2007-2011 Financial Crisis (Research Paper Sample)

2007-2011 Financial Crisis
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Abstract
This paper provides a comprehensive analysis of the 2007-2011 financial crisis by focusing mainly on the causes of the crisis; strategies adopted to counter the crisis; and the lessons learnt from the crisis. The 2007-2011 financial crisis crippled many financial institutions and economies across various countries. As a result, many economists considered it as among the worst financial crisis after the ‘Great Depression’. The crisis began in 2007 in the US and spread to other regions including the UK and various countries in the euro-zone.
Introduction
The financial crisis of 2007-2011 is considered by many economists as the worst financial crisis to occur since the "Great Depression" which occurred in 1930s. It began with seizure in the banking system, which was precipitated by BNP Paribas declaring that it was ceasing its operations in three hedge funds, which specialized in the United States mortgage debt. As a result, individual banks lost trust with each other and they immediately stopped doing business together (Georgieva 2012, p.47). The impact of the crisis was noted on September 15, 2008, when the United States’ government allowed the Lehman Brothers to go bankrupt. At that instance, the notion that some banks were too big to fail evaporated. On May 9, 2010, the crisis took another turn with the focus shifting from private to public sector. Consequently, the European Union and the IMF announced that they would offer financial assistance to Greece, since the issue had now shifted from solvency of banks to solvency of governments (Kaji & Ogawa 2013, p.23). Greece had unique problems extending from collection of taxes to management of public funds. Many other countries were also experiencing budget deficits, and austerity was adopted as the new watchword, influencing policy decisions in the euro-zone, UK, and the US.
Causes of the 2007-2011 financial crisis
Many factors directly and indirectly caused the 2007-2011 financial crisis, but experts place more weight upon specific causes. First, experts claim that there was the Asian financial crisis of 1997-1998, which led to generation of large current account surpluses in the Asian economies, which had to be invested offshore in order to keep their nominal exchange rates low. Consequently, capital flowed from Asia to the United States dotcom stocks driving up equity prices. This was followed by the bursting of the dotcom bubble which saw the booming of NASDAQ over 1998-2000 burst in 2001. Because of the fear of downturn and deflation, the United States Federal Reserve lessened monetary policy in a series of steps from 2001-2004. Consequently, with easy credit and a rise in the housing market, a boom in house prices followed, and there was an increased growth in credit and leveraged loans (Georgieva 2012, p. 59).
Moreover, risk premia hit low levels and leveraged deals became the talk of the day as investors chased yields in a market of lax regulatory oversight. At the same time, increasing demand from China and India and the booming world economy led to rise in commodity prices across minerals, oils, and food from 2004 to 2007. The impact to the global economy from this commodity price increase led to weakened economies in various countries. From this point onwards, banks started experiencing solvency problems, which later led to government solvency issues (Arestis, 2012, p.32).
Strategies adopted to counter the financial crisis
In response to the crisis, the EU, member states, and the euro area as a whole adopted a broad range of measures to ensure financial stability, improve economic governance, and support growth and employment. At the EU level, coordination between the member states had to be enhanced in order to pave way for quick recovery from the adverse effects of the crisis. In 2011, the council and the European Parliament adopted a legislative package on the economic governance, which was branded the name "six-pack”. This package reinforced the already existing "Stability and Growth Pact" commonly known as SGP. Originally, the SGP focused on monitoring the member states compliance with the set targets in their budgets. The "Six-Pack" adopted the same strategy to deal with public debt levels (The EU's response to the crisis, n.d.).
As a way of safeguarding financial institutions from collapsing, in 2011, the EU initiated new supervisory authorities, which included the European Banking Authority, the European Securities and Markets Authority, the European Insurance and Occupational Pensions Authority, and the European Systematic Risk Board for macro-prudential supervision. A banking union known as the EU-Level banking supervision and resolution system has also been created. Its core objective is to ensure that the banking sector in the euro zone is safe and reliable, in such a way that failing banks will be resolved without recourse to taxpayer’s money, and with minimal effect on the real economy (Arestis 2012, p.63).
Lessons learnt from the financial crisis
The financial crisis exposed the importance of interconnections among the banking system; payment and settlement systems; and the capital markets. Focus on only one section of the financial system can obscure vulnerabilities that might be requiring urgent response. For instance, the disruption of the securitization markets contributed by poor performance of highly rated debt securities caused significant problems across various financial institutions. Banks were forced to take assets back on their books, and they could no longer, securitize loans, and as a result, there was increased pressure on their balance sheets. Moreover, it was learnt that transparency plays an integral role in every economy. Lack of transparency led to loss of confidence, which...