The 2007 to 2011 Financial Crisis Causes, Effects and Lessons
This cardboard provides a abrupt assay of the actual causes and furnishings of the 2007 cyberbanking crisis, as able-bodied as an overview of acquaint abstruse from it. I achieve that abortion to appropriately adapt and administer cyberbanking institutions set the date for the crisis, while the US residential mortgage bang and apprehension triggered it. A acclaim freeze, bankruptcies, and hundreds of billions in government accomplishment ensued, consistent in a accepted bread-and-butter downturn. The bequest of the crisis should be credible as an befalling to alter the cyberbanking arrangement as a whole.
The cyberbanking crisis that started in 2007 is the aftereffect of complex, interconnected, and accompanying developments. As such, I focus my assay on the United States and two audible absolute causes: (1) erroneous coffer adjustment – which destabilized the cyberbanking arrangement – and (2) the pre-crisis absolute acreage bang and bust. Whereas the above conditioned the crisis, the closing was its catalyst. In this abrupt essay, I altercate alone the best important and actual furnishings of the crisis – those that emerged amid 2007 and 2012 – and altercate the abstracts that can be fatigued accordingly.
1. Adjustment destabilized the cyberbanking system
Regulation of US banks by the Fed, SEC, and FDIC, as able-bodied as alternative authoritative agencies, contributed decidedly to the abrasion of cyberbanking arrangement adherence (Barth, Caprio and Levine, 2012, p.86). For example, in 1996, the Fed legitimized the use of Acclaim Absence Swaps (CDS) as risk-hedging instruments (Levine 2010, p. 202, Appendix 1) and as a aftereffect abounding banks developed massive exposures (Figure 1) – AIG captivated over $500 billion in 2007 – while others were able to abate their basic affluence by up to bisected in allotment agreement (Barth, Caprio and Levine, 2012, p.92).
Figure 1: CDS bazaar aggregate Q1 2001 to Q2 2007, abundance US$
(International Antithesis and Derivatives Association cited in Baily, Litan and Johnson, 2008)
Another archetype is the SEC’s use of the “NRSRO” designation, which led to a austere misalignment of acclaim appraisement agencies’ business incentives and resulted in inflationary accoutrement of investment-grade ratings for chancy securities. This added attenuated the activity of banks’ antithesis bedding (see Appendix 2).
1.1 Residential mortgage bang and bust
Simultaneously, the US residential absolute acreage balloon (inspired by the acceptance that apartment prices would alone go up) fueled boundless arising of home mortgages (Figure 2). In turn, ailing lending practices, abnormally in sub-prime mortgage lending, bolstered apartment prices by accusation demand, while bushing institutions’ antithesis bedding with anonymous blow (Barth 2009, p.92). The affability of mortgages as “fail-safe” investments prompted abounding banks to about-face their business archetypal from “originate-to-hold” to “originate-to-sell”; instead of affairs mortgages as an advance that generated a abiding banknote flow, banks securitized and awash them (Barth 2009, p.22). This finer removed any allurement to assay and ascendancy risk. However, this “out-of-sight-out-of-mind” mentality did not annual for the actuality that banks that securitized mortgages and invested in mortgage-backed antithesis (MBS) were generally identical. Thus, blow was absent from antithesis sheets, but around present in antithesis backing (Appendix 3).
Figure 2: S&P-Shiller apartment prices basis (monthly), January 2001 to August 2012
(Standard & Poor’s Cyberbanking Services LLC, 2012)
The bizarre arrangement of securitization faltered back apartment prices started to abatement and mortgage borrowers defaulted (Figure 3). This broiled up the banknote breeze of mortgage-backed antithesis and fabricated them around worthless; banks that relied on them to accommodated their obligations encountered trouble. Moreover, circuitous securitization practices fabricated the admeasurement of any one institution’s acknowledgment anyone’s guess. Since, no one could be assertive which banks would alive to see accession day, interbank lending froze. In short, not alone did cyberbanking institutions access abandoned assets, but they were additionally clumsy to arch shortages in banknote (Figure 4). In addition, accumulation defaults activated billions of dollars in CDS obligations and bankrupted all who were over-exposed.
Figure 3: Increase of crime ante (percent) of subprime loans amid 2003 and 2007
(Arentsen, Mauer, Rosenlund, Zhang and Zhao, 2012, p.39)
Figure 4: Increase of the Federal Funds amount (percent, monthly) indicates interbank lending crisis
(Federal Reserve Coffer of St. Louis, 2012)
2. Cyberbanking collapse and bread-and-butter downturn
The actual furnishings of the crisis are able-bodied known. Banks ahead advised untouchable filed for defalcation (e.g. Lehmann Brothers), while others were acquired (Merrill Lynch by Coffer of America), bailed-out, or taken over by the government (AIG and the GSEs Fannie Mae and Freddie Mac). Soon, the acclaim benumb afflicted the actual abridgement as costs investments and borrowing became added difficult. For example, amid 2007 and 2009, about 8.8 actor American jobs disappeared, U.S. GDP fell by added than bristles percent from its pre-recession aiguille (Treasury 2012), and the S&P 500 absent about 57 percent of its amount (Lleo and Ziemba, 2011). Perhaps best famously, after authoritative assistance, American auto manufacturers GM and Chrysler would accept become bankrupt (Stewart 2012). Yet accession bequest amount is the astronomic government debt that resulted from rescues and alternative bread-and-butter resuscitation programs (Barth 2009).
The crisis advance internationally (and best damagingly to Europe) because abundant accommodation derivatives were awash abroad. This does not betoken that the U.S. is to accusation for the crisis; every government had admission to the aforementioned advice as Fed, SEC, and FDIC, yet about all bootless to admit and abode the systemic botheration (Cox, Faucette and Lickstein, 2010).
Mostly importantly, the crisis credible the colossal abortion of coffer regulators, and prompted a axiological restructuring of cyberbanking adjustment (such as the 2010 Dodd-Frank Act). In addition, the boundless complication and behemoth admeasurement of the cyberbanking arrangement accept appear beneath acute scrutiny. An important catechism has emerged from this examination, which asks, because TARP, are some cyberbanking institutions “too big to fail?” (Greeley 2012). Moreover, the crisis has spawned a reexamination of the agreeableness of “laissez-faire” aural the cyberbanking markets – that is, to what amount can bazaar armament be relied aloft to avoid crises (Barth, Caprio and Levine, 2012, p.90)?
The cyberbanking crisis that began in 2007 still troubles us today. While some cyberbanking institutions accept collapsed, those that abide accept had to fundamentally amend their role as acclaim providers. Governments were larboard with amazing cyberbanking commitments, tasked with deconstructing the moral hazard of coffer bailouts, and with acclimation and authoritative the cyberbanking arrangement added efficiently. History has credible us that cyberbanking crises are a alternate occurrence. Appropriately the catechism charge be, can the aeon be broken, or is the abutting crisis cat-and-mouse in the wings?
Arentsen, E., Mauer, D.C., Rosenlund, B., Zhang, H.H., Zhao, F., 2012. Subprime Mortgage Defaults and Acclaim Absence Swaps. [pdf] University of British Columbia Sauder School of Business. Available at: [Accessed 25 November 2012].
Baily, M.N., Litan, R.E. and Johnson, M.S., 2008. The Origins of the Cyberbanking Crisis. [online] Brookings Institution. Available at: [Accessed 25 November 2012].
Bank of International Settlement (BIS), 2012. Detailed tables on semiannual OTC derivatives statistics at end-June 2012. [online] Available at: [Accessed 26 November 2012].
Barth J.R., 2009. The Rise and Fall of the U.S. Mortgage and Acclaim Market. Hoboken, New Jersey: John Wiley & Sons, Inc.
Barth, J.R., Caprio, G. and Levine, R., 2012. Guardians of Finance, authoritative regulators assignment for us. Cambridge, Massachusetts: The MIT Press.
Barth, J.R., Caprio, G. and Levine, R., 2012. Rethinking Coffer Regulation, till angels govern. New York, New York: Cambridge University Press.
Congressional Budget Office, 2012. Report on the Troubled Asset Relief Program—October 2012. [pdf]. Available at: [Accessed 25 November 2012].
Cox, J., Faucette, J. and Lickstein, C.V., 2010. Why Did the Acclaim Crisis Advance to Global Markets[pdf] The University of Iowa Center for International Finance and Development. Available at: [Accessed 25 November 2012].
Federal Reserve Coffer of St. Louis, 2012. Effective Federal Funds Amount (FEDFUNDS). [online] Available at: [Accessed 26 November 2012].
Greeley, B., 2012. The Price of Too Big Too Fail. Bloomberg Businessweek, [online] Available at: [Accessed 26 November 2012].
Jickling, M., 2009. Causes of the Cyberbanking Crisis. [online] Congressional Research Service. Available at: [Accessed 25 November 2012].
Kohn D.L., 2010. The Federal Reserve’s Policy Actions during the Cyberbanking Crisis and Acquaint for the Future. [online] Board of Governors of the Federal Reserve System. Available at: [Accessed 25 November 2012].
Levine, R., 2010. An dissection of the US ?nancial system: accident, suicide, or behindhand homicide, Journal of Cyberbanking Bread-and-butter Policy. [online] Available at: [Accessed 25 November 2012].
Lleo, S. and Ziemba, W.T., 2011. Stock Bazaar Crashes in 2007-2009: Were We Able to Predict Them[pdf] Available through Social Sciences Research Network website [Accessed 25 November 2012].
Pagliari, S. and Young, K.L., 2012. Leveraged Interests: Cyberbanking Industry Power and the Role of Private Sector Coalitions. [pdf] Available at: [Accessed 25 November 2012].
Standard & Poor’s Cyberbanking Services LLC, 2012. S&P Dow Jones Indices. [online] Available at: [Accessed 25 November 2012].
Stewart, J.B., 2012. Back Debating the Auto Bailout, Consider Lehman’s Fate. The New York Times, [online] 9 March. Available at: [Accessed 25 November 2012].
U.S. Department of the Treasury, 2012. The Cyberbanking Crisis Response In Charts [pdf] Available at: [Accessed 26 November 2012].
A CDS is a acquired that enables the client to affirmation advantage from the agent if the basal asset (such as a Mortgage Backed Antithesis or MBS) defaults. While advantageous for ambiguity purposes and as appraisal apparatus for acclaim blow (a ascent CDS exceptional indicates accretion blow for the basal asset), it can be abolished for abstract investing, as it does not crave the client (or the seller) to absolutely authority the basal asset.
The SEC appropriate every issuer of a new aegis to access a blow appraisement from a NRSRO in adjustment to accredit abeyant buyers to appraise its blow and acquiesce regulators to actuate basic requirements (which were based on risk-adjusted assets). Those acclaim appraisement agencies advantaged abundant to accept accustomed NRSRO appellation (namely the big three, S&P, Moody’s, and Fitch) boring realigned their business models to board issuers’ needs to acquirement ratings by incentivizing advisers to affair AAA ratings in adjustment to abound the chump base. As a result, 56 percent of MBS issued amid 2005 and 2007 and rated by S&P were eventually downgraded (Barth 2009, p.156).
A accepted convenance in the forerunner to the crisis was to amalgamation mortgage loans into asset-backed antithesis (ABS, best notoriously, collateralized debt obligations or CDOs) and alternative antithesis according to tranches. These tranches were associated with altered degrees of blow in adjustment to baby to altered investors. Oftentimes, ABS were re-packaged into CDOs boxlike and cubed. The accepted delusion prevailed that this would abate blow by overextension it. In the deathwatch of the crisis, with absence ante skyrocketing, it became credible that this arrangement had become too circuitous for anyone to unravel, appropriately authoritative any acknowledgment appraisal impossib
Order a unique copy of this paper