Causes and Consequences of the Financial Crisis in 2007-08: A Historical Perspective

Pages: 6 (1200 words) Published: December 28, 2014
The Causes and Consequences of Financial Crisis in 2007 – 2008: From the Historical Perspective

In September 2008, the financial crisis abruptly transmitted to emerging markets. It began with the credit boom, steeply rising home prices and finally led to the global imbalances in foreign trade. In a short time, the problems in subprime market became increasingly visible and include the failure of several subprime originators. The reason why it created a shortage of U.S. dollars in global markets was because the shortage in U.S. dollars affected the foreign exchange swap market with the U.S. dollar being used as the main swap currency for cross-currency funding (IMF, 2010). II. ACADEMIC VIEW

There are three typical viewpoints towards the accelerations to the crisis. Global debt crises have often radiated from the center through commodity prices, capital flows, interest rates, and shocks to investor confidence (Reinhart and Rogoff, 2008). Based on their research, Gorton and Metrick (2012) argue that external debt increases sharply in advance of banking crises and banking crises tend to lead sovereign-debt crises. Schularick and Taylor (2012) make several important points in developing the idea that an acceleration of debt from both governments and financial intermediaries are the most important antecedents. Overall, the three papers identify accelerations in debt as the key antecedent to banking crises, with the former focusing on public and private debt and the latter on the structure of banking sector.

In terms of the cause of GFC, there are two totally different views. The first one is excess saving view, which can be recognized by saying that net capital flows from CA surplus countries to deficit ones helped to finance credit booms. However, the excess elasticity view focuses on the degree to which the monetary and financial regimes constrain the credit creation process. The weak constraints led to high elasticity, which resulted in the excessive mortgage given from economic agents to unqualified borrowers. Both views can be seen as the trigger to GFC, with the former focuses on the exogenous factors while the latter pays attention to the domestic factors itself.

In the case of GFC, the credit boom took the form of an increase in the issuance of mortgage-backed securities. Bernanke (2010) pointed out that the main vulnerability was short-term debt, which represented the fastest growing component of the wholesale funding markets, not only were these markets large, but they were unregulated. A second point Bernanke (2005) makes is that if a country’s saving exceeds its investment during a particular year, the difference represents excess saving that can be lent on international capital markets. Credit booms are always accompanied by house price increases. Case and Shiller (2003) are more concerned about the housing price. They define the bubble of house market is a situation in which excessive public expectations of future price increases cause prices to be temporarily elevated. And house price run-ups prior to crises are common. III. THE BUILD-UP TO FINANCIAL CRISIS

The main reason directly causing the American subprime mortgage is the increasing interest rate and the depression of the estate market. Figure 1 plots FED reduced interest rates from 6.5% in 2000 to 1% in 2003, and then increased it suddenly from 1% to 6% in 2006. Figure 1. Interest Rate in America, 1995 - 2009

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Figure 2 indicates that housing prices were relatively stable during the 1990s but began to rise toward the end of the decade. Between 2002 and 2006, housing prices increased by a total of 87 percent. The boom had turned to a bust, and the housing price declines continued throughout 2007 and 2008. By the third quarter of 2008, housing prices were approximately 25 percent below its peak. Figure 2. House Price Change: 1987 - 2008

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References: Jeffry Frieden (2006), "Will Global Capitalism Fall Again?" Presentation for BRUEGEL 's Essay and Lecture Series. Brussels, June 2006.
Gorton, Gary, and Andrew Metrick. 2012. "Getting Up to Speed on the Financial Crisis: A One-Weekend-Reader 's Guide." Journal of Economic Literature, 50(1): 128–50
Carmen Reinhart and Kenneth Rogoff (2008), This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises” manuscript, Harvard University, April 2008.
Lo, Andrew W. 2012. "Reading about the Financial Crisis: A Twenty-One-Book Review.” Journal of Economic Literature, 50(1): 151–78.
Reinhart C M, Rogoff K S. Is the 2007 US sub-prime financial crisis so different? An international historical comparison. National Bureau of Economic Research, 2008.
Bernanke B S. Monetary policy and the housing bubble. Speech at the annual meeting of the American Economic Association, Atlanta, Georgia. 2010, 3.
Case K E, Shiller R J. Is there a bubble in the housing market?. Brookings Papers on Economic Activity, 2003, 2003(2): 299-362.
Gorton G, Metrick A. Securitized banking and the run on repo. Journal of Financial Economics, 2012, 104(3): 425-451.
Schularick M, Taylor A M. Credit booms gone bust: monetary policy, leverage cycles and financial crises, 1870–2008. National Bureau of Economic Research, 2009.
International Monetary Fund. Global Financial Stability Report, IMF Multimedia Service Division, October 2010.
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