Financial crisis (2007–present) From Wikipedia, the free encyclopedia The financial crisis from 2007 to the present is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.[1] It was triggered by a liquidity shortfall in the United States banking system,[2] and has resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity.[3] Many causes for the financial crisis have been suggested, with varying weight assigned by experts.[4] Both market-based and regulatory solutions have been implemented or are under consideration,[5] while significant risks remain for the world economy over the 2010–2011 period.[6]
Contents 1 Overview 2 Background 2.1 Growth of the housing bubble 2.2 Easy credit conditions 2.3 Weak and fraudulent underwriting practice 2.4 Sub-prime lending 2.5 Predatory lending 2.6 Deregulation 2.7 Increased debt burden or over-leveraging 2.8 Financial innovation and complexity 2.9 Incorrect pricing of risk 2.10 Boom and collapse of the shadow banking system 2.11 Commodities boom 2.12 Systemic crisis 2.13 Role of economic forecasting 3 Financial markets impacts 3.1 Impacts on financial institutions 3.2 Credit markets and the shadow banking system 3.3 Wealth effects 3.4 European contagion 4 Effects on the global economy 4.1 Global effects 4.2 U.S. economic effects 4.3 Official economic projections 4.4 2010 European sovereign debt crisis 5 Responses to financial crisis 5.1 Emergency and short-term responses 5.2 Regulatory proposals and long-term responses 5.3 United States Congress response 6 Media on the crisis 7 Stabilization 8 Predictions for a second wave of the financial crisis 9 See also 10 References 11 External links and further reading
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Overview The collapse of the U.S. housing bubble, which peaked in 2006, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally.[7] Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during late 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined.[8] Critics argued that credit rating agencies and investors failed accurately to price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st-century financial markets.[9] Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts.
Background The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006.[10][11] Already-rising default rates on “subprime” and adjustable rate mortgages (ARM) began to increase quickly thereafter. As banks began to increasingly give out more loans to potential home owners, the housing price also began to rise. In the optimistic terms the banks would encourage the home owners to take on considerably high loans in the belief they would be able to pay it back more quickly overlooking the interest rates. Once the interest rates began to rise in mid 2007 the housing price started to drop significantly in 2006 leading into 2007. In many states like California refinancing became more difficult. As a result the number of foreclosed homes began to rise as well. Steadily decreasing interest rates backed by the U.S Federal Reserve from 1982 onward and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption.[13] The combination of easy credit and money inflow contributed to the United States housing bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.[14][15] As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and Share in GDP of U.S. financial sector since 1860[12] investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.[16] While the housing and credit bubbles built, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialization. U. S. Government policy from the 1970s onward has emphasized deregulation to encourage business, which resulted in less oversight of activities and less disclosure of information about new activities undertaken by banks and other evolving financial institutions. Thus, policymakers did not immediately recognize the increasingly important role played by financial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations.[17] These institutions, as well as certain regulated banks, had also assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses.[18] These losses impacted the ability of financial institutions to lend, slowing economic activity. Concerns regarding the stability of key financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial 19