The Causes and Consequences of the Financial Crisis of 2008

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English Dossier

Miléna Gandroz
2A Cycle ICM
What are the causes and the consequences of the global financial crisis of 2008?

SOMMAIRE

INTRODUCTION3

WHY IT HAPPENED?4
1.Deregulation policy4
2.Securitization of mortgages4

HOW IT HAPPENED?6
1.The subprime crisis6
2.The financial crisis6

WHAT ARE THE CONSEQUENCES?7
1.In the financial sector7
2.In the United States8
3.Abroad8

WHAT IS HAPPENING NOW?8
1.Some things are changing8
2.But others remain the same8

CONCLUSION9

INTRODUCTION

This dossier is about a story, the story of how and why the financial industry collapsed in 2007/2008. It is not about bad bankers which have created a global crisis affecting every nice people. It is about people who have made some decisions, good or bad, during the last decades and how it led to such a crisis. I have chosen this subject because I want to work in this sector and I am interested in but also because I think it is one of the major events of our century and as we are still facing the consequences, everyone should be interested in understanding this crisis in order to understand how our economy works. I will first explain the different causes of the crisis, and then I will talk about the crisis in itself and the consequences that it brought about. Finally, I will point out what have been done to avoid these same mistakes in the future and what remains to be done.

WHY IT HAPPENED?

1. Deregulation policy
After the Great Depression, the USA has known a forty years period of growth without any crisis. At this time, the banking system was regulated: on one hand, the deposit banks were not allowed to speculate with their clients’ money and on the other hand, the investment banks invested the associates’ money. Starting from 1980, the investment banks became public (with initial public offering) and began to earn a lot of money. This was the beginning of 30 years of deregulation. The Reagan administration, supported by the financial lobby allowed the banks to invest their clients’ money in risky placements and Clinton pursued this deregulation. Finally, at the end of the 90’s, there were only big financial companies, not compartmentalized anymore, which are helped by the government to become bigger. Indeed, in 1998, the US government votes the Gramm-Leach-Bliley Act to allow the merger between Citicorp and Travelers which became then Citigroup. At the end of the 90’s, the Interned bubble burst and the Federal Reserve decided to lower the Federal funds rate to avoid a recession. This is why Alan Greespan, the president of the FED at this time, lowered the rate eleven times between 2001 and 2003. This policy was a way to encourage people to borrow in order to stimulate the economy despite the burst of the Interned bubble. Indeed, a lot of interest rates are indexed on the fed funds rate (in particular the interbank bid rates) and the lower this rate is, the cheaper it is to borrow money. 2. Securitization of mortgages

While the US government was deregulating the banking system, the new technologies allowed them to create complex products called derivatives. With this kind of products, they were then able to turn everything in a financial product and to speculate on it. In particular, some specialists of insuring and banking invented the CDO (Collateralized Debt Obligation) and the CDS (Credit Default Swap) in the middle of the 90’s. An obligation is a financial instrument (a bond) which allows its issuer to borrow money from people with precise characteristics known at the emission. The most known are the state bonds which are the less risky but any organization, private or public, can issue obligations. The CDOs are an obligation type which is an aggregate of a lot of different credits and it has been used a lot in the building sector.

The process of turning the mortgages in CDOs is called “securitization”. It has been used a lot since...
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