The Global Financial Crisis

Topics: Subprime mortgage crisis, Mortgage, Freddie Mac Pages: 8 (2062 words) Published: November 18, 2014
The Global Financial Crisis: Causes, Remedies and Discourses

The Global Financial Crisis of 2008-2012 is widely considered to be second in severity to only the Great Depression of the 1930s. Sardonically coined as the ʻGreat Recessionʼ by commentators and media alike, what began as a housing crisis in the United States rapidly degenerated into a systemic mess that wrecked brand-name financial institutions, led to government bailouts and in some cases, liquidation. The crisis reduced consumer wealth in the region of trillions and sparked off a series of recessions in both the developed and developing world. In this essay we will look at the causes, evaluate the measures taken to contain it and examine some of the underlying discourses that plied the timeline of the recession.

The subprime mortgage crisis
Easy credit conditions in the United States led by steadily decreasing interest rates and an influx of foreign funds created a housing bubble, which was financed by a large number of subprime mortgages. These were easy to obtain and put home purchasing power into the hands of consumers who received poor credit ratings and ran higher risks of not maintaining the repayment schedule or worse, default. Such ʻsecond-chanceʼ loans are offered to borrowers at higher interest rates and less favorable terms to hedge lenders against the higher credit risks (Barrow 2009). These mortgages were then repackaged and sold as investment products called collaterised debt obligations (CDOs) or mortgage- backed securities (MBS) in a process known as securitization. Government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac traditionally bought the mortgages and repackaged them in a secondary mortgage market to investors, allowing lenders to reinvest into more lending and thus increase the number of lenders in the mortgage market. Intense competition between mortgage lenders for revenue and market share exacerbated relaxed standards in lending due to limited supply of credit-worthy borrowers. A limited supply of credit-worthy borrowers led to relaxed underwriting standards. As a result, less credit-worthy borrowers were able to secure loans in large numbers as financial firms took on more risk. Many of these borrowers had taken on adjustable rate mortgages (ARMs), which carry fixed interest rates for an initial payment period for two or three years, and then adjusts to a higher rate for the rest of the loan period. What this means is that the initial repayments may start off low and thus manageable to the borrower, but subsequent payments may be much higher. About 80 percent of all sub-prime mortgage loans originated in 2005 were ARMs (Janzen 2009).

Reckless speculation
As mentioned earlier, the abundance of investment capital (coined a liquidity glut by some economists and observers) resulted in too much capital looking for too few investments. This preceded the peak of the housing bubble, when too much of this capital became invested in bad projects. Much of the floating capital preceding the GFC was invested in mortgage-backed securities and collateral debt obligations. A strong demand for these bundled mortgages by the investment banks and GSEs further drove down lending standards and created an unsustainable speculative bubble. The top five US investment banks increased their financial leverage, reporting over $4.1 trillion in debt (by borrowing) during 2007, amounting to a massive 30 percent of the US economy (Choudhury 2011, p. 301). On the other hand, regulated GSEs such as Fannie and Freddie were known for their conservative approaches towards lending. They were known to uphold high underwriting standards by lending only to those with low credit risk, even playing a constabulary role towards mortgage brokers. Before 2003, the mortgage securities market was dominated by the GSEs. But as market power shifted to the loan originators (banks that issue loans that are resold), they started to lose market share....
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • “Global Financial Crisis 2007-2012 Essay
  • Global Financial Crisis Essay
  • Essay on Why Global Financial Crisis Happened
  • Global Financial Crisis Essay
  • What is the global financial crisis, and who is it a crisis for? Essay
  • Global Financial Crisis: Causes and Effect Essay
  • Global Financial Crisis Essay
  • United States Global Financial Crisis Essay

Become a StudyMode Member

Sign Up - It's Free