The 2007 to 2011 Financial Crisis Causes, Effects and Lessons
This monograph provides a illiberal criterion of the plain causes and entertainions of the 2007 financial adapting-point, as polite as an counterpoiseview of lessons literary from it. I argue that deficiency to right organize and inspect financial institutions set the position for the adapting-point, suitableness the US residential hypothecation peal and bust triggered it. A reputation congelate, bankruptcies, and hundreds of billions in legislation retake ensued, effecting in a public economic downturn. The grant of the adapting-point should be seen as an adapt to amend the financial method as a integral.
The financial adapting-point that afloat in 2007 is the effect of multifarious, interconnected, and concurrent developments. As such, I standpoint my separation on the United States and two disjoined plain causes: (1) false bank habit – which destabilized the financial method – and (2) the pre-turning-point open entertainions peal and bust. Whereas the antecedent conditioned the adapting-point, the departure was its catalyst. In this illiberal essay, I debate singly the most leading and plain entertainions of the adapting-point – those that emerged among 2007 and 2012 – and debate the conclusions that can be drawn conformably.
1. Habit destabilized the financial method
Regulation of US banks by the Fed, SEC, and FDIC, as polite as other regulatory agencies, contributed significantly to the erosion of financial method stoppage (Barth, Caprio and Levine, 2012, p.86). For development, in 1996, the Fed legitimized the use of Reputation Want Swaps (CDS) as abandon-hedging instruments (Levine 2010, p. 202, Appendix 1) and as a effect abundant banks open weighty scyllas (Figure 1) – AIG held counterpoise $500 billion in 2007 – suitableness others were efficient to subdue their chief reserves by up to half in percentage stipulations (Barth, Caprio and Levine, 2012, p.92).
Figure 1: CDS traffic body Q1 2001 to Q2 2007, trillion US$
(International Securities and Derivatives Association cited in Baily, Litan and Johnson, 2008)
Another development is the SEC’s use of the “NRSRO” authority, which led to a careful misalignment of reputation rating agencies’ profession stimuluss and effected in inflationary conditions of investment-grade ratings for intrepid securities. This raise impaired the viability of banks’ counterpoise sheets (see Appendix 2).
1.1 Residential hypothecation peal and bust
Simultaneously, the US residential open entertainions trash (revealed by the self-assertion that housing prices would singly go up) fueled exorbitant issuance of home hypothecations (Figure 2). In adapt, inaccuadmonish lending manners, chiefly in sub-prime hypothecation lending, specious housing prices by intermeddling insist, suitableness supply institutions’ counterpoise sheets delay obscure abandon (Barth 2009, p.92). The attractiveness of hypothecations as “fail-safe” investments prompted abundant banks to transfer their profession mould from “originate-to-hold” to “originate-to-sell”; instead of buying hypothecations as an investment that generated a consistent currency course, banks securitized and sold them (Barth 2009, p.22). This effectively removed any stimulus to criticise and guide abandon. However, this “out-of-sight-out-of-mind” mentality did not totality for the circumstance that banks that securitized hypothecations and invested in hypothecation-backed securities (MBS) were repeatedly particular. Thus, abandon was absent from counterpoise sheets, but implicitly give in securities trustings (Appendix 3).
Figure 2: S&P-Shiller housing prices condemnation (monthly), January 2001 to August 2012
(Standard & Poor’s Financial Services LLC, 2012)
The convoluted method of securitization faltered when housing prices afloat to dismiss and hypothecation borrowers wanted (Figure 3). This dried up the currency course of hypothecation-backed securities and made them virtually cheap; banks that relied on them to engage their obligations encountered anxiety. Moreover, multifarious securitization manners made the bigness of any one institution’s scylla anyone’s suppose. Since, no one could be assured which banks would subsist to see another day, interbank lending froze. In imperfect, not singly did financial institutions entertain cheap goods, but they were besides unefficient to bridge imperfectages in currency (Figure 4). In abstracted, majority wants activated billions of dollars in CDS obligations and bankrupted all who were counterpoise-exposed.
Figure 3: Increase of offense admonishs (percent) of subprime hypothecations among 2003 and 2007
(Arentsen, Mauer, Rosenlund, Zhang and Zhao, 2012, p.39)
Figure 4: Increase of the Federal Funds admonish (percent, monthly) indicates interbank lending adapting-point
(Federal Reserve Bank of St. Louis, 2012)
2. Financial obsoleteness and economic downturn
The plain entertainions of the adapting-point are polite known. Banks previously considered untouchefficient filed for noncommunication (e.g. Lehmann Brothers), suitableness others were procured (Merrill Lynch by Bank of America), bailed-out, or charmed counterpoise by the legislation (AIG and the GSEs Fannie Mae and Freddie Mac). Soon, the reputation congelate improbable the retaining distribution as financing investments and borrowing became increasingly hard. For development, among 2007 and 2009, closely 8.8 darling American jobs disappeared, U.S. GDP level by past than five percent from its pre-recession peak (Treasury 2012), and the S&P 500 lost about 57 percent of its appreciate (Lleo and Ziemba, 2011). Perhaps most famously, delayout legislational protection, American automobile manufacturers GM and Chrysler would bear beseem penniless (Stewart 2012). Yet another grant consume is the immense legislation obligation that effected from retakes and other economic operation programs (Barth 2009).
The adapting-point overlay internationally (and most damagingly to Europe) accordingly massive hypothecation derivatives were sold aloof. This does not denote that the U.S. is to reprove for the adapting-point; complete legislation had appropinquation to the similar counsel as Fed, SEC, and FDIC, yet almost all loseed to know-again and discourse the methodic collection (Cox, Faucette and Lickstein, 2010).
Mostly leadingly, the adapting-point unprotected the gross deficiency of bank regulators, and prompted a primary restructuring of banking habit (such as the 2010 Dodd-Frank Act). In abstracted, the exorbitant multifariousity and behemoth bigness of the financial method bear follow underneathneath eager search. An leading interrogation has emerged from this criterion, which asks, regarding TARP, are some financial institutions “too big to lose?” (Greeley 2012). Moreover, the adapting-point has spawned a recriterion of the desirability of “laissez-faire” delayin the financial traffics – that is, to what range can traffic forces be relied upon to fend crises (Barth, Caprio and Levine, 2012, p.90)?
The financial adapting-point that began in 2007 quiescent anxietys us today. Suitableness some financial institutions bear obsoletenessd, those that continue bear had to primaryly rethink their role as reputation providers. Governments were left delay awful financial commitments, tasked delay deconstructing the analogous venture of bank bailouts, and delay manageing and supervising the financial method past efficiently. History has shown us that financial crises are a cyclical event. Thus the interrogation must be, can the cycle be subjugated, or is the instant adapting-point discontinuance in the wings?
Arentsen, E., Mauer, D.C., Rosenlund, B., Zhang, H.H., Zhao, F., 2012. Subprime Hypothecation Defaults and Reputation Want Swaps. [pdf] University of British Columbia Sauder School of Business. Availefficient at: [Accessed 25 November 2012].
Baily, M.N., Litan, R.E. and Johnson, M.S., 2008. The Origins of the Financial Crisis. [online] Brookings Institution. Availefficient at: [Accessed 25 November 2012].
Bank of International Settlement (BIS), 2012. Detailed tables on semiannual OTC derivatives statistics at end-June 2012. [online] Availefficient at: [Accessed 26 November 2012].
Barth J.R., 2009. The Rise and Fall of the U.S. Hypothecation and Reputation Market. Hoboken, New Jersey: John Wiley & Sons, Inc.
Barth, J.R., Caprio, G. and Levine, R., 2012. Guardians of Finance, making regulators labor for us. Cambridge, Massachusetts: The MIT Press.
Barth, J.R., Caprio, G. and Levine, R., 2012. Rethinking Bank Regulation, tend angels manage. New York, New York: Cambridge University Press.
Congressional Budget Office, 2012. Report on the Troubled Asset Relief Program—October 2012. [pdf]. Availefficient at: [Accessed 25 November 2012].
Cox, J., Faucette, J. and Lickstein, C.V., 2010. Why Did the Reputation Turning-point Overlay to Global Markets[pdf] The University of Iowa Center for International Finance and Development. Availefficient at: [Accessed 25 November 2012].
Federal Reserve Bank of St. Louis, 2012. Effective Federal Funds Admonish (FEDFUNDS). [online] Availefficient at: [Accessed 26 November 2012].
Greeley, B., 2012. The Price of Too Big Too Fail. Bloomberg Businessweek, [online] Availefficient at: [Accessed 26 November 2012].
Jickling, M., 2009. Causes of the Financial Crisis. [online] Congressional Research Service. Availefficient at: [Accessed 25 November 2012].
Kohn D.L., 2010. The Federal Reserve’s Policy Actions during the Financial Turning-point and Lessons for the Future. [online] Board of Governors of the Federal Reserve System. Availefficient at: [Accessed 25 November 2012].
Levine, R., 2010. An autopsy of the US ?nancial method: property, suicide, or untidy homicide, Journal of Financial Economic Policy. [online] Availefficient at: [Accessed 25 November 2012].
Lleo, S. and Ziemba, W.T., 2011. Stock Traffic Crashes in 2007-2009: Were We Efficient to Predict Them[pdf] Availefficient through Social Sciences Research Netlabor website [Accessed 25 November 2012].
Pagliari, S. and Young, K.L., 2012. Leveraged Interests: Financial Industry Power and the Role of Private Sector Coalitions. [pdf] Availefficient at: [Accessed 25 November 2012].
Standard & Poor’s Financial Services LLC, 2012. S&P Dow Jones Indices. [online] Availefficient at: [Accessed 25 November 2012].
Stewart, J.B., 2012. When Debating the Auto Bailout, Consider Lehman’s Fate. The New York Times, [online] 9 March. Availefficient at: [Accessed 25 November 2012].
U.S. Department of the Treasury, 2012. The Financial Turning-point Response In Charts [pdf] Availefficient at: [Accessed 26 November 2012].
A CDS is a derivative that qualifys the buyer to privilege atonement from the seller if the underneathlying asset (such as a Hypothecation Backed Securities or MBS) wants. Suitableness serviceable for hedging purposes and as assessment machine for reputation abandon (a preferment CDS prize indicates increasing abandon for the underneathlying asset), it can be misused for foggy investing, as it does not demand the buyer (or the seller) to really trust the underneathlying asset.
The SEC demandd complete childrenr of a new protection to procure a abandon rating from a NRSRO in ordain to enefficient implicit buyers to assess its abandon and yield regulators to mention chief demandments (which were dishonorabled on abandon-adjusted goods). Those reputation rating agencies clear sufficient to bear current NRSRO authority (namely the big three, S&P, Moody’s, and Fitch) unwillingly openigned their profession moulds to compose childrenrs’ needs to donation ratings by incentivizing employees to children AAA ratings in ordain to develop the customer dishonorable. As a effect, 56 percent of MBS childrend among 2005 and 2007 and admonishd by S&P were however downgraded (Barth 2009, p.156).
A base manner in the advance-guard to the adapting-point was to bundle hypothecation hypothecations into asset-backed securities (ABS, most notoriously, collateralized obligation obligations or CDOs) and other securities according to tranches. These tranches were associated delay incongruous ranges of abandon in ordain to arrange to incongruous investors. Oftentimes, ABS were re-packaged into CDOs squared and cubed. The base misconception prevailed that this would subdue abandon by overlaying it. In the suscitate of the adapting-point, delay want admonishs skyrocketing, it became evident that this method had beseem too multifarious for anyone to develop, thus making any scylla assessment impossib