De-regulation was the Major Cause of the 2008 Financial Crisis
In 2008, the world experienced a financial crisis which stemmed mainly from the U.S housing market and the failure to manage it. It is considered by many economists as one of the worst recessions since the Great Depression of the 1930s. After having a huge effect on the U.S economy, the financial crisis expanded to Europe and the rest of the world. It destroyed economies, financial institutions and individual lives. The contagion, which began in the United States when the housing prices finally turned assertively downward and spread quickly to the entire financial sector in the U.S and then to other financial markets abroad through financial and trade linkage. The financial crisis prompted in the early 2006 when the subprime mortgage began to show an increasing rate of mortgage defaults which later increased higher than normal rate in the late 2007, and on September 15,2008, one of the biggest investment banks in the world, failed, Lehman Brothers (2008financialcrisis.umwblogs.org, 2018). Financial innovations and deregulation during the “Great Moderation” allowed bankers the opportunity to increase their return on investment with the use of various mechanisms. The purpose of this essay is to explore the causes of the 2008 Financial Crisis and support the argument that deregulation was the chief cause of the crisis. Throughout the essay the key terms used in the literature surrounding the financial crisis such as subprime mortgages, securitization, credit rating agencies, collateralised debt obligations and more will be defined, and their role in the downfall of the economy explained.
Just to highlight the extent of the shock on the economy of the crash we should first look at the economy in the years leading up to the financial crisis. “The Great Moderation” is term given to the period of decreased macroeconomic volatility from the late-eighties (collapse of the Berlin Wall) right up to the great recession of 2008 (Investopedia, 2018). It is a common theory among economists (like Ben Bernanke) that this period of stability in economy can be mainly attributed to good luck but researchers at the European Central Bank and US Federal Reserve have rejected the claim and attribute it mainly to improved monetary policies. As a result of globalisation, in the early nineties, we saw the rise of China. The cheap labour and export-led growth model allowed it to benefit hugely from the rise in popularity in developed economies of outsourcing. Excess savings in developing countries like China led to an influx of capital into the United States, leading to a reduction in interest rates.
Role of Innovative and Complex Financial Instruments
With interest rates so low, financial institutions and investors started to take more and more risk, in attempt to find higher returns, but without compensation. This became known as the “search for yield”. Central banks were aware...