Factors Contributing to The Financial Crisis Of 2008
The financial crisis of 2008 resulted from a financial bubble which was originated from the breakdown of the “securitization food chain”. It was the conventional practice of borrowers who used to secure a loan for a mortgage and then pay it back with interest to a financial institution. These loans were then sold to the investors in the post-Reagan period, which initiated the gambling of trillions of dollars. Finally, the number of loans in the financial sector increased tremendously without considering the capacity of the borrowers to repay them, which led to the economic crisis in 2008.
Lehman Brothers Vs. AIG
Both Lehman Brothers and AIG suffered a great loss during the recession. AIG received a bailout from the federal government and survived, but Lehman Brothers experienced complete failure. The total assets of Lehman Brothers in 2008 were $639 billion, while its total debt was $613 billion dollars, a lot lower than its assets in technical terms. When it failed to sell them, the cash flow was disturbed significantly, resulting in bankruptcy for the bank.
AIG was among the largest insurance companies that gambled on collateralized debt obligations and finally lost. In response to these failures of one of the largest financial institutions, the federal government provided bailout support to AIG with $180 billion while no bailout was provided to Lehman Brothers, arguing that Lehman Brothers did not have sufficient collateral. This resulted in the complete failure of Lehman Brothers, which also impacted AIG because it had around $400 billion in credit default swap contracts with AIG. Thus, the decision not to bail out the Lehman Brothers actually made the bailout of AIG relatively expensive, while it only needed $30 billion to survive as compared to $180 billion for AIG (Grunwald, 2014). Thus, it seems that the Fed’s decision to bail out AGI only is not completely justified.
Loss of Confidence and Self-Fulfilling Prophecy
The loss of confidence in economics can lead to many adverse impacts on the overall condition of the financial sector. For instance, people following their fears tend to decrease their spending, sell their stocks, and tighten their budgets, which actually leads to the overall poor economic conditions that they anticipated. A similar condition occurs when investors begin to lose their confidence in government policies and then actually find them to be non-efficient, while the inability of the government itself results from their low confidence. A similar case can be observed during the financial crisis of 2008 as well.
The Global Economic Crisis
The financial crisis became a global crisis because different financial institutions were engaged in international trading and investment. Previously, international banks were allowed to engage in hedge funds with derivatives, but when their values decreased as a result of financial crises, they stopped lending to each other, and thus, international trade declined, which led to global crises. Moreover, when the banks collapsed, many businesses also stopped working, and hence, a global impact of the financial crises was observed.
Another Financial Crisis in The Coming Future
According to Harrell (2020), we might be on the verge of another financial crisis, and the main reason for this is the insufficient efforts being made by financial institutions and the federal government to tackle the destructive impacts of climate change. The number of natural disasters is increasing every year, and such events have a great influence on the prices of houses. Also, insurance companies can be impacted greatly if houses collapse in significant numbers, leading to a situation similar to the one in 2008. Rating companies can also contribute to this financial loss because they only consider financial indicators when evaluating companies. Therefore, it is necessary to investigate the adverse effects of mispriced flood and fire insurance and transparently talk about Americans’ exposure to climate change.
References
Grunwald, M. (2014, September 30). The Real Truth About the Wall Street Bailouts. Time; Time. https://time.com/3450110/aig-lehman/
Harrell, E. (2020, December 18). Are We On the Verge of Another Financial Crisis? Harvard Business Review. https://hbr.org/2020/12/are-we-on-the-verge-of-another-financial-crisis
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