Financial Crisis

Only available on StudyMode
  • Download(s) : 17
  • Published : May 9, 2013
Open Document
Text Preview
In 2008, a sequence of bank and insurance company failures resulted in a financial crisis that effectively brought global credit markets to a halt and required unprecedented government intervention. For example, Fannie Mae (FNM) and Freddie Mac (FRE) were both taken under the control of the government. In addition Lehman Brothers declared bankruptcy after it was unable to find a buyer. Furthermore, Merrill Lynch was purchased by Bank of America, and American International Group was bailed out by the federal government with an $85 billion dollar capital injection. Shortly after, Washington Mutual (WM) went under; however, J P Morgan Chase (JPM) agreed to purchase the assets of WM resulting in the largest bank failure in the history of the United States. Due to the failures stated above it brings me to realize why banks are so hesitant to lend money between themselves or to anyone.

The crisis began in the real estate market and the subprime lending crisis. As long as we can remember, the values in commercial and residential properties have been exponentially increasing and were not interrupted for nearly a decade. With housing prices increasing it lead to banks lowering lending standards allowing unqualified buyers to take out mortgages while at the same time deregulation blended lines between traditional investment banks and mortgage lenders. However, when housing prices failed to rise and homeowners were not able to keep up with their payments, banks were obligated to recognize write offs and write downs on these assets causing many institutions to become insolvent and having to either raise capital or go bankrupt. The above paragraphs are a brief introduction about what my paper will consist of and will go farther in depth on the subject matter. The contents of my paper will consist of: some facts about the 2008 financial crisis, proposals for immediate help, how did we get here, fiscal stimulus and bailouts, and how do we get out of this mess. I will be looking at several different economists views and give my opinion on each view. It is important to remember that I do not agree with everything that I refer to in the paper, the reason I included the information was to either criticize the claims made or to back up my opinion with evidence. Some Facts

Spendthrift Nations/Social Security Crisis
In September 2005, the personal saving rate for disposable income was negative for a fourth consecutive month. This means that for four straight months people were spending more than 100% of their after tax income. Some of the factors that led to this were rapid increases in both the housing and stock prices (Lansing 2005, 1) In my opinion, this makes sense because if both housing prices and stock prices are rising, the average person will see this as a substitute for putting money aside due to the fact that if something goes wrong they have the notion that they can sell these assets since they have risen in price and still have money.

A simple statistical model of household saving behavior can be constructed by regressing personal saving rate on a constant and three explanatory variables: (1) the ratio of household stock market wealth to personal disposable income, (2) the ratio of household residential property wealth to personal disposable income, and (3) the yield on a 10-year Treasury bond. As you can see the wealth ratios go off the idea that people perceive that both stock market and housing market appreciation are substituted. The Treasury yield measures the perceived return to saving and captures the fact that asset valuation ratios are strongly influenced by movements .

From 2000 to 2005 the rate of residential property appreciation had doubled the growth rate of personal disposable income . This raised a concern about a housing bubble and the consequences if the bubble was popped (Lansing 2005, 2) In my opinion, if the stock or housing markets started to depreciate the personal savings rate...
tracking img