis. It is one the Global Financial Crisis that started from the United States. This crisis had a profound impact on the U.S. and global economies. This crisis resulted in the loss of trillions of dollars, a sharp contraction in economic activities and widespread job losses. This financial crisis of 2008 is considered to be the worst financial crisis since the Great Depression of the 1930s.
Impact of the crisis
The financial crisis of 2008 had a significant impact on both the US and global economies. Some of the key impacts due to the crisis are:
Losses in the Financial Sector
Financial sector is the bearer of every economic and financial crisis. They are either the prime agents for the crisis or are the prime victims of such financial crises. This crisis led to over $ 1 trillion in losses for the financial sectors around the world.
The bank heavily used financial instruments like Collateralized Debt Obligations (CDOs) and Credit Default Swaps (CDSs) which amplified the risk in the financial system as it was poorly understood and lacked transparency.
The crisis had a big impact on the U.S. economy. It not only impacted the banks and other financial institutions, it also impacted different industries and business houses. Many businesses filed for bankruptcy and many of them ceased to exist. This economic crisis was one of the biggest crises after the Great Depression of the 1930s. Some of such bankruptcies are:
|Lehman Brothers||Lehman Brothers filed for bankruptcy on September 15, 2008. This bankruptcy triggered the crisis. The estimated loss was $691 billion.|
|Washington Mutual||Washington Mutual, one of the largest banks in the United States, was seized by the Federal Deposit Insurance Corporation and sold to JP Morgan Chase. The estimated loss for Washington Mutual was $ 307 billion.|
|General Motors||In June 2009, General Motors filed for bankruptcy. The US government ultimately provided over $5 billion to GM. The loss estimated for the company was worth $ 82 billion.|
|Chrysler||This automaker company filed for bankruptcy in 2009. The U.S. government also approved the bailout plan for Chrysler. The company was later sold to Fiat.|
|Circuit City||Circuit City, one of the major electronics retailers in the US, filed bankruptcy in 2008. Later in 2009, it was liquidated, ending its operation.|
|Linens ‘n Things||In 2008, LNT filed bankruptcy out of the crisis and ceased its operation. Later in the same year, LNT was liquidated.|
|Mervyn’s||Mervyn’s was one of the department store chains. It filed for bankruptcy protection in 2008. In 2009, the company’s assets were liquidated and all the stores were closed.|
|Sharper Image||In February 2008, the company filed for bankruptcy and was liquidated later that year. Sharper Image was a gadget giant.|
|KB Toys||Depleting demand, increase in competition, and economic crisis led KB Toys to file for bankruptcy in 2008. Later in 2009, KB Toys liquidated its assets and went out of business.|
|Steve & Barry’s||Steve & Barry’s was one of the rapidly growing clothing brands. After the financial crisis hit, the company could not operate with debt over $ 1 billion. In 2008, the company filed bankruptcy.|
As a result of this crisis, different banks, financial institutions and companies filed for bankruptcy. Many of those companies were liquidated. As a preventive measure, the government introduced different bailout strategies for the different companies. During the crisis period, the United States registered 1.4 million bankruptcy. Some of such notable bailouts include:
|American International Group (AIG)||In September 2008, AIG was bailed out by the US government for $ 182 billion.|
|General Motors and Chrysler||The US government provided the fund worth 80 billion to General Motors and Chrysler as a bailout amount.|
|Fannie Mae and Freddie Mac||The US government took control over Fannie Mae and Freddie Mac, two mortgage giants. These giants controlled half of the countrys’ $12 trillion mortgage market.|
|Citi Group||For the bailout, CitiGroup received funds worth $ 45 billion. CitiGroup was one of the largest financial institutions in the world.|
|Bank of America||The US government provided $45 billion in bailout before its acquisition by Merrill Lynch.|
|Troubled Asset Relief Program (TARP)||The US congress passed a bailout package of $ 700 billion to support the troubled banks and other financial institutions.|
|Wells Fargo||The company received $ 25 billion as bailout fund from the government. Wells Fargo was one of the biggest banks in the US. This collapse would have triggered a bigger financial instability in the country.|
It is obvious to have economic contraction during such a financial crisis. The global economy was impacted by the financial crisis of 2008. The impact of this crisis was seen in different economic factors like GDP, unemployment, stock market etc.
This crisis led to negative growth for many weak economies. The United States experienced a decline in GDP of 2.8% in 2009. In the year 2008, the GDP fell to -8.4% in the fourth quarter of 2008 from 2.0% in the second quarter of 2008. Similarly, in 2009, the Eurozone experienced a decline of 4.5% GDP and Japanese GDP declined by 5.5% in 2009.
Similarly, there was a dip in consumer confidence during the crisis leading to reduction in consumer spending. Such a decline in spending directly affects the GDP of the country.
Stock Market Decline
Stock market indices are a strong indicator of economic performance. During the crisis, the Dow Jones Industrial Average fell from a peak of 14,164 in October 2007 to a low of 6,547 in March 2009.
The DAX index, which tracks the performance of 30 large-cap companies listed on the Frankfurt Stock Exchange, declined to 3,580 in March 2009 from 8,107 in July 2007.
The S&P 500 declined from 1,656 to 676 in an 18 months period from October 2007 to March 2009. S&P 500 tracks the performance of 500 large-cap companies listed on U.S. stock exchanges.
Employment market is another market that is directly affected by any type of economic or financial crisis. The first action that companies during the crisis take is laying off the employees to reduce the cost for the company. During the crisis of 2008, different industries laid off their workers.
The unemployment rate of the US reached 10% in October 2009, which was the highest since 1983. Similarly, the number of people with no employment for 27 weeks was at record level.
In the United States alone, 8.7 million jobs were lost between 2008 and 2010. This figure was the largest decline since the Great Depression. Circuit City, U.S. largest electronic retailer, laid off 34,000 employees. Similarly, Linens ‘n Things laid off 17,000 employees.
Housing Market Decline
Housing market is the prime reason for the 2008 crisis of 2008. Hence, the impact on the housing market is greatest during the crisis. The home prices declined nationwide. From 2006 to 2012, the home price fell by an average of 30% nationwide. Similarly, the percentage of mortgage for housing increased from 1.4% to 4.6% from 2006 to 2010.
Similarly, Harvard University studies found that the number of new construction projects declined from 2.27 millions in 2005 to around 554,00 in 2009. This impact was reflected in the house rental business which increased by 9 million between 2005 and 2015.
Causes of The Financial Crisis of 2008
Subprime mortgages are the prime factor for the financial crisis of 2008. But there are other different factors that equally contribute to the crisis of 2008.Some of such factors are:
Low interest rate and loose lending regulation made housing investment easier and attractive. Hence, the demand for housing increased, shooting the price of homes up to unsustainable levels. Along with this, the speculation in the housing market increased making the investment very volatile. Later this housing bubble burst, leading to the financial crisis.
In a study by Case-Shiller Home Price Index, the national home price increased by more than 70% between 2000 to 2006 before crashing by 30% in between 2007 and 2009.
Poor lending standards catalyzed the housing bubbles. Banks and lenders offered the loans to borrowers with no proper credit analysis. Borrowers with poor credit histories were granted housing loans. It was evident that borrowers without any verifying source of income and employment status were granted loans. There were no proper standards to track where the loans were being used.
Due to such weak lending practices, the mortgage market collapsed when the market began to decline and borrowers started to default.
A report by the Mortgage Bankers Association reflected that the overall mortgage market rose from 8% in 2003 to 20% in 2006.
Another lending loophole is securitization of mortgages. This caused the subprime crisis. Most of the further investments made by the investors were mortgage backed securities. The lending practice of subprime mortgages was not of standard. Again using the mortgage as security for investment made the market even more volatile. Mortgage as security became toxic assets
The mortgage backed securities outstanding increased from $1.1 trillion in 2002 to $ 6.5 trillion in 2007.
Banking and Financial Institutions were operating in high levels of leverage i.e. the proportion to debt investment is more in the portfolio. This made the investment of banks and other financial institutions more vulnerable to losses when housing market began to decline and borrowers started to default
For banks and financial institutions, the leverage ratio increased from 27.5 in 2000 to 31.6 in 2007.
Lack of Regulation
The lending regulations practiced before the crisis encouraged risky and speculative behavior. Along with this, insufficient disclosure requirement, the level of leverage for banking and financial institutions and lack of proper supervision combinedly led to failure of the financial system bursting the Subprime mortgage bubble.