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How the 2008 Financial Crisis Happened

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The financial crisis (2008): It is known as the worst economic tragedy since the Great Depression (1929).U.S. Investment bank and Lehman Brothers collapsed due to that crisis. The crisis was the outcome of many sequence events, each event activated a mechanism that almost led to the deterioration of the banking system. Arguably the roots of this crisis go back to the 1970s when the Community Development Act was issued, it forced banks to loosen their credit requirements for the people of low income, which generated a market for subprime mortgages.

Before the collapse of Lehman Brothers, the U.S. government refused to bail them out, which created uncertainty in the atmosphere from counterparty risk that the number of transactions will significantly drop in the financial markets during the third and fourth quarters of 2008. Deficiency of working capital began spreading which led anxious firms to liquidate their stocks, parts and components, and fire staff. Trade finance started becoming rare and the purchases decreased by firms and consumers’ international trade began to crash.

Many aggressive steps were taken by the governments and central bank to stabilize the national economies. This is the second phase of the crisis, the stabilization phase which started in the fourth quarter of 2008 and ended by the end of 2009. Where interest rates were nearly zero, and liquidity being made available in large quantities to financial market institutions, central bank purchased a range of financial assets and the implementation of large fiscal stimulus packages.

From 2010 on, then, the third phase started with austerity plans were announced, which involved an increase in tax and government spending cuts. However, these measures were seen rather controversial, as the majority thought that the implementation of these measures was early since economies had not returned to their growth paths prior to the crisis. Austerity and structural reforms worked together to increase the growth rate of economies in the long run that would lead later on increasing future tax levels and stop the doubts about the long-term solvency of the governments.

Austerity was merged with many industry-based economies with high rates of saving, people were willing to pay their debts and start rebuilding their financial portfolios. The severe decline in the prices of the housing industry in some jurisdictions and the effects of the acquisition of foreign financial assets that had significantly decreased in value implied that there were a considerable amount of bad debts held by banks. Throughout the process of identifying and writing off bad debts, bank loans for the new project were miserable. Deleveraging and rebuilding bank balance sheets were the main concerns of austerity had in mind during the year from 2010 to 2012, which means that numerous huge economies had fallen under the economic growth projections.

During the third quarter of 2012, austerity was heavily questioned by International Monetary Fund; it was not before 2013 that several former adherents (such as the President of the European Commission) started questioning austerity policies which led to demoting them, if not abandoning them. This started the fourth phase of the crisis, where the concentration is on structural reforms, which included labor, product market reforms, and banking reforms.

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