Financial Crisis

Table of Contents

I. Introduction        2

II. Financial Crisis Causes        2

Macroeconomic Causes        2

Microeconomic Causes        4

III. Government Policy Responses        5

IV. Conclusion        8

V. References        9

Introduction

The financial crisis of 2007-2009 has been characterized as the most worst economic calamity since the great depression of the late 1920s. This essay identifies main macroeconomic and microeconomic factors that led to the crisis, and a brief assessment of the UK policy responses.

Financial Crisis Causes

Since 2007, the subprime mortgage market turmoil from the United States quickly spread to the global financial crisis, national economies have been affected with varying degrees. It has had a massive adverse effect on global banking and global financial markets and systems.

Macroeconomic Causes

Global imbalances

Many countries had been running large and persistent current account deficits for many years. The situation became worse during the 2000´s. At the same time, oil exporting countries, like the oil-rich Gulf, and some emerging countries, especially China, have been running large and rising current account surpluses, see figure below. The emerging market countries economies (EMEs) with a large amount of current account surpluses - China and the Gulf in particular - were investing in the West and paying for the indebtedness of developed countries. The increased demand resulted in higher prices and lower government bond yields and low returns on fixed income financial assets across all advanced economies.

Current account, OECD countries 1997-2008, $ billions (Source: OECD)

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Low interest rates

A low interest rate environment encourages consumer to spend money that resulted in housing bubble bursting and encourages banks and other institutions to take higher risk to get greater return that an explosion in the search for yield, leading to huge complexity in the securitisation markets (e.g. derivatives used to spread risk).

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Source: academia.edu

Because of low interest rate, individuals could borrow money to purchase residential housing and it led to house prices rose doubled or trebled in a decade. The household debt/disposable income got new highs in almost all Western countries.