ELECTRONIC ASSIGNMENT COVERSHEET
Financial Markets and Institutions
13 March 2015
Major causes of GFC and the ongoing economic impacts
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The recent financial crisis was the worst we have experienced since the Great depression in the 1930s. A Financial crisis is essentially when the price of assets in the markets plummet and firms begin to go insolvent and fail. It is debated that there are many causes of the recent crisis, however ill describe the major causes of this devastating phenomenon followed by its ongoing economic impacts in terms of regulations. No doubt this was a global crisis, however, it originated in the U.S. of which I will describe about more. Stage 1: Initiation of the financial crisis
Mismanagement of financial innovation in the mortgage market: Financial innovation in the mortgage market strived to provide more individuals in the US with homeownership especially those who earned low incomes and had little or no assets. Banks in the US were than taking advantage o the low interest rates and lending funds to borrowers at an unprecedented scale. Furthermore, revolutionary innovation in the market enabled banks to lend more by securitizing the mortgages. According to investopedia this is a type of asset-backed security that is secured by a mortgage or a collection of mortgages. Investors who invest in MBS are essentially actually lending money to the homebuyer or business and in exchange getting periodic payments from the mortgages. Furthermore, these mortgages can be divided into different trenches, which paid out cash flows from the MBS based on the investors risk appetite called collateralized debt obligations.
The problem was that many of the mortgages were sub-prime which in the US is conclusively a mortgage with a FICO score of less than 640, as a result of these mortgages being of poor credit quality, the subprime borrowers were charged higher interest rates therefore the rate of returns for investors of MBS were high, this also meant that there was a higher risk of defaults. In 2006, the property bubble burst and the housing market in the US started to decline and fall to its fundamental value. The price boom began to come to a halt and go in the inverse...
References: Business insider, finance article: “what really went wrong with mortgage backed securities”) by John Carney, 2009
Investopedia, 2007-08 financial crisis review, Manoj Singh
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