2008 Financial Crisis Essay

2/19/2018

The financial crisis was mainly caused by deregulation in the financial industry. This gave banks permission to be involved in hedge fund trading with derivatives. This caused banks command more mortgages to support the profitable sale of these derivatives. This led to interest-only loans which eventually became more affordable to subprime borrowers. In 2004, the Federal Reserve increased the fed funds rate when the interest rates on the new mortgages reset. Housing prices began to fall as the supply outnumbered demand. Homeowners then could not afford their house payments, and they could not sell their houses. When the values of derivatives decreased, banks stopped lending to each other which led to the financial crisis and to the

In the next year, the Commodity Futures Modernization Act excused credit default swaps and other derivatives from regulations. This federal legislation overruled the laws that state created which formerly forbidden this as gambling, specifically excused trading in energy derivatives. Big banks had the resources to become sophisticated at the use of these complicated derivatives, therefore, the banks with the most complicated financial products made the most money in the financial industry. This led them to buy out smaller and safer banks. But by 2008, many major banks became too big to fail (for example, Bear Stearns and Lehman Brothers). A derivative backed by both real estate and insurance became very profitable. As the demand grew for derivatives, the banks’ demand for more mortgages to back securities also grew. In order for banks to meet this demand, they offered home loans to anyone and they offered subprime mortgages due to the fact that they made profit from the derivatives than the loans themselves. The Feds raised the rates on subprime borrowers. At first, they lowered the fed fund rates several times. They also lowered interest rates on adjustable-rate mortgages which made payments cheaper because the interest rates were based on short-term T-Bills yields (which was based on fed

Therefore, the demand of mortgages rose up the demand for housing. The cheap loans caused many people to buy home as investments to sell when the prices kept rising. When the fed raised the rates, homeowners were not able to afford their payment. Housing prices decreased which prevented mortgage-holders from selling homes that could not make no more payments. The increased fed fund rates led to the financial crisis. The executive branch of government tried to take measures on this crisis by having direct aid to a number of prominent financial firms. The FHFA (the Federal Housing Finance Agency) with the Treasury Department put Fannie Mae and Freddie Mac together to strengthen the housing agencies plus pledged to capital inject $100 billion into each agency if need for a positive net worth. The government wanted to give stability to the financial markets. After that, the government did not save the Lehman brothers, letting them bankrupt. Then the government gave AIG $85 billion for emergency loan in exchange for warrants of 80% of the company. They wanted to protect AIG to prevent systemic risk to the financial market. The next thing the government tried to do was a bailout. They proposed a $700 billion