According to research, an economic recession happens at the time when growth declines. In most cases, this happens when there is a reduction in the demand by consumers (Cashell, 2010). This is because as total demand in the economy declines, companies stop escalating, as a result they stop hiring.
With time the situation gets worse and the companies start firing their employees. The level of unemployment rises, purchasing power drops and consumer purchases drop even further and house prices begin to decline. The economic crisis of 2008 had its origin in the U.S. Most economists held responsible the mortgage market for the decline. It is clear that no one knew the worst economic crisis could occur in2008.
The results were severe as the economy was forced to freeze. The freezing of the economy is attributable to the shrinking of profits as well as collapse of several companies that had managed to employ thousands of employees. The market could be answerable although again there should be the main cause that made the problem to spread in the whole mortgage market of the United States, as well as the entire world.
Remarkably, the Lehman’s Brothers had much of its investment in the mortgage market. Though Lehman’s Brothers knew that the sub-prime mortgage market was quite risky for its investment, it is amazing to see Lehman’s Brothers’ bold measure towards investing heavily in the sub-prime mortgage market.
The main target of investing in the sub-prime mortgage market was to capture large profits considering that this market attracted high interest rates. However, the market proved to be risky due to high levels of bondholders defaulting to pay the interest rates and the subsequent principals. The attractive real estate market led to high demands and as a result, house prices went up. Many people called it the housing bubbles.
In this incidence, the rising inflation prices of assets tend to exceed that for incomes making it quite difficult to purchase assets from ones’ income. Specifically, the mortgage market became volatile and predicting the interest was not easy since interest rates could deviate with large margin.
For instance, in a single day, Dow Jones recorded an intra-day range of 1000 basis points the worst intra-day range ever since its inception. Such huge margins were attributed to lack of confidence in the mortgage market forcing many investors to withdraw their stocks in companies that had invested much in the mortgage market especially the sub-prime mortgage market.
People thought that mortgage associated companies were looking forward to make a lot of profits only to be shocked by the instabilities that were later realized in this market. The consequence of the collapse of Lehman’s Brothers was selling some of its units at a lower price. The company tried as much to compensate bondholders though with a lot of difficulties.
Lehman’s Brothers caused mayhem in the economy considering that large financial institutions had corporate stocks with Lehman’s Brothers. The U.S. Federal Reserve was directed by the government to give out a bailout package of 700 billion U.S. dollars to secure other companies that were on the verge of collapsing but very critical to sustaining the economy of the U.S. It is clear that most shareholders lost their shares worth millions of U.S. dollars.
Recalling that Lehman’s Brothers was a multinational financial institution, one could notice that its effects were spread rampantly to other parts of the world. France had a number of Lehman’s units. Asia as well had a number of Lehman’s Brothers business units that were later acquired by various companies abroad. Nevertheless, the large question could be what made Lehman’s Brother to fall leading 1000s loss of jobs and 1,000,000s shares.
This was the heaviest blow to the U.S. for the last 18 years after the fall of one considerably large company, perhaps answers for the fall could be important to assist in avoiding such incidence in the future. The obvious reason was the large investment made by the company in the risky sub-prime mortgage market (Cooper, 2008). Due to much reliance on this profitable but risky market, the company had no option of finding alternatives to defend its position in the market.
However, the company went to another extent of practicing gimmick accounting game in their accounts. Some malpractices that were practiced in their accounting attempted to hide the true financial position and as a result, investors could not make informed and wise investments. All stakeholders including employees, potential and existing shareholders, customers and government had developed much confidence with Lehman’s Brothers financial position.
Little did they know that Lehman’s Brothers was heading towards filing for chapter 11 bankruptcy. The failure of Lehman’s Brothers to pay its debt holders was enough to justify its declaring as bankrupt. At this point, it became fundamental to shut down its operations to pay its creditors with assets at hand, as shareholders shared the remaining part. Nevertheless, the company was not adequately enabled to pay its shareholders plunging them into worth U.S. dollars millions losses.
Other financial institutions that had invested in the mortgage market as well as in Lehman’s Brothers assets as well suffered huge losses while others ceased their operations. The consequence was loss of jobs as well as shares worth U.S. billions of dollars. The total income for the U.S. economy remarkably fell to lower levels. As levels of income of consumers went down, their purchasing power weakened. There was less income to encourage saving as well as investment in the economy.
The manufacturing sector had to reduce the number of employees since the decreased levels of revenue could not sustain all employees. The layoffs in the manufacturing sector further led to much more pressure on the economy. Capital goods were majorly affected as consumers resorted to the purchase of basic goods and services. The ripples were felt in other parts of the world including developing countries such as those of Africa.
To secure the economy from the difficult financial moments, a number of governments chose diverse measures to secure firms in the economy. The U.S. government in particular resorted to giving out bail out packages to financial institutions that were on the verge of collapsing. Other measures included the use of fiscal stimulus, loosening the monetary policy as well as allowing cooperation between international banks.
Effects of Monetary Policies implemented in Reaction to the Crisis
As a result of lack of illustrations in which the central banks applied the composition of their balance sheet in order to involve the cumulative expenditure of the community by impacting credit flows, there is little chronological foundation for assessing the efficiency of credit policy.
Nevertheless, the policies that were implemented by the government concerning the credit policy followed two directions. For instance, in case Fed had established the asset side of its balance sheet to buy debt in the markets it considered dysfunctional, and left unsterilized, the allied increase in the monetary support would have mystified the credit and money establishment influences.
In addition, due to the financial crisis of 2008 that led to the implementation of monetary policies, there were costs linked with the sustaining of money supply, despite the fact that the government gets overall income. For instance, it was claimed that about ninety percent of the money supply was established by the private banking systems and carried interest as a condition of its existence.
The new policy required that all commercial banks to keep only 50% of all deposits they had and therefore the remaining 50% be to be kept with the Federal Reserve. To make the matter worse, Mr. Marriner decided to raise the Federal Reserve requirement to 75%.
Following the increased reserve requirement, majority of commercial banks resorted to tightening their lending capacity in order to avoid situations of liquidity in the bank. Most commercial banks restricted their levels of lending by raising the level of interest rates. This meant that the level of borrowing decreased sharply and as a result, the level of investment as well went down. The policy by the Federal Reserve led to low level of money supply in the economy.
The effects were two and this included reduced level of purchasing power as well as decreased levels of investment. Consequently, many parts of the economy failed to perform well leading to layoffs in various manufacturing industries, which dominated during these periods such as the mining industry. Others claim that the decision by the Great Britain to return Gold Standard at parities was as well the major cause of the crisis
Fiscal Policies
Fiscal policies are financial, economic or monetary plans or strategies put in place to realize certain goals in a given economic set up. Concerning the financial crisis of the year two thousand and eight, there are a number of fiscal policies that had been put in place; the monetary and liquidity policy.
This policy caused banks to have a certain fear in that they were not willing to lend money to other banks and central banks of many countries cut their interest rates which forced them to provide unlimited liquidity to banks as a result (Bernanke, 2009). All the incidences happened because of the rapid fall of the capital markets as a result of the monetary and liquidity instrument fiscal policy implemented earlier on.
The fiscal stimulus policies that had been implanted earlier on also had the biggest effects that brought the world into the two thousand and eight financial crises. Perhaps the implementers had put a lot of efforts and expectations in the policies such that their failure left the implementers with no option in terms of an alternative way out. Thus, the world was left at sake and consequently falling into the financial crisis.
The Effects of the Fiscal Policies implemented in Reaction to the Crisis
The fiscal policies had a lot of negative effects on both people and the general economy. To begin with, the fiscal policies caused negative economic growth as many banks globally feared to lend money even to their fellow bank operators as a result of the policies that had been implemented earlier. Banks feared to lose their money as interest rates fluctuated rapidly. The offering of more liquidity by many central banks did not solve the problem, but it rather worsened it as more fear crept in.
Secondly, the collapse of many banks due to the failure of the implemented fiscal policies caused a lot of uncertainties. Consequently, many banks across the globe restrained from giving out loans. Many countries in the world including the United Kingdom and the United States, experienced high unemployment rates as a result of the failure of the fiscal and monetary policies that did not give out promising results but instead brought negative outcomes.
References
Bernanke, B. (2009). Essays on the great depression. Princeton: Princeton University Press.
Cashell, B. W. (2010). The federal government debt: Its size and economic significance. Congressional research service. Web.
Cooper, G. (2008). The origins of financial crisis: Central banks, credit bubbles, and the efficient market fallacy. New York, NY: Vintage Publishing.