The Subprime Crisis of 2008
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The subprime mortgage crisis was a financial emergency, manifested by a sharp increase in the number of payments on mortgage loans mostly with a high level of risk. A higher incidence of foreclosed property by banks and the fall in prices for securities characterized this period. The banking emergency in the USA marked the beginning of a financial decline in 2007 that soon grew into a global economic challenge. The current paper seeks to explore and analyze the negative effects that the subprime crisis had on the stock, bond and foreign exchange markets in 2008.
Traditionally, the U.S. share of mortgage loans with a high degree of risk was low, but before the nationwide economic emergency, it had increased significantly. Consumers turned to banks because of an attractive floating interest rate. An increase in a share of sub-prime loans was one of the manifestations of a general trend of decline in lending standards, as well as bringing risky products to the market. At that time, consumer crediting became increasingly popular in the USA. The share of the debt rose to 127%, which was largely due to widespread mortgage lending (Rapp 287).
The artificial stimulation of the U.S. economy led to massive loan defaults, as well as the chain of losses and bankruptcies of financial institutions not only in the country, but also in the whole world. The crisis in the American mortgage market grew into a large-scale problem in the global credit sphere that affected international banks negatively. The fall in stock prices was also significant. The manifestation of the crisis was associated with the day, when the largest U.S. mortgage company, the New Century Financial Corporation, engaged in crediting unreliable borrowers, left the New York Stock Exchange, announcing that they expected significant losses from operations, and, therefore, intended to review financial results of the previous months. In April 2007, the lender declared bankruptcy, ceased lending and filed for the protection from creditrs, including such banks as Morgan Stanley, Credit Suisse Group, and the Bank of America (Hagerty, Zuckerman, and Simon).
Over the next few months, dozens of banking institutions suffered losses or collapsed. In summer 2008, the crisis affected investment funds of financial companies that invested in mortgage bonds, such as Bear Stearns, Goldman Sachs, and BNP Paribas. By September 2007, Freddie Mac and Fannie Mae, which accounted for 44% of the entire market, had been also close to bankruptcy (“Emerging Markets”). Therefore, the U.S. government was forced to take them under proper control and nationalize.
Many investment banks ceased to exist. While Bear Stearns was sold to JP Morgan Chase, Merrill Lynch was sold to the Bank of America. Lehman Brothers filed for bankruptcy. Stocks and shares of Morgan Stanley and Goldman Sachs fell by almost half. As a result of the decline, only two independent investment banks continued operating on Wall Street. In the course of time, the nationwide emergency also negatively affected the financial activity of Wells Fargo, JP Morgan Chase, Bank of America, and Citigroup.
Primarily, the bond market suffered from the economic crisis. Therefore, the majority of investors avoided or sold risky assets. They favored safe treasuries that brought them income despite the crisis. The yield on short-term treasury securities fell, and some of them were negative. As investors expressed no confidence in the U.S. financial system, they were ready to cooperate only with the Treasury, since they wanted to get a significant return. Therefore, they refused to invest in any risky company nationwide. At that time, U.S. officials recognized that debt refinancing required the stability of the dollar, attractive rate, crisis management, and economic recovery. Rate cut had to work in the right direction. However, it could also lead to inflation. Due to the depreciation, many countries were ready to reduce the share of their foreign exchange resserves in dollars, contributing to the fall of the U.S. currency. The extreme volatility of exchange rates led to sharp price fluctuations in short-time intervals. The sale of assets caused a rapid dollar decline, and, therefore, the depreciation of reserves only accelerated. However, central banks had reserves in dollars, and, therefore, were tied to the U.S. currency. In addition, its decline significantly reduced export to the United States from Japan and China. The country lost profit, and the strengthening of the euro had a negative impact on the European economy.
The financial crisis of 2007-2008 affected every country significantly. In addition to a considerable shift in exchange rate dynamics, the volume of the market, its volatility, and the structure of operations fundamentally changed. As currency markets have been based on liquidity, standardization of tools and price transparency, the crisis affected the market infrastructure and dominating tendencies significantly. Other countries also suffered from the nationwide financial emergency that ceased adequate functioning of institutions. As an asset class, the currency was rarely traded at that time. In most cases, foreign exchange operations were a result of transactions with stock or interest assets, and served for hedging the cash flow. In 2008, business activities in currency markets could serve as a great example of how customers adapted to the banking crisis and the way institutions were functioning during the emergency.
The economic decline that erupted in the United States had an adverse impact on the entire banking and financial markets. During the rapid growth of real estate prices, people were willing to take mortgages, since an interest could be easily compensated in the course of time. Consumers could resell the house a year later at a higher price, and costs rose annually. The U.S. mortgage crisis occurred in late 2006, and spread to the global economic system, bringing a negative impact on the banking sector and world financial markets.
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