The global economic crisis of 2008 has truly become a turning point in the evolution of the global economic system. It uncovered huge inconsistencies in how the U.S. economy managed its macroeconomic risks. The real estate bubble that originated in excessive and obviously misbalanced securitisation of real estate mortgages followed a long period of prosperity and policy blindness. In the era of macroeconomic abundance, the U.S. financial authorities were unwilling and reluctant to look further into the future. The legacy of the financial stress caused by the global economic crisis in 2008 persists until present. It teaches a lesson of macroeconomic caution and necessitates the development of more robust protective mechanisms to avoid similar shocks in the nearest decades.
The current state of theory and research in macroeconomics presents economic development as a cyclical activity. In other words, in its evolution and growth, every economy goes through a distinct sequence of predetermined cycles. Considerable fluctuations in the macroeconomic conditions across cycles suggest that government bodies and policymakers are largely unable to prevent economic downfalls, which are almost always followed by growth and revival of most economic activities. Still, the economic crisis of 2008 tells much of the role, which government, banking, and financial institutions play in the economic and financial processes affecting major global economies. A brief analysis of the causes behind the financial shock of 2008 confirms that the passion for “cheap” profits shared by banks and mortgage institutions and the reluctance of government bodies to minimise the risks of another economic bubble eventually led to a crisis that was larger and more devastating than the Great Depression of 1929-1932.
The story of the economic crisis of 2008 is quite complicated. As Legg and Harris (2009) write, “it is a story of contagion, interdependence, interconnection and covariance: how the American Dream became the global nightmare” (p. 351). The key cause of the financial shock in 2008 can be found in the American subprime mortgage market (Legg & Harris, 2009). It is overreliance on affordable mortgages that led to their excess securitisation and, as a result, created a huge real estate bubble resulting in crisis. Securitisation of mortgages and the macroeconomic shift from prime to subprime mortgages played one of the principal roles in the development of the crisis spiral in the U.S. and the rest of the world.
Securitisation by itself meant that neither debtors nor financial intermediaries would bear the risks of maturity transformations in mortgage affairs (Hellwig, 2008). Those risks were eventually passed to third market players (Hellwig, 2008). Such processes would hardly be a problem, had the U.S. financial authorities regulated the process to ensure greater diversification of credit risks and guarantee that the credit trustworthiness of every client was thoroughly estimated. Yet, domestic lending was severely under-diversified (Hellwig, 2008). Most debt securitisation activities were being managed by Fannie Mae and Freddie Mac, former government institutions, which made blatant promises to provide quality debt services to back up the mortgage securities they issued (Hellwig, 2008). In the meantime, more private banking institutions moved into the securitisation field, which promises enormous profits and revenues. The percentage of subprime mortgages grew dramatically. Investors made more finance available for housing mortgages without considering the costs of inflated macroeconomic decisions (Hellwig, 2008). By the time the risks of subprime mortgages became obvious, the crisis spiral had already been in action.
The macroeconomic conditions in the U.S. at the beginning of the 21st century also contributed to the financial crisis of 2008. The rapid rise in subprime mortgages took place in the atmosphere of excess liquidity (Dabrowski, 2008). The mortgage situation only exacerbated the existing liquidity risks. Also, the long period of macroeconomic prosperity that preceded the crisis was associated with low interest rates, which further motivated borrowers to take money from the U.S. economy (Legg & Harris, 2008). A belief that property prices would continue to grow also persisted (Legg & Harris, 2008). The illusion of future profits, coupled with lax lending standards, created particularly favourable conditions for the emergence of new crisis risks. At that time, no one could even think that, some day, securitisation would turn out to be a weak guarantee against financial losses and that those losses would be large enough to launch a crisis chain reaction in the global economy.
The first crisis event took place in August, 2007, when the rating of some mortgage-backed securities was downgraded (Hellwig, 2008). Following downgrading was a rapid decrease in the market price of those securities, leading to considerable fluctuations in the U.S. stock market (Hellwig, 2008). Numerous financial institutions that relied on mortgage securities as a source of liquidity and future profits faced considerable solvency losses, which prevented them from fulfilling their obligations. Subprime lenders in the U.S. began bankruptcy procedures, and the new crisis gradually transferred from the property to the financial market (Legg & Harris, 2008). As a result of the subprime mortgage crisis, billions of dollars were written down by investment and financial institutions in security losses. The stability of the U.S. financial and economic systems was severely undermined. The wave of crisis reached the remotest corners of the global economy. The crisis of 2008 could have been readily avoided, had U.S. lenders been more responsible in their economic decisions and actions.
To sum up, the crisis of 2008 was a result of financial greed, combined with lax credit standards, excess liquidity, and government inactivity. After a long period of economic prosperity, the key players of the financial and property markets were simply unwilling to recognise the risky nature of their activities and decisions. The subprime mortgage bubble grew out of the enormous securitisation of mortgages, followed by their depreciation and the loss of financial solvency. The crisis could have been easily avoided, had U.S. financial institutions been more reasonable building their revenue-generation schemes.
- Dabrowski, M. (2008). The global financial crisis: Causes, anti-crisis policies and first lessons. CESInfo Forum, 9(4), 28-32.
- Hellwig, M. (2008). The cause of the financial crisis. CESInfo Forum, 9(4), 12-21.
- Legg, M., & Harris, J. (2009). How the American Dream became a global nightmare: An analysis of the causes of the global financial crisis. UNSW Law Journal, 32(2), 351- 390.
