Reasons for the recent global financial crisis Essay

Reasons for the recent global financial crisis - Essay Example The present article has identified that the cause of the recent financial crisis and economic recessions has been attributed to various factors in the economy. The initial trigger of the financial crisis has been traced to the toxic mortgage backed assets whose decline in value and uncertain duration led to massive losses in the U.S economy. Fannie Mae and Freddie Mac were both taken over by the US government. Lehman Brothers was declared bankrupt since it could not increase its capitalization. Merrill Lynch was bought by the Bank of America while American International Group (AIG) was rescued by the Federal government through an $ 85 billion capital bailout. Washington Mutual which is currently the largest bank failure was purchased by J P Morgan Chase. The crisis can be traced to the failure of the real estate market due to subprime lending which saw the commercial and residential housing prices increase for a decade from 1990. The Asian financial crisis of 1997-1998 saw the econom ies in Asia generate huge current account surpluses which were invested offshore in economies like US and UK in order to keep the nominal exchange rates low. The US stock prices went high due to the influx of capital. The high growth in economic demands and especially in China saw commodity prices such as minerals, oil and food soar up from late 2004 to late 2007. There are numerous explanations and arguments which have been proposed as the causes of the 2008-2009 financial crisis and the recessions.... The burst of the housing bubble led to massive loan defaults which led to the decline in the values of the mortgage backed securities (Freedman 2010). The subprime mortgages were risky since their true values were hidden in the house price appreciation which allowed mortgage refinancing. The real estate bubble was occasioned partly by easy credit in the economy which was facilitated by expansionary monetary policy of the Federal Reserve where the Fed funds rate was cut from 6.5% in 2000 to 1% percent in 2003 (Freedman 2010). Innovations in the financial system resulted to collateralized debt obligations and other derivatives which fueled the housing bubble. Losses of US subprime mortgages were estimated at $ 250 billion dollars in 2007 while the decline in the stock market capitalization was $ 26,400 billion dollars from the period July 2007 to November 2008. Weak banking regulations and poor risk assessment methods forced coupled with the government regulations which blended the ope rations of mortgage providers and investment banks saw many risky and unqualified customers access the housing mortgages (Freedman 2010). According to the Securities Industry and Financial Markets Association, the aggregate collateralized debt obligations issuance expanded from USD $ 150 billion in 2004 to US $ 500 billion in 2006 before increasing further to US $ 2 trillion by the end of the year 2007. The value of the Mortgage backed assets held in banks’ books, insurance companies and other major financial institutions explains how the burst of the housing bubble led to massive losses to holders of the mortgage backed securities. However, subprime mortgages had higher interest rates after the initial offer and only 43 percent of the adjustable rate mortgages were subprime