Financial CrisisStudent`s NameInstitutional Affiliation
Financial Crisis Financial crisis is discovered when organizations, country, or any other financial assets lose a huge part of their nominal value, which can either be the value on a note like dollar bill or the exact amount of a share and bond at the time of its issuance (Kindleberger & Aliber, 2005). It does not represent the current market price of the share. Moreover, a number of factors related to market value may cause the crises. Notably, financial crisis mostly lead to the loss of paper wealth but does not cause or alter the real economy in most cases. Many theories have been developed by economists to explain the development of financial crisis but none of the theories has helped in preventing it from happening. Causes of Financial Crisis of 2008Deregulation Deregulation is the primary cause of the crisis and occurs when regulations and restrictions in particular firms or industries are removed. According to Kindleberger and Aliber (2005), deregulation in the financial industry allows banks to be involved in hedge fund trading in regard to their derivatives. As a result, the banks demands for more mortgages to finance their profits from the derivatives. Therefore, the banks create loans that are described as “interest-only loans” and are only affordable to the minor subprime vagabonds. Securitization Securitization is a practice where there is bringing together of various types of contractual debt and selling of the cash flows generated from contractual debts to third party investors in the form of security. Contractual debt may is part of residential mortgages. Auto loans also are included in contractual debt. A security backed mortgage is a financial product and its value can be calculated based on the guarantee of the mortgage. More often, acquiring a mortgage from a banking institution, involves selling a hedge fund on the accessory market (Lau & Valencia, 2008). Later, it follows a chain of processes, including calculating the future value of the mortgage before selling it as a loan to the investors. Securitization causes financial crisis – investors takes all the risk of default because they have no worry concerning the risk as they have been backed up with insurance. Result of the Crisis World Wide Financial crisis deter economic growth of both developed and developing countries. The developed countries are not shaken, in a significant way, by financial crisis as compared to developing countries. Particularly, the developing countries rely on developed countries for support, which is cut of when these developed countries are experiencing economic crisis. Systematic Risk Systematic risk can be defined as the uncertainty inherent to all of market segment. It is made of the daily fluctuations in the market. Moreover, it can be represented using interest rates, wars, and recession, as the sources (Fratianni & Marchionne, 2009). The only way to avoid systematic risk is through hedging.Conclusion Economists have developed many theories to explain the development of financial crisis but none of them has helped in preventing it from happening. Practically, the financial crisis was caused by the creation of too much money by the banks. The money was used to implement house prices and speculation of the financial markets, which has led to accumulation of debt. The accumulation caused a financial crisis, when the debt was not able to be paid.
ReferencesCharles P. Kindleberger and Robert Aliber (2005). Manias, panics, and crashes: A History of financial crises. 5th ed. Wiley, ISBN 0-471-46714-6.Fratianni, M. and Marchionne, F.(2009). The role of banks in the subprime financial crisis available on SSRN. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1383473Luc Laeven and Fabian Valencia (2008). Systemic banking crises: A new database. International Monetary Fund Working Paper 08/224.