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).

Answer 1

The areas that were the primary causes of crisis of 2008-09 were deregulation, reckless speculation etc.

The subprime mortgage crisis originated in USA with the bursting of the housing market and the contraction of the financial market in USA.

The causes were as follows:

Due to a reduction in the federal funds rate, the banks were able to lend at cheap rates of interest. This led to lending to both the high and low risk customers, which was earlier limited to only low risk ones. This encouraged the consumers to buy homes which were at a high increase due to the concept of everyone owning a house. This led to the prices of houses being higher than their face value.

There was huge about of loans being given to risky consumers, higher risky speculations and people started borrowing more and more based on the prices of their houses which was higher than anticipated.

It was a great option for both the banks and customers. The banks knew that they could sold off the house in case of default and hence engaged in risky ventures. On the other hand ,the banks knew they could rely on the houses in case these loans defaulted.

Also banks had started selling bundles of loans in form of securitization to financial institutions like investors etc. These were mortgage backed securities. These helped banks in a way to reduce the risk and also led to more liquidity to bank. Banks continued to be a part of these risky reckless speculative activities with a belief that they were too big to fail.

All these caused the financial market to collapse leading to a burst in housing market and this led to the financial crisis of 2008.

(You can comment for doubts)