Global Financial Crisis Essay Example | Topics and Well Written Essays - 1500 words

Global Financial Crisis - Essay Example The crisis had great impact as it led to slow growth which translated into unemployment further worsening the situation. The paper will discuss the origin or causes of the financial crisis and how it affects individuals and the economy as a whole. Loose monetary policy in USA has mostly been blamed for the crisis. According to Taylor (2009, p. 20), low interest rates led to depreciation of the dollar and consequently rise in oil prices from $70 a barrel in August 2007 to over $140 per barrel in July 2008. This consequently led to the increase in commodity prices especially housing prices. Davies (2010) argues that the crisis was precipitated by financial innovations and laxity in monetary policy which were used as measures to offset the impact of income inequalities on aggregate demand. Households were encouraged to borrow funds to finance consumption hence growth of leverage in American households. Credit expansion led to economic growth thereby pushing up the value of equities, com modities and real estate (Jackson, 2009). The increased housing prices were the beginning of the crisis. There was speculation in the market that the prices would continue rising in future creating an opportunity for banks to offer mortgage-backed loans even to subprime borrowers. Households were being encouraged to own homes and hence were given mortgages at low interest or waiver of interest for two years and no down payment (Kolb, 2010). The mortgage brokers then sold the mortgage to a bank at a commission hence transferring risk to the bank. The banks then bundled the mortgages into one complex product and got the services of credit rating agencies for valuation. Due to complexity of the product, the rating agencies gave a good rating to the product. The bank then securitized the loans and due to the high rating, the securities were worth much more than government securities thereby attracting investors. Banks could borrow funds to buy more mortgages so as to securitize and earn high returns. The easy money and overconfidence due to speculation of high housing prices in future led to excessive risk-taking by banks and other financial institutions. Davies (2010) argues that the financial market regulators are to blame for allowing speculation and not offering adequate risk management controls. Due to speculation, there was decline in risk perceptions by banks as well as risk tolerance such that investors were accepting low returns for mortgage-backed securities. The investors did not know the value of the securities or risks involved as they were relying on credit rating agencies who were giving wrong ratings due to complexity of the mortgages. Swan (2010) on the other hand, argues that the government programs aimed at promoting home ownership and increasing profits of real estate investments were to blame. The government enterprises and mortgage lenders Fannie Mae and Freddie Mac promoted the program by deducting interest for owner-occupied home loans. The y were buying mortgage-backed securities including those that were formed with risky subprime mortgages.