Financial Crisis

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Was the financial crisis, which led to the austerity measures now being followed by the coalition government, caused by investment bankers or by government?

A lot of economists stated that the recent financial crisis was the worst crisis since Great Depression, which resulted in the collapse of a number of large financial institutions followed by the government’s bailout and austerity measures. It has affected billions of people globally, which made bankers and politicians very unpopular. Though not a lot of people understand what are the main causes of the crisis and who really are the people to blame.

Initially before indicating who really caused the recent financial crisis, it will be very essential to point out what caused the financial crisis? According to Charles Bean, one of the Deputy Governors of the Bank of England, the fundamental cause of the financial crisis is not a particular group of assets, but rather a combination of macroeconomic and microeconomic factors that encouraged increased levels of risk taking. These factors includes; the subprime lending, growth of the housing bubble, easy credit conditions, deregulation, extremely high use of financial leverage and an excessive complex innovation in the derivatives markets that were poorly understood by many investors as well as regulators and a large number of frauds in the financial industry were reported after the crisis. The specific factor, which made the greatest contribution to the crisis was the subprime lending in the United States. It all began with an intense competition between mortgage lenders for revenue and market share several years before the crisis. In order to gain more revenue and customers, a lot of lenders relaxed the conditions and standards with the aide of government deregulation. Clinton Administration pressured Fannie Mae to expand mortgage loans among people with low and moderate income, who are unlikely to pay back the loan, it was taking on a huge risk. This also increased the number of people who could take on the mortgages thus the house prices rocketed. Moreover, complex financial instruments such as Mortgage-backed securities (MBS) and Collateralized debt obligations (CDO), based on the mortgage payments were also rocketed. Such instruments attracted huge number of investors worldwide, which made the US housing market very big and fragile. It only takes a fall in the price of the housing market for the whole subprime market to collapse. IMF estimated the total losses to be over 20 trillions of US dollar globally. With the effort of the US government to encourage lenders to lend to the low income people, the price of the typical American house increased by 124% between 1997 and 2006. This had increased the housing bubble dramatically. As prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid higher payments associated with rising interest rates and began to default. Gradually, this led to millions foreclosure and defaults hence the trigger of the financial crisis. It is vital to consider what led to the substantial growth of subprime lending and housing bubble? It is not uncommon to state that easy credit conditions accompanied with a set of deregulations were the main factors. After the collapse of the dot-com bubble and 9/11 terrorist attacks, Federal Reserve lowered the federal funds rate target from 6.5% to 1% in order to combat the effect of such events. Federal Reserve had also borrows money from abroad in order to bid up bond prices and lowered interest rates. Between 1996 and 2004, the USA current deficit has increased from 1.5% to 5.8% of national GDP, which required the USA to borrow more money from abroad especially from the emerging economies in Asia and Middle East. In order to balance the national deficit, US also need to have an investment surplus which equivalent the debt. Hence large and growing amounts of foreign funds flowed into the country to finance its imports....
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