Essay on the 2008 Credit Crunch

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Essay on the 2008 Credit Crunch

Before the havoc wreaked the markets in the United States and across the globe in 2007, the world’s economy was booming and expanding, growth rates of output significantly increased. Surprisingly, this expansion started to stop when the housing prices which has seen an increase over the years began to fall. Some economists were of the view that the fall in the pricing of houses would not result to a credit crunch, although it can decrease the spending of customers. Their view was that the Federal Reserve Board could cut down interest rates to escape a decline in growth of output and a hike in demand. Nonetheless, other argued that a reduction in rate of output may not be enough to cease output to fall and a rise in demand.

Financial institutions and banks already sold these securities that were backed by assets to banks and people who interested in investments. Due to the complexity and complications associated with the assessments of the valuations of these securities banks became reluctant in lending to each other, due to uncertainty of the quality of their assets to prevent default when repaying. IndyMac the largest mortgage lender in the US collapsed and was taken over by the government. Issues got worse as Fannie Mae and Freddie Mac who had ownership about $5.1 trillion of the US mortgage market became financially incapacitated and was taken over by the government in 2008. The problems continued as numerous banks found themselves burdened and this resulted to the insolvency of a leading investment bank called Lehman Brothers. This resulted to the credit crunch popularly known as the ‘Great Recession’.

Events That Led to the Credit Crisis

The two key macroeconomic factors that accounted for the credit crisis in the US were the US growth model in relation to the effects it had on making demand and distribution of income model and the global economic engagement of the US model. The US growth model can be referred to as the neo-liberal growth model that cut off the medium by which wages should grow with productivity and replaced it rather with borrowing and a persistent increase in asset pricing. This saw a sudden growth in the business sector and that motivated households to manage their spending with debt (Palley, 2009).

The global financial crisis which had its origin in the US housing market began in 2007 with a pervasive decrease in the US houses prices and other EU nations (Thakor, 2015). The blend of the global macroeconomic factors and US monetary policy created an environment for financial institutions to enjoy a lengthy period of sustained profitability and growth. This led to an elevation in perceptions of skills in managing risk (Thakor, 2015) and this motivated financial innovation. The financial innovation was directed towards information technology which made all securities tradeable and marketable and this sparked the expansion of subprime mortgage market. This made banking connected with markets (Boot and Thakor, 2014). This made the government thought very well of its citizenry by enacting a legislation that stipulates that 30% and later increased to 55% of mortgages purchased by mortgage guarantee companies should come from the low- and average-income earners (Schoenbaum, 2012); this epitomizes subprime households. Nonetheless, there were no proper systems to track the financial records of these firms and individuals the loans and mortgages were awarded to (Kolb, 2010). Because banks reduced the interest rates to the minimum level, household capitalize on it and purchased more than they could afford (McKinsey,2008). Nonetheless, many defaulted in the subprime mortgage sector; this is because numerous debtors in the housing sector were not able to pay their debt obligations (Gennaioli and Vishny, 2012). By October the aggregated weight of these events had caused the crisis to spread in Europe and other economies (Thakor,2014).

The housing asset bubble is an upward price movement which largely depends on persistently borrowing excessively and persistent fall in the level of savings so that the people will demand more. This will cause spending to continually increase at a constant level. The severity of the 2008 credit crisis in the financial sector and its effects on economies was too pervasive and break up the entire financial system due to excessive use of debt financing, there were no savings and people borrowed to a level that they could no borrow anymore (Kolb, 2008; Palley, 2009).

Effects of the Credit Crunch

The ripple effects the credit crisis had on numerous markets and the United States economy cannot be underestimated. Both the stock and money markets experienced a huge loss as result of the financial crisis. The financial crisis cost the US an estimated 40% to 90% of one year’s output, an estimated to $6 to $14 trillion which is equivalent of $50,000 to $12,0000 for every US household (Attikson, Luttrell and Rosenblum, 2013). Also, investors lost confidence in the capital market and they stopped investing. This caused bond yields to fall and stock prices’ performance fell eventually (Johnson, 2013). Due to easy credit with relaxed underwritings standards, booming house priced, and a low interest rates household debt significantly increased (Mian, Rian and Sufi 2013). Moreover, highly levered households cut down consumption and the prices of houses and stock prices of household reduced (Mian, Rian and Sufi 2013). Unemployment rose, stock market decreased by approximately 50% in the mid-2009 and GDP reduced significantly. The growth of the economy can be linked to its rate of unemployment. Whenever the growth of the economy falls, unemployment increases.

The Effects of the Credit Crisis on the African Stock Market

The 2008 credit crisis created a severe impediment to the progress of the African stock market. Even though the crisis emanated from the US subprime mortgage, it transmitted to other economies which led to a fall in the sentiment of investors (Umar and Sabri, 2019). South Africa and Nigeria have the largest stock markets in the region representing about 89% of the total market capitalization (Boamah et al., 2017). Since the US economy contributes about one fourth of the world’s GDP, a decrease in their economy would impact economies across the globe (World Bank, 2016). Stock markets are globally related, and this accounts for the transmission of the effect of credit crisis to the African stock market. Many economies experienced a massive depletion in wealth (Srivastava, 2015). The credit crisis resulted to a massive fall in exports, imports and the flow of foreign direct investments to economies in Africa, accompanied with a significant decline in market capitalization and national indices (Boamah et al., 2017). There was a shrank in the South Africa’s stock market (Majapa and Gossel,2015) and the value of Nigeria’s market capitalization reduced significantly by about 96% (Boamah et al., 2017).

Regulatory Changes to the Financial Crisis

One would have thought that the US savings and loans and banking crisis in 1980s and early 1990s should have been an avenue for both the UK and US regulators to learn regulatory lessons in restructuring the system to reduce failures (Eisenbeis and Kaufman, 2010). The 2008 credit crunch is most likely to happen again if the blunder and errors made are not perfected and appropriate measures are not being staged to protect financial sector and avert it from reoccurring. The US government created the Financial Stability Oversight Council (FSOC) under the Dodd-Frank Wall Street Reform and Consumer Protection Act to avoid reoccurrence of the credit crisis. The enactment of this legislation is designed to eradicate some of these informational gaps, risks and safeguard rights of consumer (Acharya and Onucu, 2011). Under the auspices of the Dodd-Frank Act, the Consumer Financial Protection Bureau is safeguarding households against being short-changed by these mortgage firms and creditors and stops lending associated with great risks (Thakor, 2014). Also, the US government set up the Federal Depository Insurance Corporation as a measure of regulating and reducing risks and ensure a sanitized banking operation for people who do business in the money market funds.

Conclusion

Warren Buffet, one of the world’s greatest stock investors, once said: “Never let go off money”. Having envisaged the impending crunch, I would cease investing by withdrawing my money from these investment banks. In addition to this, I would have sold my real estate properties earlier before investments banks were still mortgaging despite the general decline in the housing market. Furthermore, the benefits associated with the liquidity in the forex market and its corresponding substantial amount, forex traders would have had favorable circumstances to benefit in the direction of either the bullish or bearish dependent on the market’s technical benefit. The Euro to the Dollar technically broke down from its bullish medium within period commencing by early August, 2008 subsequently extending to twice peak at its high around 1.60450 within the period commencing early July, 2008. A bearish would have made profits in this circumstance. Moreover, because real estate properties’ values dived at a fast pace and supply increased, it would have been an appropriate period to procure the real estate properties with the surplus gains earned from the forex market at absurd prices and later sell them for a quick profit after the brouhaha in 2008. Conclusively, having envisioned the severity of the loss in the stock market, I would have moved my funds into bonds and cash. Nonetheless, I would revert my funds back into shares when the outlook improves.

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