The 2007-2008 Great Recession was arguably the worst economic crisis after the Great Depression. On September 2008, Lehman Brothers, a major global bank, collapsed (Torres, 2010) and this was the beginning of the crisis. The largest economies in the world continued to suffer from the effects of the financial crisis. The cost of the crisis and the factors that contributed to its manifestation are therefore fundamental in influencing futuristic economic policies in the countries. There are several fundamental factors that led to the 2007-2008 financial crisis: the collapse in prices of mortgage, unstable market and income inequalities.
The 2007-2008 credit crunch is among the fundamental factors that contributed to the crisis. Investors in major economies, especially in the United States began losing trust in the rapidly expanding real estate industry. The lack of investment resulted in reduced liquidity culminating in reduced financial activities in major stock exchange markets globally. Due to the large amount of money available through cheap credit, there was a sense of economic power. Consumers could afford to spend and invest in businesses. However, when the mortgage business declined a chain reaction occurred in the entire economy (Guina, 2014). The value of things and property in the markets became unpredictable. There was also less money in circulation because banks had over-utilized their credit reserves and were offering less credit or none at all. Investors kept off from spending. Households were hoarding money in a bid to save for darker days that seemed closer than before (Torres, 2010).
Initially borrowers were taking up loans to invest, whether in homes or other businesses, and they based their profit expectations on speculations. Low interest rates enticed borrowers to get loans and invest in high-risk ventures with a promise of higher returns. Guina (2014) says that private firms invested billions of dollars in purchasing companies; yet, they failed to create value in their investments. As a result, the rate of inflation increased and the money that had become available lost its value. The increased price of goods and services was a consequence that greatly affected the economy and buyers lost their purchasing power. Consumers found that they were buying fewer things with more money than before.
The speculation on the size and lucrativeness of the real estate industry in the large economies enticed many investors; most of whom were from the commercial banks a feature that resulted in the reduction of the economy’s liquidity. Further, real estate investors had built and made available more homes. The stakeholders had predicted a major gain due to the economic growth that was being experienced before 2007. Eventually, supply overtook demand when the credit crunch hit. People stopped buying as banks stopped lending and mortgage lenders went for the existing borrowers’ throats. Home prices plummeted and employees in the sector were laid off as their employers stopped investing in building more (Guina, 2014). The investments made in building these homes became worthless and the market’s growth declined. The investors who had previously put their wealth in the sector were pulling out due to fear of the looming losses to be made. The pressure was left to the home providers to continue struggling to find buyers.
In developed countries, real estate is a major industry that drives the economy. When it became affected, investors shied away from it and the reduction in the revenue and major players caused the subprime meltdown and the effects were felt as far as Europe. Global stock markets crashed and consumers also took a step back, afraid to make any more investments in the real estate (Davies, 2014). Some banks ran to governments for help and taxpayers’ money was being used to bail them out, creating a credit crunch (Chapra, 2009). A lot of damage was done as mortgage lenders repossessed the homes from homeowners who were unable to continue with the payments on the now low valued homes and land. As Davies (2014) continues to explain, the lenders went on to resell the property at much lower prices than the initial price, they were loaned on in order to solve their own liquidity crisis.
Crisis broke out due to inefficient distribution of money from the growth during the pre-crisis period. The 2007-2008 economic and financial crisis caused significant income inequalities. Prior to the crisis, economic growth had led to increased gains in wealth. The crisis led to changes in the wages earned. As expected, the low-earning workers were greatly affected because their incomes stagnated yet the prices of goods and services had significantly increased (Torres, 2010). Banks were still lending at the same rates despite the change in the value of the income of potential borrowers. A fragile economy came as a result. Low income earners defaulted on payments, including mortgages and other short-term loans that banks were heavily relying on. Some of the borrowers had hoped to gain profit from their mortgage-financed homes through renting them out or refinancing at a lower rate but their plans were thwarted because incomes decreased and potential customers kept away (Guina, 2014). Generally, homes became unaffordable and financial institutions that had provided the loans were left to bear the brunt. Consumers had lost trust in the financial market and stopped spending (Davies, 2014).
The subprime mortgage crisis was another cause for the financial crisis. In 2007, the mortgage crisis saw the property market become greatly affected. Mortgage lenders irresponsibly made available loans available to the public. A case in point can be shown using the US scenario whereby the subprime mortgage crisis created major emergencies in the banking sector. Previously, after the 9/11 terrorist attacks, the Federal Reserve tried to save the US economy by reducing interest and citizens gained easy access to cheap credit (Guina, 2014). Lenders took unfair and deceptive advantage by offering loans at very low rates and even extended the services to individuals who would have otherwise been unqualified for traditional loans. Banks rushed to compete for the increased investment opportunities as potential buyers began to spend their money (Torres, 2010). Unfortunately, most of these were only buying homes (Guina, 2014). Later on, in the wake of the financial crisis that began in mid-July 2007 the real estate market could handle no more pressure.
It is clear that credit is the main cause of this mess. It is an ironic situation because this same credit is what keeps an economy going. The economy was destabilized by that which keeps it stable. The reason behind this scenario is that credit was poorly utilized in the market. Lack of proper regulations in the financial sector saw the unscrupulous lending business take the day. Consumers were caught unaware in the much hyped mortgage loans and they ended up taking loans without proper advice and guidance. Most of the borrowers had no idea what the consequence of such loans was since the picture painted by the lenders was that of a cheap, affordable and very worthwhile investment. They failed to show the public the real deal and were only out to make profits during the housing boom as fast as possible. When it came crashing down, everyone was affected the world over, but the most affected was the ordinary citizen who bore all the pain and suffering of a high cost of living.
References
Chapra, M. (2009). The Global Financial Crisis: Can Islamic Finance Help? Insights,1, 27-38.
Davies, J. (11/04/2014). Global Financial Crisis – What caused it and how the world responded. Canstar. Retrieved from http://www.canstar.com.au/home-loans/global-financial-crisis/
Guina, R. (2011). The 2008-2009 Financial Crisis – Causes and Effects. Cash Money Life. Retrieved from http://cashmoneylife.com/economic-financial-crisis-2008-causes/
Torres, R. (2010). Global Crisis: Causes, Responses and Challenges. Responding to the Global Crisis: Achievements and Pending Issues. United States, Washington: International Labor Office Inc.
