One of the main causes of global financial crisis can be the sub- prime crisis (the housing market boom). Investment bankers did not cause this crisis, they only exacerbated it. What caused the crisis is the housing boom where in the People assumed that housing prices would go up forever, and so took out huge and even multiple mortgages on houses they couldn't really afford. Once the housing market stalled, and even declined (as it inevitable would do once it passes sustainable levels) that's when the crisis started, as banks went 'oh crap' and stopped lending, the stock market fell through the floor, and general economic chaos grew, as the full extent of just how much debt not only individuals were in, but also the banks themselves (thanks to the selling off of toxic debt to others, disguising it as good debt).
So what does the government need to do? Start looking at the housing market, it was basically a massive bubble and was bound to burst at some point. Now, house prices haven't fallen that much and are still at unsustainable levels. To sort this out they need to reduce demand. Build more housing make sure it is sold at reasonable prices. They also need to encourage the banks to be a lot more careful when it comes to lending. Lending money to people who can't really afford to pay it back is only going to cause trouble.
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They also need to pay off the debt they have as soon as possible, and then start putting money aside, and saving for a future crisis. That way, they will have the money to provide a fiscal stimulus etc. without damaging the economy by getting into masses of debt. But at the end of the day, the only thing they can do is reduce the risks. They will never be able to totally prevent another crash, because that's the way the market works, and we have small crashes and big recessions, and you just have to focus on reducing the country's exposure to it.
At such times governments including the UK attempt to stimulate the economy. Standard economic policy should include policies to Increase borrowing, Reduce interest rates, etc.
While these could be reasonable standard things to do, it requires that during economic good times, a changes of some of these policies are required in the UK like interest rates may need to increase (one reason for the housing booms in the US, UK and elsewhere was that interest rates were too low during good times), borrowing should be reduced and debts should start to be repaid, infrastructure investments may not need to be as direct from government and private enterprise may be able to contribute, and most politically sensitive of all, taxes should increase again to offset the reduction in borrowing.
A even bigger failure was suffered by the central banks, regulators and others across the world was failing to identify the whole system failed to identify the market wide significant risk. The key was not the supervison of Northeran Rock's failure but it was to relate the deficite in current account and increase in the credit extention and housing boom, the purchase of mortgages securities by UK from the US institutions performed new form of irrational exuberance in the credit market. There was a increased risk in the total system where the financial regulators failed to release.
Following the dot com bubble burst in US since the long time monetary policy in the US and other developed countries was very aggressive. With such low interest rates asset prices also going up particularly housing boom causing the investment of more funds. Thus the overall demand increased the domestic demand in US and a large amount of domestic demand was majorly met by the countries like China and other East Asian countries which provided goods and services at a relatively low cost growing the surpluses in these countries, the surpluses of East Asian countries moved up significantly like with the oil exporters. The excessive demand for a long period in developed countries like US and UK was more influenced by its own macroeconomic and monetary policies could continue with flexiable exchange rates in china. The deep crisis in global financial markets, high risk aversion, high losses of financial institutions, the high degree of commodity prices(In the third quarter of 2008) and their subsequent collapse and the sharp decrease in the asset prices all combined together and suddenly led to a sharp slowdown in the growth of developed economies.
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What should the UK government do? The UK government felt that the only way to address crisis was by global response and called for a reform to renew the financial system, where the new global governance should have an early warning system, stronger cross boarder supervision, options for collaboration and supervision and regulation across all countries. In future, regulators need to do more sectoral analysis and be more willing to make judgments about the sustainability of whole business models, rather than just the quality of their execution. Central banks and regulators between them need to integrate macro-economic analysis with macro-prudential analysis, and to identify the combination of measures which can take away the punch bowl before the party gets out of hand. We need to ensure that when the IMF or other international
surveillance bodies do issue warnings, that big powerful countries, and not just weaker developing countries potentially dependent on IMF. Support, feel that they have to respond.
A collapse of the US sub-prime mortgage market and the inverse effect on the housing boom in other industrialized economies have had a huge effect around the world. Some financial quaries have become so complex and twisted as things start to unravel the trust in the whole system started to fail. The subprime crisis came about in large part because of financial instruments such as securitization where banks would pool their various loans into sellable assets which off-loading risky loans onto others. At the moment the government is heavily focusing on investment bankers, and bank bonuses, just reducing bonuses is not going to reduce the likelihood of a future crash.
One of the other reasons of the global financial crisis was the global imbalance where a large amount of current account funds were pulled in by some of the oil exporting countries like china, japan and other developing countries and a large current account deficets were going in US, UK and other countries. The main issues of these imbalances can be very high savings rate in countries like china, since these high savings are in excess countries like china accumulate funds on rest of the world. Adding to this these countries are libal for fixed or significantly managed exchange rates, these funds act as cetral reserve funds, property or fixed assets but almost exclusively in apparently risk-free or close to risk-free government bonds or government guaranteed bonds.
Cause of Global Financial Crisis was followed by the bankruptcy of the Lehman Brothers (Investment Bankers) in September 2008 who were dealing with some financial instruments like securitization where banks invest their loans into sellable assets moving risky loan on to others. Millions can be earned by banks through loan, for safety they turned their loans into securitices, the security buyer will collect the payments from mortgages and the bank dereases its risk. This form of securitization grew as the investors were getting more keen to earn money and more loans were turned into this form of securitization and people with low income were also given loan to buy houses, when mortgage holder fails to pay his installment the mortgage property will move to the bank. When the housing the boom started going down more mortgages stoped paying their payments this resulted in such a way that the people who even afforded to pay their installments stoped paying. This freezes the entire system and causes the bankruptcy of the Investment bankers.