Question

A short background of the Global Financial Crisis and the main reasons behind it, that led to changes in financial regulations.

Answer 1

Global Financial Crisis:

After stock market crash of 1929, it was the most damaging Financial Crisis. Starting with mortgage lending problem in 2007 that expanded with a global crisis in banking with the Collapse of Lehmann Brothers in the September of 2008. Since then global regulation of financial sector and its associated compliances processes have tried to adapt to prevent from any further future crisis. Many measures were taken into consideration to limit spreading of the damage being happening and then global economy failed into a great recession.

1) Loosened Lending Standards

The crisis was the result of a sequence of events. The seeds of the crisis were sown as far back as the 70s of 20^th centuary with the Community Development Act(1974). This required banks loosening up their credit requirements for consumers with below average income, creating a market for subprime mortgages.

Out of the many forms of crisis, include a credit panic or a crash of stock market , but it differs from a recession, which is generally the result of all such a crises.

The net amount of subprime mortgage debt guaranteed by Freddie Mac and Fannie Mae, remained into expansion until early 2000s, when Reserve Board of Fed began to drop interest rates drastically to avoid a great recession. The mixture of loose requirements of credit and cheap money increased demand for houses and then caused a real estate bubble.

2) Complexity of Financial Instruments

In the meantime, the investment banks, in search of easy profit solution created collateralized debt obligations (CDOs) from the mortgages purchased on the secondary market because of the dotcom bubble(Due to technological advancement) and recession of 2001 . Because of pairing/bundling of subprime and prime mortgages there was no way for investors to know what is the risk associated with the product. When the market for CDOs began to agitate, the housing bubble finally burst up(that had been building now for several years). Now subprime borrowers began to thrive on loans that were worth more than their homes(because housing prices just fell down), hence accelerating the decline in prices .

The only solution from Fed to this situation was by lowering the interest rates about to zero.

• Buy back mortgage
• Buy back government debts
• Bailing out of some of the financial institutions which were struggling

Now as the interest rates became very less the return on bonds went down and was much less attracting to investors as compared to stock prices and returns(including the risks it has). So response from government lit up stock market in a 10 years competition with s&p 500 returning 250% over that time period.

The U.S. housing market recovered in most major cities but the unemployment rate fell down as businesses began to hire and make more & more investments.