Question

What are two areas that you believe are primary contributors to the '08-'09 financial crisis for both the US and Iceland?

Hello! Please help explain the two areas from an economic standpoint (preferably Macro but anything will do).

Thank you so much!

Answer 1

Any economic phenomena or development is a result of more than one overlapping causes. 2008 financial crisis was a result of the following causes:

1. Sub prime lending: In response to an expected recession is 2001 federal reserve Bank of America reduced the federal funds rate around 11 times. This made it possible for the banks to lend more at less interest rates. Also not only to low risk prime customers but also to high risk sub prine customers which by 2008 defaulted. Related to this was the second reason of the crisis.

Housing bubble: As a result of increaaed availablity of credit housing prices increased. Increased prices made motgage loans profitable for banks even in case of loan defaults. As the banks or the customer itself would sell the property to repay the debt. Banks increasingly offered debt to poor credi or low asset posessing customers. This led to increased Mortgage loans or subprime crisis.

The economic assumption of prices of homes and other securities will never fall caused the crisis.

2. Shadow banking: During the early 2007, in the wake of financial crisis, when traditional banks like LehmanBrothers started failing, institutions unregulated by FDIC came into play to lend more when already recession was coming in because of more money held by the public. This resulted in further fall in prices and increased recessionary tendencies of the economy.