Financial Crisis 2008 -causes and effect

 I am going to try to answer this question as simply as possible... so basically a financial crisis is caused when money is not circulated well in an economy (or country) and when this happens everywhere in the world, it is called 'global financial crisis'. 

Say for instances you didn't have a job, then you wouldn't earn money to buy your day to day products, when you don't buy these things the companies that sells them don't get your money, when that happens those companies have all these products which they have manufactured and cant sell, so they tend to suffer losses and shut down the company, when that happens all the people working in the company loss their jobs as well... so now there are 10000 other people like you who don't have a job and this cycle keeps on going. At the end of it nobody has any money to buy things (therefore no demand) and if there is no demand then companies can't sell anything.

Nothing good comes out of anything that has the word 'crisis' in it... the bad thing is people get broke, loose jobs, dont have money, people dont pay taxes, government doesn't get money to fund for the welfare of its people, companies shut don't, banks shut don't etc and we go into a state of poverty.

The 2008 GFC was caused when people in America started taking bank loans (huge loans) to buy houses and then couldn't pay back the loans to the bank thereby starting the cycle I mentioned above. When I say people I don't mean like 100 people, I mean like a huge chunk of population. Also this was caused over a period of 10 to 15 years. Now, since America is such a strong economy when America was in a financial crisis it affected import and export to other countries (stopping the circulation of money in and out of those countries as well)

A Few causes are

1. Uncontrolled Lending to customers with poor credit history
2. Too much leverage provided by complex derivative products
3. The Real estate market crash

GREED.
The U.S. has the most influential economy because the dollar is the standard of international exchange. A sudden contraction of the money supply ( the Federal Reserve is the only institution capable of doing this ) caused an economic crisis in the U.S. and there was a ripple effect throughout the world because so many other countries are holding U.S. dollars in their reserve.
To be quite honest without a doubt the crash of the housing market was the biggest cause.Low interest rates played a big part in dragging people in with a poor credit history who really in the eyes of the banks couldn't pay their loans off but were still given them.Also too much deregulation and the banks and business' being able to do pretty well whatver they wanted even playing with future predicted earnings on the stock market that never actually came in, also contributed in a large way to the financial collapse when companies could not afford to pay their workers and the debts that they owned to the banks and to other companies causing them to go into negative liquidity and since the banks themselves weren't lending money anymore,in many respects because they didn't have it anymore caused more and more companies and people to forfeit on their payments and debts causing a large downward spiral!

The effects of this economic meltdown are:

1. Banks have incurred huge losses. Their earnings came down.
2. Financial institutions have gone bust or have been taken over by bigger organizations
3. The housing prices have plummeted
4. The liquidity in the financial system has come down
5. High unemployment
etc. 

Recession happens when growth is negative for successive two quarters.

DEFINITION of 'Collateralized Debt Obligation - CDO'

A structured financial product that pools together cash flow-generating assets and repackages this asset pool into discrete tranches that can be sold to investors. A collateralized debt obligation (CDO) is so-called because the pooled assets – such as mortgages, bonds and loans – are essentially debt obligations that serve as collateral for the CDO. The tranches in a CDO vary substantially in their risk profile. The senior tranches are relatively safer because they have first priority on the collateral in the event of default. As a result, the senior tranches of a CDO generally have a higher credit rating and offer lower coupon rates than the junior tranches, which offer higher coupon rates to compensate for their higher default risk.

As many as five parties are involved in constructing CDOs:

• Securities firms, who approve the selection of collateral, structure the notes into tranches and sell them to investors;
• CDO managers, who select the collateral and often manage the CDO portfolios;
• Rating agencies, who assess the CDOs and assign them credit ratings;
• Financial guarantors, who promise to reimburse investors for any losses on the CDO tranches in exchange for premium payments; and
• Investors such as pension funds and hedge funds.

The earliest CDOs were constructed by Drexel Burnham Lambert – the home of former “junk bond king” Michael Milken – in 1987 by assembling portfolios of junk bonds issued by different companies. Securities firms subsequently launched CDOs for a number of other assets with predictable income streams, such as automobile loans, student loans, credit card receivables and even aircraft leases. However, CDOs remained a niche product until 2003-04, when the U.S.

What happened: scenarios

Bear Stearns: absorbed by JPMorgan Chase with help from the Federal Reserve. Lehman Brothers:gone. Fannie Mae and Freddie Mac: taken into government oversight. Merrill Lynch: absorbed by Bank of America. AIG: given an $85 billion lifeline by the Federal Reserve and sold off in parcels to financial institutions around the world. Wachovia: taken over by Wells Fargo. Washington Mutual: taken over by JPMorgan Chase. Morgan Stanley: 20 percent bought by Mitsubishi, a large Japanese bank. These are some of the events in the financial crisis of 2008. What was going on and how can a replay be avoided? Between 2002 and 2005, mortgage lending exploded and home prices rocketed. Mortgage lenders bundled their loans into mortgage-backed securities and sold them to eager buyers around the world. When interest rates began to rise in 2006 and asset prices fell, financial institutions took big losses. Some losses were too big to bear and big-name institutions failed.

Pension Funds:  Pension funds are financial institutions that use the pension contributions of firms and

workers to buy bonds and stocks. The mortgagebacked securities of Fannie Mae and Freddie Mac are

among the assets of pension funds. Some pension funds are very large and play an active role in the

firms whose stock they hold.

Insurance Companies:  Insurance companies enable households and firms to cope with risks such as accident, theft, fire, ill-health, and a host of other misfortunes. They receive premiums from their customers and pay claims. Insurance companies use the funds they have received but not paid out as claims to buy bonds and stocks on which they earn interest income. In normal times, insurance companies have a steady flow of funds coming in from premiums and interest on the financial assets they hold and a steady, but smaller, flow of funds paying claims. Their profit is the gap between the two flows. But in unusual times, when large and widespread losses are being incurred, insurance companies can run into difficulty in meeting their obligations. Such a situation arose in 2008 for one of the biggest insurers, AIG, and the firm was taken into public ownership.

In the hope of avoiding a replay, Congress has enacted the Restoring American Financial Stability Act

of 2010. The main points of the Act are

■ A Consumer Financial Protection Agency to enforce consumer-oriented regulation, ensure that

the fine print on financial services contracts is clear and accurate, and maintain a toll-free hotline

for consumers to report alleged deception.

■ A Financial Services Oversight Council to anticipate financial market weakness.

■ Authority for the Federal Deposit Insurance Corporation to seize, liquidate, and reconstruct

troubled financial firms.

■ Tight restrictions to stop banks gambling for their own profits and limit their risky investments.

■ Mortgage reforms that require lenders to review the income and credit histories of applicants and

ensure they can afford payments.

■ Require firms that create mortgage-backed securities to keep at least 5 percent of them.

The 2010 Act does nothing to solve the problem that Fannie and Freddie remain under government oversight. Many people believe that the measures are too timid and leave the financial system fragile.

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