Discuss the Major Causes of the 2007 Global Financial Crisis? (Research Paper Sample)

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Securities Markets
Question 1: Discuss the major causes of the 2007 Global Financial Crisis?
According to Welch (2011, 10), the 2007 Global Financial crisis occurred due to the numerous issues. They include high risk borrowing and lending practices, and poor fiscal choices related to government expenses and revenues. Other causes of the 2007 Global Financial Crisis were trade imbalances in the international market and the real estate bubble.
High risk borrowing and lending practices
Between the years 2000 and 2006, the Bush administration made it a priority to increase first time home ownership in America. This program mainly targeted low income earners and single parents. The program provided low interest loans with no money down to people who wanted to purchase their first homes. Notable institutions providing such services included “Bank of America” and Citigroup (Tuckman, B. 2011, 13). One needed an income as low as 20000 dollars to qualify. The 2003 war in Iraq caused a slowdown in the American economy and a decrease in Budget surpluses. This in turn resulted in an increase in interest rates and consequent increases in mortgage rates and payments. The increased mortgage payments led to people defaulting as they could not pay the now variable interest rate. Rates on credit cards also increased, forcing people to take second equities on their mortgage. Unfortunately, they discovered that their homes were now less than they anticipated. This then led to the defaults in both mortgage and credit card payments. The banks responded with increasingly risky lending practices such as second or third credit cards (Howell, C. 2008, 3). ). In time, the poor financial practices forced the US banks to sell their debt to foreign banks like AG Zurich, Barclays bank and RMB Scotland. When the housing bubble burst, all those local and foreign entities with sub prime mortgages investments suffered financial distress. This led to the 2007 global crisis.
Poor fiscal choices relating to government expenses and revenue
In some critical areas, the US government continues to make poor fiscal choices. The examples include large scale road construction projects, social programs, printing money, raising the debt ceiling and tax increases. The road in Alaska provides the best example of poor fiscal choices. The federal government gave money to build a road “to nowhere” and also allocated funds for costly oil exploration. These uneconomic developments known as “Pork Barrel projects” divert money from places where it could create maximum benefits. Several other military projects for new generation aircraft carriers could be attributed to poor financial choices by policy makers too. Coupled with increased spending on wars in Iraq and Afghanistan, these contributed to the 2007 global downturn. The military spending made America’s exports decrease and then led to a trade deficit. The trade deficit, in turn, led to less dollars circulating in the global trade. Research shows that increased spending on social programs does not add revenue to the federal coffers. By 2007, the US was spending a significant amount of its revenue from exports on social welfare programs. Money raised from internal taxation also went towards Medicare subsidies to those who could not afford it; these included veteran and union benefits and Social Security payments. Rather than come up with private schemes that could take away the financial burden, the government continued to increase the payments made. Thus, autoworkers gained in increased benefits while large automakers like GM filed for bankruptcy. Increasing costs and decreasing revenues led the government to print money to finance these costly interventions. The dollar’s value fell and international trade suffered as more countries bought dollars “on the cheap” only to hoard them.
Trade Imbalances in International trading
The rise of China as a major global trading player caused alarm at first. American companies soon caught on and outsourced manufacturing to China; this was to save on costs. This outsourcing led to a trade deficit in favor of China. As time went by, Chinese held more actual dollars in their reserve than the US federal government. The latter opted to “borrow” back these dollars from Chinese (Michie, R. 2008, 19). This caused the ratio between the amounts of money owed by America to its revenue to increase. America’s reduced manufacturing, debts to China and inability to raise capital for expenditure led to a decline in global trade. This decline means less money in the traditional market and more money in the hands of emerging markets like China. These emerging markets tend to hoard dollars to shore up their foreign exchange reserves or fund populist programs.
The real estate bubble
As mentioned earlier, banks fund the real estate market through facilitating generous mortgage terms. When people cannot pay their mortgages, the US banks tend to intervene by buying toxic loans (sub prime mortgages).When this intervention fails, the banks usually sell the part of those mortgages to foreign entities to avoid issuing decreased dividends to shareholders. In the case of the institutions like Citi Group, Bank of America and Merrill Lynch, that transfer occurred to speculative foreign investors. These investors stretched out mortgage payments, anticipating long term higher overall principal amount payments. Problems arose when companies began laying off people and those could not make their mortgage payments. The “contagion” spread and both foreign and local entities made losses. Since governments had to cover these losses financially, there was an increase in taxes. The taxes served to immediately provide the access to revenue, but when too high, they caused companies to incur losses and layoffs. The latter, in turn, led to reduced manufacturing and profit margins around the world, and thus a global financial downturn.
Question 2: Quantitative easing has not achieved anything major objective since the start of the Global Financial Crisis. Discuss [10 Marks]
Quantitative easing refers to a monetary policy used by central banks around the world to stimulate economy. Governments employ this unconventional financial structure when standard monetary regulations and policies prove ineffective (Mishkin, F. 2010, 11). Central bank (or in the case of America, the Federal Reserve) implements this easing by purchasing financial assets from private institutions and commercial banks to increase the monetary base. Quantitative easing has not achieved any significant objective for the following reasons. First, every time one buys T-Bills and “adds dollars to the financial system”, the extra dollar decreases the value of existing currency. This is akin to printing money which causes currency to lose value as the supply of goods remains static. If one printed money and then kept goods production at the same level, a buyer would need more money to get a single item as the system “mops” up excess currency. One can say that quantitative easing causes the increase in inflation and also disrupts market forces action. When the federal government floods the financial system with money to stabilize bubbles, it creates an artificial climate. This climate leads to a deceptively quick recovery which then causes people to spend more money. This is done in the belief that the federal government will eventually take care off all debts. This easing does not consider that the real estate market should come into equilibrium slowly and on its own. In other words, quantitative easing prevents people from buying cheap houses. If market forces prevail, growth in the housing market naturally occurs and home value prices surge. Quantitative easing can also cause speculators to engage in currency speculation (Kienitz, J.2010, &). This could lead to rising commodity prices as the investors make use of the readily available investment opportunities. The US dollar competes in the global market against stronger currencies like the Euro and the Sterling Pound. With increased quantitative easing, the US dollar loses value, causing American exports to be cheaper. While this makes the exports more attractive (leading to more sales), the dollar’s weakness means that imports like oil become more expensive. Since petroleum products form a major portion of the US exports, America will pay more for oil than Germany or Britain which use strong currencies. This high oil import bill passes onto a consumer who pays high prices at the pump. Quantitative easing may also cause the US dollar to look volatile, much like the Chinese Yuan. No nation will want to trade with another when the currency swings up and down as a result of Treasury bill buying and other interventions. Monetizing debt is another way to describe quantitative easing. America’s high debts (17 trillion) and ever rising debt ceiling cause nations like China to shy away from “buying” that debt. By giving corporations, individuals and foreigners a chance to buy treasury bills, the Federal Reserve in effect confirms that it cannot finance its debts. Sooner or later, the investors figure out that the US cannot finance its debt. This causes those investors to abandon their 'donations' and the US government then encounters future difficulties while seeking new (Haughen, R.2010, 11).One should note that a country’s credit rating drops when they cannot find lenders or creditors. The US in such a case can only attract new lenders by offering higher interest rates. They will lead locals to pay more in taxes to cover the revenue shortfall. One can see that very little benefit arises from qu...