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Chicago
Subject:
Social Sciences
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Essay
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English (U.S.)
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Topic:
The causes of the Financial Crisis of 2008 in the United States and in EU
Essay Instructions:
5 to 6 pages explaining the causes of the Financial Crisis in the US and in the EU.
Explain what led to the financial crisis in the USA and its spread in the EU.
Explains how the issue was different in the USA and in the EU.
Explains important terms such as mortgage back securities, subprime lending.
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The Causes of the Financial Crisis of 2008 in the United States and EU
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Some assets suddenly losing a larger portion of their nominal value has occurred in the past. While the financial crises led to direct loss of paper wealth, they may not particularly cause substantial changes in the real economy. One of the crashes that had the greatest jolt to the world’s financial system the financial crisis of 2008. The banking systems of the world almost collapsed. Some of the largest banks in the U.S. like 2008, Lehman Brothers went bankrupt within a few weeks of September. The U.S. government announced that there would be no bail-out for the bank. The 2008 financial crisis was as a result of reduction in the federal funds rate by the Federal Reserve, rise to mortgage-backed securities (MBS) and the inability to anticipate volatility due to the previous economic stability.
The 2008 financial crisis was due to a combination of several factors. While experts agree that these factors played a critical role, they disagree regarding their relative importance. One of the causes was the reduction in the federal funds rate by the Federal Reserve and the Central Bank of the U.S. (Carmassi, Daniel & Stefano, 2009 pg. 987). In 2001, the two institutions anticipated the possibility of a mild recession and hence started putting measures to combat it. The interest rates that banks charge one another for overnight loans of federal funds reduced drastically (Baily, Litan & Johnson, 2008 pg. 30). As a result, commercial banks could extend loan facilities to customers at a lower prime rate. The clients who were initially considered high-risk, or “sub-prime” could access loans, although it was at high-interest rates. The availability of credit facilities prompted led to a surge in borrowing and acquisition of houses (Bernanke, 2018 pg. 3). The demand for houses increased since now many people had access to loans and mortgages. The result was a rapid increase in the prices of houses. The excess speculation by the people prompted houses to surpass their intrinsic value.
Additionally, changes in baking laws in the 1980s enabled banks to lend to subprime clients mortgages. Individuals with excellent credit scores and a history of dependability can qualify for lender’s interest rates (Prentzas, 2014 pg. 61). Hence, subprime mortgages were created to meet the needs of these categories of people. Individuals who are approved to receive subprime mortgages tend to have a history of low credit scores and challenges with debt (Beachy, 2012 pg. 19). Such individuals cannot access mortgages at the prime rate. While there is no exact number for the category, a FICO score between 620 and 680is considered subprime for a loan like a mortgage (Gerardi, Lehnert, Sherlund & Willen, 2008 pg. 79). Since advancing loans to individuals in subprime categories are termed as riskier, hence the interest rate tends to be higher. In the early 2000s, the recession had caused more people to struggle for credit. Hence, more qualified for the subprime mortgages because of their credit score.
At the same time, the Federal Reserve decided to spur economic growth, hence lowered the Federal Funds rate. The move sud...
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