What Caused The 2008 Financial Crisis

Introduction.

The Financial Crisis in 2007/08 brought about the near collapse of the American financial system and by extension the world financial system. It has been calculated that it wiped out more than eleven trillion dollars in house hold income and in household wealth in the United States of America alone. (Angelides, 2011)

While there are many possible causes of the financial crisis, including large capital flows into the American economy from the emerging markets in the 1990s and 2000s, this essay will focus on causes that were internal to the financial system and contributed to the 2007/08 financial crisis. It will endeavour to show that no one single decision, or event in isolation can justifiably be seen as responsible. But rather

Federal regulators would now supervise over the counter derivatives transactions under general safety and soundness standards. The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) had limited authority to assess risks of these derivative transactions. The SEC and CFTC also now administrated a voluntary program where large scale banks and financial institutions dealing in securities and commodities would report, additional information about derivate activities. Information such as, counterparty exposure policies, capital management policies and risk management procedures and controls within institutions. (Sherman,

Capital requirements ensured that a bank had to have a certain amount of capital for each loan issued, this limited the number of loans a bank could have on their books. Lenders began to sell on mortgages to third party financial institutes to increase their capital so that they could issue more loans, there by shifting their source of profit solely to short term fees associated with selling the original mortgages and no longer holding the loans in the long term.

The banks made their home loans more efficient through the securitization process whereby they would bundle many loans into a loan pool which was held by a shell company who used the borrower’s repayments as a revenue stream to create bonds which they could then sell on to investors. These bonds been backed by the underlying mortgages became known as Mortgaged Backed Securities (M.B.S) and were given different ratings related to the level of risk associated with a default on the loan. Securitization not only spread the risk but introduced more capital to the housing market which made mortgages more