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 the 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 numbers 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 Brother and AIG suffered a great loss in the time of recession while 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. And when it failed to sell them, the cash flow was disturbed significantly resulting in the bankruptcy of 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 has around $400 billion in credit default swap contract with AIG. Thus, the decision of not bailing 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 decision to bailing 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. Consider, for instance, people following their fears tend to decrease their spending, sell their stocks and tighten their budgets which actually lead to the overall poor economic conditions which they anticipated. A similar condition is when investors begin to lose their confidence in the government policies and then actually find it to be non-efficient while the inability of the government itself resulted 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 the global crises because different financial institutions were engaged in the international trading and investment. Previously, the international banks were allowed to engage in hedge funds with derivatives but when their values decreased as the result of financial crises, they stopped lending to each other and thus an international trade declined that 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 already on the verge of another financial crisis and the main reason for this is the insufficient efforts being taken by the 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, the insurance companies can be impacted greatly if houses are collapsed in a significant number leading to a very similar situation as happened in 2008. The rating companies can also contribute to this financial loss because they only consider the financial indicators while evaluation the companies. Therefore, it is required to investigate the adverse effects of mispriced flood and fire insurance and transparently talk about Americans’ exposure to climate change.
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