What Caused The Financial Crisis? Essay -- Economics

The roots of the financial crisis can be traced back to the property asset bubble in the US between 1997 and 2006. This asset bubble was enabled by a poorly regulated subprime mortgage industry and the assumption that property prices would continue to rise. The collapse of the property bubble and subsequent foreclosures led to many financial institutions suffering huge losses due to their exposure to the subprime market through a series of innovative and complex investment vehicles. While these investments carried extra risk, they also gave the opportunity for massive short term returns, and the move to these riskier and more complicated financial investments may have been facilitated by a ‘too big to fail’ mentality by many US financial institutions. The collapse of the property bubble and uncertainty in the markets led to a run by depositors and a sudden loss of funding for banks day to day activities. Due to the dependence of the interbank lending market for short term funding, these banks were unable to fund their day to day operations and some collapses, (Lehman Brothers) while others were bailed out by the US government (AIG). Such a loss of confidence within the financial industry eventually led to banks operating a more cautious approach to lending and ensured a severe reduction in the availability of credit, both to other banks and consumers. I will look at the how subprime lending, assisted by expansionary macroeconomic policies and lenient regulatory supervision, eventually morphed into a full financial crisis rather than the view that such crises are cyclical in open market economies and are part of the boom and bust characteristics of capitalism. Sub-prime Mortgages and the Building Blocks of the Financial Crisis .. ...pubs/ft/fandd/2008/06/dodd.htm Carmassi, J, Gros, P and Micossi, S. The Global Financial Crisis: Causes and Cures. Journal of Common Market Studies. Vol.47, No.5, pp. 977-996, 2009. Available at: http://www.relooney.info/SI_FAO-Asia/Global-Crisis_23.pdf Blakenburg, S and Palma, J.G. Introduction: the global financial crisis. Cambridge Journal of Economics. Vol.33, pp.531-539, 2009. Available at: http://cje.oxfordjournals.org/content/33/4/531.full.pdf+html Online Publications Inman, P. Easy money hits home with lenders facing  £250bn losses. The Guardian Online, July 10th, 2007. Available at: http://www.guardian.co.uk/business/2007/jul/10/usnews.internationalnews1?INTCMP=SRCH Baldwin, R. Excessive risk-taking by Banks. Wall Street Pit. Global Market Insight, April 9th, 2012. Available at: http://wallstreetpit.com/90959-excessive-risk-taking-by-banks