The Global Financial Crisis (GFC), also known as the great recession, has impacted economies on a global scale in 2007 - 2008. Its effects have been far reaching and prolonged, with economies still bearing the consequences more than half a decade on, although recovery seems to be picking up albeit rather slowly.
A myriad of factors caused the GFC and can be traced back to even before the widespread issuing of subprime loans and mortgage backed securities due to securitisation and financial deregulation. However, the one thing that remains clear thus far was that the GFC was largely attributed to the bursting of the housing bubble in the United States as a result of poor regulation and ease of borrowing. With an increasingly globalised economic landscape, and with the US remaining as the financial superpower, a failure in the economic system in the US as well as its financial institutions such as Lehman Brothers, has led to the recessionary plight that currently dwells in the global economy. To explain the cause of the GFC as merely because of the risky subprime mortgages and credit derivative investments would thus be rather myopic. However, one should trace back the accumulation of factors and the given time effect which set the stage for an eventual downfall. In this essay we will explore various key factors which were attributed to the cause of the GFC.
With the US economy in a recession due to the dot-com bust, with valuations in a bear market but being offset by earnings in a bull market, US companies were making significant earnings but there was little confidence in the market.1 With consumer sentiment already on the downtrend since the dot-com bust, the September 11 terrorist attack in 2001 exacerbated the decline in consumer sentiment.2
In a bid to restore consumer sentiment and stimulate spending, the Federal Reserve made the decision to decrease interest rates. 3 Interest rates were thus lowered from 3% in September 17 2001 to 1.75% by the end of 2001. Such a low interest rate was never seen before where interest rates were as high as 8% in 1990. From macroeconomic theory, it is hoped that lowered interest rates would result in an ease in borrowing for consumers. The ease of borrowing would thus translate into an incentive for higher consumption, resulting in slowly but surely recovery of the economy. For the next 3 years, the Federal Reserve kept interest rates below 2%, reducing it even as low as 1% on June 25 2003. The Fed’s decisions to keep interest rates low during this period eventually raised consumer sentiment and the US economy was commencing its recovery by November 2001.4
However, one of the repercussions of such low interest rates at this time was that consumers were building up more debt as a result of cheap borrowing costs.5 The accumulation of a greater household debt was a result of consumers borrowing to purchase big ticket items, such as housing, which is one of the proceeding causes of...