This leads to interruptions in aneconomy through; banks and other financial institutions function as financial intermediaries,changes in asset price volumes and national credit, interven
Background of the financial crisis in 2008
Finance is an important part of a country's economy, which is the basis for accurately assessing the level of economic development Along with the global economic development are opportunities for the development of the global financial system, but at the same time, there are many potential risks of crisis.
The financial crisis is one of the leading challenges for countries The financial crisis has wrap many countries into its spiral, causing a lot of strong impacts on the economy, society and politics of each country and each region.
Purpose of the research
An overview study of the concept of financial crisis, focusing on the most severe crisis:
2008 financial crisis The study clearly distinguishes between the concept of economic crisis and financial crisis, understanding the causes and its effects on the world economy Then relate to the Vietnamese economy, find out how it affects the national economy.
What is the difference between a financial crisis and an economic crisis?
Meaning of Financial crisis
This is a situation whereby the financial assets’ values fall rapidly in an economy Due to this, assets decline in value, consumers are unable to pay their debts and financial institutions are faced with liquidity shortages, causing economic instability This leads to interruptions in an economy through; banks and other financial institutions function as financial intermediaries,changes in asset price volumes and national credit, intervention by the government in recapitalization, and efforts by all stakeholders to increase liquidity
Meaning of Economic crisis
This is a situation whereby a country experiences a sudden downturn due to a financial crisis This results in a drying up of liquidity, a high rate of unemployment, low production levels, a falling GDP, and economic fluctuations as a result of deflation or inflation An economic crisis can be in the form of a depression or a recession.
An economic crisis can be caused by; huge scale mismanagement of scale, mismatch of assets by financial institutions, the sudden decline in the values of securities and stocks.
An economic crisis has a negative impact on the general public, financial institutions, and the entire economy An increased unemployment rate negatively impacts the living conditions in an economy.
Differences between Financial crisis and Economic crisis
While a financial crisis occurs when the prices of financial assets in an economy fall fast, an economic crisis occurs when a country faces a precipitous decline as a result of a financial crisis.
The financial and banking industries are immediately impacted by the financial crisis An economic crisis, on the other hand, has a direct impact on all economic activity in a country.
Uncontrolled and unanticipated consumer behavior, regulatory and systemic failures, and high-risk incentives are all variables that contribute to a financial crisis High interest rates, a decline in consumer expenditure, a high unemployment rate, and a financial crisis, on the other hand, are contributing elements to an economic crisis.
Types of the financial crisis
Currency Crisis
While other sorts of crises have developed through time, so have the theories surrounding currency crises, which are frequently more explicitly described The literature, in particular, has changed from emphasizing the basic causes of currency crises to stressing the potential for numerous equilibria and the importance of financial variables, particularly changes in balance sheets, in precipitating currency crises (and other types of financial turmoil) Currency crises that have occurred during the previous 40 years are often explained using three generations of models These models are known as "KFG" models since they are based on important papers by Krugman (1979) and Flood and Garber (1984) They demonstrate how rational investors who properly predict that a government has been running large deficits financed by central bank credit can cause a surprise speculative attack on a fixed or pegged currency When investors believe that the exchange rate regime will remain in place, they keep holding the currency But, when they believe that the peg is going to terminate, they start selling it The central bank swiftly loses its liquid assets or the hard foreign money that supports the exchange rate as a result of this run After then, the currency falls The significance of many equilibria is emphasized by the second generation of models
These models demonstrate that uncertainty regarding a government's willingness to uphold an exchange rate peg could result in various equilibria and currency crises (Obstfeld and Rogoff, 1986) These models allow for the possibility of self-fulfilling prophecies, in which investors attack the currency because they anticipate other investors doing the same According to Flood and Marion (1997), changes in policies in response to a potential attack (even if these policies are compatible with macroeconomic fundamentals) can result in an attack and be the catalyst for a crisis In contrast, policies prior to the attack in first-generation models can translate into a crisis The European Exchange Rate Mechanism Crisis, which impacted nations like the UK in 1992, served as a major inspiration for the second generation of models, even though other outcomes (that were consistent with macroeconomic fundamentals) were also conceivable (see Eichengreen, Rose, and Wyplosz (1996), Frankel and Rose (1996))
The third generation of crisis models looks at how rapidly degrading balance sheets brought on by changes in asset values, particularly exchange rates, can result in currency crises. The Asian crises in the late 1990s served as a major inspiration for these models. Macroeconomic imbalances in Asian nations were minimal prior to the crisis; fiscal situations were frequently in surplus and current account deficits were thought to be manageable; nonetheless, the banking and corporate sectors had significant vulnerabilities Simulations demonstrate how imbalances in these sectors' balance sheets might lead to currency crises For instance, Chang and Velasco (2000) demonstrate how a banking currency crisis may occur if local banks have significant amounts of outstanding debt denominated in foreign currency The models of this generation also take into account the functions that banks play and how crises tend to self-fulfill Government subsidies, according to McKinnon and Pill (1996), Krugman
(1998), Corsetti, Pesenti, and Roubini (1998), maybe the cause of banks' excessive borrowing (to the extent that governments would bail out failing banks) Moreover, overborrowing-related vulnerabilities might result in currency crises Fiscal worries and erratic real exchange rate fluctuations, according to Burnside, Eichenbaum, and Rebelo (2001 and 2004), can make crises self-fulfilling (where the banking system has a government guarantee, a good or poor equilibrium may occur).
In a broader sense, Radelet and Sachs (1998) contend that self-fulfilling panics that affect financial intermediaries can compel asset sales, which subsequently confirm the panic and trigger a currency crisis Which generation of these models best describes currency crises has not been distinguished by empirical investigation KFG model early work had good success. For instance, Blanco and Garber (1986) used the KFG model to analyze the 1976 and 1981–
1982 Mexican devaluations and found that crisis probability peaked right before the devaluations (Cumby and van Wijnbergen (1989) and Klein and Marion (1994)) Yet, while the KFG model performed well when macroeconomic fundamentals grew rapidly and money demand was unstable, it did not operate well when fundamentals were merely very variable. Subsequent empirical research abandoned explicit structural model testing Other research (Eichengreen, Rose, and Wyploz (1996), Frankel and Rose (1996), Kumar et al (2003)) used censored dependent variable models, for example, Logit models, to predict crisis probability based on a wide variety of lagged variables Others, including Kaminsky, Lizondo, and Reinhart (1998) and Kaminsky and Reinhart (1999), used signaling models to assess the value of various characteristics in predicting an imminent crisis The results of this literature have been disappointing despite the fact that some indicators have a tendency to be linked to crises(see Kaminsky, Lizondo, and Reinhart (1998) for an early review, Kaminsky (2003) for an update, and Frankel and Saravelos (2012) for a comprehensive recent survey up to the 2000s).Later, we shall talk about crisis prediction again.
Foreign and Domestic Debt Crises
Theories of foreign debt crises and default are inextricably tied to those of sovereign lending.
When a country, or at least a sovereign, refuses to meet its debt obligations, lenders cannot collect collateral from that country Without an enforcement mechanism, i.e., a domestic equivalent of bankruptcy, economic rather than legal considerations are required to explain why foreign (sovereign) financing exists at all As a crude approximation, models developed rely on either intertemporal or infratemporal punishments Intertemporal penalties develop as a result of the fear of future lending being cut off if a government defaults (Eaton and Gersovitz, 1981). With no access (forever or for a limited period), the country can no longer use foreign financial markets to moderate idiosyncratic income shocks Even if there are no immediate, direct costs to default, this cost may persuade the country to continue making debt payments today.
Infratemporal sanctions can result from a country's inability to generate foreign exchange today because trading partners implement sanctions or otherwise exclude it from international markets, either permanently or temporarily (Bulow and Rogoff, 1989a) Both forms of costs can support a certain amount of sovereign lending (for reviews, see Eaton and Fernandez, 1995; Panizza, Sturzenegger, and Zettelmeyer, 2009) According to these models, inability or unwillingness to pay, i.e., default, can be caused by a variety of causes Government debt repayment incentives differ from those faced by firms and people in the domestic sector They also differ between models In the intertemporal model, a country defaults when the opportunity cost of never being able to borrow again is low, presumably when trade terms are excellent and are expected to remain so (Kletzer and Wright, 2000) Under the infratemporal sanction model, however, the costs of a trade cutoff may be the lowest when the terms of trade are poor Indeed, Aguiar and Gopinath (2006) show how, in a model with persistent shocks, countries default to smooth consumption in hard times As a result, the models have varied consequences for a country's borrowing capability Such models, however, are unable to adequately account for why sovereigns default and creditors lend so much Several models predict that default will not occur in equilibrium because creditors and borrowers will avoid the deadweight costs of default by renegotiating debt payments While some models have been adjusted to mimic actual default experiences, models frequently underestimate the likelihood of actual defaults Importantly, as most models anticipate, countries do not always default when circumstances are tough: According to Tomz and Wright (2007), output was below trend in only 62% of default scenarios Models also overestimate investors' willingness to lend to countries despite high default risk
Furthermore, changes in the institutional framework, such as those implemented following the 1980s debt crises, do not appear to have altered the relationship between economic and political variables and the likelihood of a debt default This shows that models continue to fall short of capturing all of the information required to explain defaults (Panizza, Sturzenegger, andZettelmeyer, 2009) Although domestic debt crises have occurred throughout history, they have garnered little attention in the literature until lately Domestic debt crises play a minor significance in economic theory since models frequently assume that governments always respect their domestic debt obligations—the common assumption is of "risk-free" government assets Models frequently assume Ricardian equivalence, which reduces the importance of government debt Recent historical assessments (Reinhart and Rogoff, 2009a) reveal that few governments were able to avoid default on domestic debt, with often negative economic implications This frequently occurs as a result of the abuse of the government's monopoly on currency issuance In the late 1770s, the United States suffered a rate of inflation close to 200 percent This category also includes hyperinflationary times in certain European countries following World War Two Currency breakdowns are frequently followed by debt defaults in the form of inflation Historically, countries would "debase" their currency by lowering the metal composition of coins or moving to a different metal This reduced the real value of government debt, resulting in fiscal relief
There has also been other types of debt "default," such as financial repression (Reinhart, Kirkegaard, and Sbrancia, 2011) It takes a long time to persuade the public to trust the currency again after a period of inflation or depreciation As a result, the fiscal costs of inflation stabilization rise dramatically, resulting in large negative actual impacts of high inflation and concomitant currency crashes Debt intolerance is typically associated with the "severe duress" that many emerging economies face at levels of foreign debt that advanced countries could easily manage Empirical research on debt intolerance and serial default suggests that, while safe debt thresholds depend on country-specific factors such as default history and inflation when an emerging economy's external debt level exceeds 30-35 percent of GNP, the likelihood of an external debt crisis increases significantly (Reinhart and Rogoff, 2009b) More crucially, when an emerging market country repeatedly defaults on its foreign debt, it increases its debt intolerance, making it extremely difficult to join the club of countries with uninterrupted access to global financial markets.
There are numerous problems with predicting countries' ability to sustain various types of domestic and external debt One significant difficulty is that the type of financing used by countries is endogenous According to Jeanne (2003), short-term (foreign exchange) debt can be a beneficial commitment device for countries to implement sound macroeconomic policies. According to Diamond and Rajan (2001), given the low-quality institutional context in which developing-country banks operate, they have no alternative but to borrow short-term to finance illiquid projects Eichengreen and Hausmann (1999) present the "original sin" theory, which explains how countries with adverse conditions are forced to rely on short-term, foreign currency-denominated debt as their primary source of capital In general, while short-term debt can exacerbate vulnerabilities, particularly when the domestic financial system is underdeveloped, poorly supervised, and plagued by governance issues, it can also be the only source of (external) financing for a capital-poor country with limited access to equity or FDI inflows As a result, countries must choose between amassing short-term debt and becoming more vulnerable to catastrophes In general, it is difficult to distinguish the deeper causes of debt crises from the proximal causes Many of the vulnerabilities that increase the likelihood of a debt crisis can be attributed to issues relating to financial integration, political economy, and institutional contexts Capital flows can render countries with wasteful governments and poorly governed financial sectors more vulnerable to shocks McKinnon and Pill (1996, 1998) explain how moral hazard and insufficient supervision, together with unrestrained capital flows, can lead to crises as banks face currency concerns Debt crises are also likely to feature abrupt halts,currency or financial crises (or a combination of these), making it difficult to pinpoint the originating cause Hence, empirical research on cause identification faces the normal issues of omitted variables, endogeneity, and simultaneity Although utilizing short-term (foreign currency) debt as a crisis prediction may work, it does not prove the underlying cause of the crisis The difficulty in identifying underlying reasons is mirrored in the fact that debt crises have existed throughout history.
Banking Crisis
While they happen often, banking crises are arguably the least understood Due to their inherent fragility, banks are vulnerable to depositor runs Moreover, issues with specific institutions can swiftly spread to the whole financial system While governmental safety nets, such as deposit insurance, might reduce this risk, they also come with distortions that may actually make a catastrophe more likely Institutional flaws might also make a catastrophe more likely For instance, in order to make wise investment decisions and collect on their debts, banks substantially rely on the information, legal, and judicial contexts Risks may be increased when institutions have vulnerabilities Banking crises have existed for millennia and have shown certain common characteristics, but it is still difficult to predict when they will occur. Due to their inherent fragility, Bank Runs and Financial Institutions can cause a variety of coordination issues
Financial institutions operate with heavily leveraged balance sheets due to their involvement in maturity transformation and liquidity generation As a result, banking and other activities that involve financial intermediation can be risky Coordination, or lack thereof, is a significant difficulty in the financial markets due to fragility When investors, institutions, or both take actions (such as withholding liquidity or capital) purely out of concern that others may do the same, coordination issues result Due to this fragility, a crisis is easily foreseeable in which significant quantities of liquidity or capital are withdrawn as a result of a self-fulfilling prophecy—investors' fears that the crisis would occur actually come to pass Minor shocks can cause market volatility and even a financial catastrophe, whether they are real or financial A bank run is an elementary illustration of a coordination issue The saying goes that banks lend long and borrow short This maturity change reflects consumer and borrower choices
Nonetheless, it leaves banks susceptible to unforeseen liquidity needs, or "runs" (the seminal reference here is Diamond and Dybvig, 1983) When several clients remove their deposits from a bank because they think it is or could become insolvent, this is known as a
"run." A bank run gains pace as it goes along, creating a self-fulfilling prophecy (or perverse feedback loop) wherein the chance of default rises as more deposits are withdrawn, which promotes still more withdrawals As a result, the bank may become so unstable that it will eventually risk bankruptcy because it will be unable to sell off assets quickly enough to pay its immediate obligations Markets, institutions, and policymakers have long recognized these fragilities and have created a variety of "coping" mechanisms (see further Dewatripoint andTirole, 1994) Institutions are encouraged to reduce vulnerabilities through market discipline In order to lessen their fragility, intermediaries have implemented risk management measures at the organizational level
In addition, micro-prudential regulation is intended to curtail the hazardous conduct of certain financial firms and can contribute to the engineering of stability Deposit insurance can assist alleviate small depositors' worries and also lessen coordination issues In times of extreme financial crisis, lenders of last resort (i.e., central banks) can give banks short-term liquidity. When financial upheaval strikes, public sector policy measures such as governmental guarantees, capital assistance, and acquisitions of non-performing assets can reduce systemic risk Although regulation and safety net measures might be beneficial, they can also make a financial crisis more likely if they are badly planned or managed Rules seek to lessen brittleness (for example, limits on balance sheet mismatches stemming from interest rates, exchange rates, maturity mismatches, or certain activities of financial institutions) Yet, regulation (and monitoring) frequently finds itself lagging behind innovation Moreover, it could not be well thought out or executed The public sector's assistance may also cause distortions (see further Barth, Caprio, and Levine, 2006) Moral hazard brought on by a governmental guarantee, such as explicit or implicit deposit insurance, might cause banks to take on excessive leverage, for instance Institutions that are aware of their size may take unnecessary risks, which can lead to systemic weaknesses More generally, policies at the macro and micro levels can lead to financial system fragilities (Laeven, 2011) runs on banks in the past Throughout history, races have taken place in several nations During the financial panics of the 1800s and the early 1900s, bank runs were frequent in the United States (during the Great Depression) Most runs in the US didn't end until the advent of deposit insurance in
1933 (Calomiris and Gorton, 1998) In recent decades, widespread runs have also occurred often in developing nations and emerging markets, such as in Indonesia during the 1997 Asian financial crisis
Runs happened less frequently in other wealthy nations, and even less frequently in recent decades, in part because deposit insurance is widely available 16 Yet, Northern Rock, a bank in the UK that specializes in mortgage finance, represents a fairly recent example of a bank run in a developed nation (Shin, 2011) During the current financial crisis, when numerous investment and commercial banks were confronted with significant liquidity demands from investors, wholesale market financing was also rapidly withdrawn In non-bank financial markets, there is also a possibility of widespread runs For instance, certain mutual funds "broke the buck" in the United States in the fall of 2008, meaning that their net asset value decreased below par This resulted in significant withdrawals from several mutual funds and individual investors (Wermers, 2012) In response to this "run," the government decided to offer a guarantee against additional reductions These assurances represent a recurring source of fiscal risk since they might necessitate government intervention to stop another run Since there was a widespread
"flight to safety" (i.e., higher demand for government bonds and T-bills from industrialized nations), other investment vehicles specializing in certain asset classes (such as those in developing markets) also saw substantial withdrawals More broadly, many have seen the2007–2008 crisis as a widespread liquidity run (Gorton, 2009) Banking crises have deeper causes Although financing and liquidity issues might serve as catalysts or immediate causes, a bigger picture reveals that issues in the asset markets frequently play a role in banking crises.Although banking crises frequently include solvency problems, they may initially appear to come from the liability side When many of their loans fail or securities swiftly lose value, banks sometimes have issues This occurred in a variety of crises, including the current crises in Europe and Japan as well as the Scandinavian financial crises in the late 1980s and 1990s. There were really no significant bank deposit runs in any of these periods, but real estate loans caused widespread issues that left many banks undercapitalized and in need of government assistance
The latest crisis was significantly impacted by issues in the asset markets, such as those involving subprime and other mortgage loans These sorts of asset market issues can go unnoticed for a while, and a financial crisis frequently comes to light when a significant number of institutions experience financing issues Banking crises and other financial panics are seldom random events, even if the precise causes are sometimes difficult to pinpoint and hazards can be challenging to anticipate in advance Because of worries that loans won't be repaid, banking panics are more likely to happen during the pinnacle of the business cycle when recessions are on the horizon (Gorton 1988; Gorton and Wilton, 2000) Recognizing the hazards, depositors ask banks for money A panic might happen since banks can't (quickly) fulfill all demands This method was used to link shocks in the real sector to the widespread financial distress of the 1930s External factors, such as abrupt changes in capital flows, global interest rates, and commodity prices, which in turn caused a surge in nonperforming loans, were the cause of banking crises in many emerging nations Policies can also cause panic When certain banks encounter problems and governments respond haphazardly, without clearly indicating the state of other institutions, panic might result Poorly managed early actions have been blamed for the
1997 financial crisis in Indonesia (see Honohan and Laeven, 2007, for this and other case studies) Government actions can also cause runs For example, the 2001 bank runs in Argentina happened when the government limited withdrawals, which led depositors to doubt the stability of the whole banking system The lack of consistency in government interventions and other policy initiatives has been partly blamed for the recent financial crisis in advanced countries (e.g., Calomiris, 2009)
Banking crises can also be caused by structural issues A number of common, structural traits associated with banking crises have been documented in studies (e.g., Lindgren, Garcia, and Saal, 1996; Barth, Caprio, and Levine, 2006; and many more) They include, in particular, a lack of market discipline brought on by moral hazard and excessive deposit insurance, a weak corporate governance structure, insufficient disclosure, and subpar monitoring, partly as a result of conflicts of interest Large state ownership, little financial system competition, including barriers to the entrance from overseas, and an undiversified financial system, such as a predominance of banks, are other structural factors that have been identified to enhance the probability of a crisis (World Bank, 2001) The financial industry benefits from a variety of public programs, making it simple for policy distortions to develop that might trigger crises.Large government backing for mortgage financing (via the government-sponsored firms FannieMae and Freddie Mac) has been claimed to encourage excessive risk-taking in the context of the current financial crisis in the US At least in some wealthy nations, the propensity to adopt accommodating fiscal and monetary policies in response to crises can be seen as a type of ex- post systemic bailout, which distorts ex-ante incentives and may encourage excessive risk- taking (Farhi and Tirole, 2010) Another issue that is frequently brought up is "connected lending," which can increase systemic risk because it creates perverse incentives for politicians and companies to borrow excessive amounts from banks Mexico is one country where this phenomenon has been extensively researched There are still many unanswered questions about systemic banking panics, particularly in regard to how contagion develops As many of the aforementioned causes frequently occur simultaneously, it is unknown how important each one is in creating crises Financial intermediation still has its share of vulnerabilities, and panics frequently have obscure root causes Little shocks can cause serious issues for the whole financial system for sometimes unexpected causes Similar to how shocks can spread from one country or market to another, causing financial crises
The most recent financial crisis began with numerous factors that are typical of prior crises The recent crisis's causes have been extensively discussed in writing (see Calomiris
(2009), Gorton (2009), Claessens et al (2012), and several others) The list of elements present in prior crises is largely the same, even though analysts disagree on the precise weights assigned to individual aspects Asset price increases that proved to be unsustainable, credit booms that resulted in excessive debt loads, the accumulation of marginal loans and systemic risk, and the inability of regulation and supervision to keep up with financial innovation and foresee the crisis before it materialized are the four characteristics that are frequently mentioned as being common Yet there were also some brand-new elements that contributed to the global financial catastrophe The widespread use of complicated and opaque financial instruments, the increased interconnectedness of financial markets, both domestically and abroad, with the U.S at their center, the high level of leverage of financial institutions, and the importance of the household sector are the four main new aspects that are frequently mentioned The biggest financial crisis since the Great Depression was caused by a mix of these variables, along with others that are typical of past crises, and occasionally by ineffective government interventions at various stages To restore confidence in financial institutions, significant government expenditures and guarantees were necessary Several developed nations are still dealing with the crisis aftereffects, and other European nations are still experiencing it.
THE CAUSES OF FINANCIAL CRISIS
Excessive risk-taking in a favorable macroeconomic environment
Economic circumstances in the United States and other nations were favorable in the years preceding the GFC Economic growth was strong and consistent, while inflation,unemployment, and interest rates were all low House prices rose dramatically in this atmosphere.
Expectations that housing prices would continue to grow drove consumers, particularly in the United States, to borrow excessively to buy and develop houses A similar anticipation for housing values encouraged European property developers and households (including Iceland, Ireland, Spain, and other Eastern European nations) to borrow excessively Many mortgage loans, particularly in the United States, were for sums near to (or even greater than) the purchase price of a home A major portion of such hazardous borrowing was done by investors seeking short-term gains by 'flipping' properties and by subprime' borrowers (who have greater default risks, mostly because their income and wealth are relatively low and/or they have previously skipped loan repayments).
For a variety of reasons, banks and other lenders were ready to issue progressively huge amounts of hazardous loans.
Individual lenders were more competitive in extending ever-larger sums of house loans, which appeared to be quite profitable at the time due to the excellent economic situation
Several lenders that made home loans did not thoroughly analyze borrowers' ability to repay their debts This reflected the popular belief that favorable conditions will persist. Furthermore, because they did not anticipate to incur any losses, lenders had no motivation to exercise caution in their lending selections Instead, they sold a huge number of loans to investors, mainly in the form of loan packages known as'mortgage-backed securities' (MBS), which were made up of thousands of individual home loans of variable quality MBS products got increasingly sophisticated and opaque over time, yet they were still assessed as extremely safe by external authorities.
Investors who acquired MBS packages believed they were purchasing a relatively low risk asset: even if certain mortgage loans in the package were not repaid, it was considered that the majority of loans would be repaid Large American banks were among these investors, as were international banks from Europe and other nations seeking larger profits than could be obtained in their own markets.
Increased borrowing by banks and investors
In the run-up to the GFC, banks and other investors in the US and elsewhere borrowed increasingly large sums to expand their lending and acquire MBS securities Borrowing money to buy an asset (also known as increasing leverage) multiplies possible rewards but also potential losses As a result, when property values began to collapse, banks and investors suffered significant losses due to the massive amount of money borrowed.
Furthermore, banks and certain investors borrowed money for relatively short periods of time, even overnight, to buy assets that could not be sold fast As a result, they were increasingly reliant on lenders, including other banks, for fresh loans when old short-term loans were repaid.
Regulation and policy errors
Subprime loans and MBS products were not adequately regulated In particular, the institutions that manufactured and sold the complicated and opaque MBS to investors were not adequately regulated Not only were many individual borrowers given loans that were so huge that they were unlikely to be repaid, but fraud was becoming more frequent, such as overstating a borrower's income and over-promising investors on the safety of the MBS products they were being sold.
Furthermore, as the crisis evolved, many central banks and governments failed to recognize the extent to which faulty loans were extended during the boom, as well as the numerous ways in which mortgage losses were spreading across the financial system.
FINANCIAL CRISIS 2008
Overview
The financial crisis in 2008 is a big deal Ben Benarke said it could result in 1930s style global financial and economic meltdowns with catastrophic implications This is the most complex financial crisis in financial history because it involved so many closely interlinked relationships There are a lot of complicated tools that have been put into this crisis and derivatives and derivatives on derivatives as well.
Cause of the financial crisis in 2008
The initial cause of this crisis was the securitization of subprime mortgages In the US,securitization has a long history dating back to 1977, but it has truly taken off during the 1990s.The process of securitization involves using assets that are already on the balance sheet as security for the issuing of debt instruments Securitization, then, is the process of issuing debt securities with the certainty that the future cash flows will come from a collection of already- existing financial assets As a result, when purchasing debt securities, investors agree to take on the risks related to the portfolio of collaterals being securitized Mortgage loans, commercial loans, trade receivables, loan portfolios, and other financial assets are only a few examples of the numerous financial assets that may be securitized today loans for commercial real estate,credit cards, subprime portfolios, high-yield bonds, etc Because of this, securitization allows the lender to readily shift credit risk to others by issuing debt securities and using the credit portfolio as a credit portfolio Collateral Due to this, investment banks may simply and reliably infuse funds into operations related to subprime lending.
The procedure generally goes like this: Investment banks first provide cash advances to financial institutions that specialize in subprime mortgage lending Home loans are provided by financial institutions via a network of loan agents Working directly with consumers, lending agents assess credit using conventional financial company forms and provide paperwork to financing businesses for approval The finance firm will complete the mortgage process and payout after approval Finance businesses will aggregate loans into a credit portfolio made up of a variety of loans and sell them back to the investment bank, reimbursing it for the money it had previously advanced to the company finance Investment banks securitize subprime portfolios after buying them The investment bank sells the credit portfolio to a special purpose entity it established, which then issues debt instruments to investors This specific corporation has no capital, no staff, and just loan portfolios as assets and issued bonds as liabilities The service provider is hired to handle all tasks including tracking, debt collection, and bond principal and interest payments (usually the finance company that makes the loan) In ideal circumstances, this specific firm completes its mission and is dissolved after the loan portfolios are entirely recovered and the bond debt is paid off to investors Mortgage-backed obligations are short- term debt securities Bonds are broken up into several packages (tranches) that are rated differently, have varying risk levels, and have varying interest rates, such as package A, package B, and package Z The highest credit factor under Plan A is paid in full initially. Package B will then take the lead, and package Z will be paid off last after the initial package of package A The following characteristics apply to Package Z, a unique package without a credit rating that carries the greatest level of credit risk share Package Z will make the maximum money if the credit portfolio performs well, and vice versa The waterfall concept, which states that water flows from top to bottom, is the basis for distributing cash flows to bondholders In light of this, investors have a wide range of bond packages made possible by securitization to choose from This is also what fuels the surge in subprime lending and the market for bonds created through securitization.
International investment banks quickly see securitization as a powerful risk transfer mechanism for subprime lending Formerly, commercial banks used to lend house mortgages with their limited capital from client deposits, but today this source of cash seems to have no end International investment banks fight to fund financial firms that specialize in offering subprime mortgage loans or to launch their own lending firms Investment banks, financial institutions, loan brokers, credit rating agencies, and management firms are a few examples of the players who participate in the lending and securitization process and make a living from it.gigantic The greatest winners are likely investment banks Subprime mortgages have extremely high interest rates, thus investment banks can make money by lending cash to financial firms as well as through securitization activities Due to the ease with which extra packing will be possible at high interest rates, investors are enticed to flood the market and purchase riskier securitized bond packages Subprime loan practices were abused as a result of high earnings and avarice Loan agents' appraisal practices are exceedingly loose, and getting access to home credit is now quicker and simpler than before First settlers in particular who have low incomes might purchase a home The United States experienced a fast proliferation of subprime mortgage loans Prices for real estate rose quickly If subprime mortgage loans were just beginning to materialize in the early 1990s and growing very slowly, they have expanded significantly during the past five years In 2002, subprime loan sales contributed roughly 200 billion USD to the market; in 2003, 320 billion USD; in 2004, 550 billion USD; and in 2005–
2006, almost 700 billion USD yearly, or about 25% of total home mortgage loans in the United States The danger of poorly prepared loans is most influenced when the economy is inefficient, rising interest rates place a burden on low-income borrowers to repay their debt, and unemployment rises A number of homebuyers who were unable to pay the loan had their homes foreclosed upon and sold The problem that began in Cleveland (Ohio) and expanded across the country and the globe was the result of this metropolis Around 1 in 10 properties in Cleveland are up for sale due to foreclosure, according to data Dreamers of house ownership who immigrate often return empty-handed The third quarter of 2007 saw the steepest decline in U.S house values since the financial crisis of the 1930s.
A loan having a high risk level and low quality These loans are not carefully examined, and they are secured with scant or no evidence of the borrower's financial capacity A borrower often has to submit a loan application to a bank A credit officer has evaluated this application, and their evaluation must be formally recorded in writing The borrower must also present documentation pertaining to their income, employment history, assets, and obligations A 30- year fixed-rate mortgage or an ARM, or adjustable-rate mortgage, may be offered by the bank. The majority of customers choose for loans with fixed interest rates During the 1980s, as the number of enterprises grew quickly, banks thought the conventional loan process was too time- consuming and ineffective As a result, they began using a client credit score algorithm Every resident of the United States has a credit score, which ranges from 300 to 850 and represents their payment history There are three credit unions that gather data on each client's payment history To get the suitable credit rating, banks use the average score from these three agencies. Although though the borrower must still provide paperwork proving their income, employment history, and assets, the process may be streamlined Credit scores are the main factor that credit officers consider when approving loans.
The quantity of paperwork was kept to a minimum in the early years of the twenty-first century, when the housing boom was at its height Because they are essentially unsecured without any paperwork, these loans are sometimes referred to as "paperless" loans The sole criteria is now credit score The loan is considered subprime if the borrower has a poor credit score (This is a loan of lower quality than a standard loan, which is loaned with all the necessary documents) These loans feature high interest rates or require borrowers to borrow at ARM rates, which have a low beginning interest rate then progressively increase to higher rates, to mitigate the high risk Initial loans were provided by commercial banks and subprime brokers, and these loans were subsequently transferred to investment banks for MBS, CMOs, and CDO conversion.
The majority of CMOs and CDOs are sold to hedge funds, a category of private investment vehicle popular with high-net-worth investors These hedge funds are not severely regulated, they are not required to produce financial statements, and few people are aware of their investing tactics thanks to a clever group of customers Clients of this unusual kind of banking come from all over the world, including Europe, Asia (particularly China), and the
Middle East House price growth ceased in August 2007 and even reversed This predicament is mostly due to the tightening monetary policy that has increased interest rates The value of fixed-income assets declines when market interest rates rise, in accordance with the laws of corporate finance The prices of hedge funds also start to decrease since a large component of their portfolios are made up of CMOs and CDOs Investors pull their money out as a result. Hedge funds had to halt payments because of a lack of liquidity The market is rife with anxiety The worth of these portfolios decreased much further.
Investment bankers predict that when the number of new mortgage loans declines, the securitization market will contract During the boom, the banks themselves made substantial investments in mortgage-backed securities, which offered highly alluring rates Losses were recorded on the bank's balance sheet as a result of the investment portfolio's drop in value.
Several institutions attempted to restore the market as it lost more and more strength. Yet it's a general rule in finance that you can't sell in a market that isn't liquid When there are few or no buyers, there is a lack of liquidity It is a small market from a business standpoint. Very few transactions will be done in such a market, and the market value of many securities won't be able to be established with objectivity And this is how the price-setting process
"breaks down." Transactions will halt and the market will become paralyzed as a result of the unstable and unclear nature of the price setting process.
Normally, if you want to borrow from a bank to buy a home in installments in the US, borrowers must ensure "standard" including 3 basic conditions: having a deposit of at least 10% of the house purchase amount, proving that they have a stable income determined so that the monthly installment amount does not exceed 28% of income and has a fair credit score Banks, on the other hand, are only permitted to lend in accordance with the volume of deposits made by the public, the limitations on the lending rate, and the necessary reserve ratio set by the government for the bank.
Nonetheless, the US government offers a "subprime lending" program to help low- and modest-income people buy a home Two companies, Fannie Mac and Freddie Mac, buy back the loans made by commercial banks to this topic Those with low incomes and those with modest incomes find it difficult to pay their obligations during a downturn in the real estate market.
Individuals rush to acquire homes in the hopes of making a profit because they think that prices will continue to climb Even before those homes were finished and placed to use,many speculators were able to make significant profits by simply purchasing and flipping residences Mortgage brokers want to complete transactions quickly so they can be paid and move on to the next one Later, it was discovered that subprime borrowers were being sought by numerous eligible mortgage purchasers since these borrowers offered intermediaries larger fees.
Lenders are at ease because as housing values continue to climb, the danger of default is gradually declining Homeowners' properties improved in value as a result.
The majority of subprime loans take the form of adjustable-rate mortgages (ARMs) In the past, purchasers have favored fixed-rate mortgages over flexible ones, which require monthly interest payments at a fixed rate for 30 years With a duration of 3 to 5 years, ARM interest rates are quite low As a result, it has drawn purchasers with modest incomes.
According to rules, the subprime loan is not taken into account when determining solvency and credit score, but in exchange, the borrower must pay a higher interest rate of 1 to 2% Moreover, subprime financing is evident in loans that cover up to 85% of the value of real estate that is mortgaged, with just a 15% down payment required from purchasers Numerous banks and mortgage lenders are still vying for consumers with further alluring credit offers.
EFFECTS OF THE FINANCIAL CRISIS
At first, the reduction in general economic activity was rather slight, but as financial market stress peaked in the fall of 2008, it became much more significant The US GDP declined by 4.3 percent from the peak to the bottom, making this the worst recession since World War II From fewer than 5 percent to more than 10 percent, the jobless rate more than doubled Between January and September 2008, 84,000 US workers lost their jobs on average. Several financial institutions, including the large and renowned ones, have filed for bankruptcy. The production sector is impacted by the credit emergency, which forces enterprises to cut output, fire employees, and cancel input contracts Increasing unemployment hurts household income and consumption, which makes it challenging for companies to market their products. The major three US automakers, General Motors, Ford Motor, and Chrysler LLC, are among the several companies that have declared bankruptcy or are on the brink of doing so The heads of these three automakers unsuccessfully lobbied the US Congress for assistance General Motors announced the temporary shutdown of 20 of its North American plants on December
12, 2008 Consumption declines and a glut of goods have caused an ongoing decline in the economy's total price level, putting the US economy at risk of deflation The US dollar increased as a result of the crisis Since the US dollar is currently the most widely used form of payment worldwide, foreign investors have purchased dollars to increase their liquidity, driving up the value of the American currency, which harms US exports.
The United States is an important import market for many countries, so when the economy is in recession, the exports of many countries suffer, especially export-oriented countries in East Asia Some economies here such as Japan, Taiwan, Singapore and Hong Kong fell into recession Other economies all slowed down.
Europe, which has close economic ties with the United States, is severely impacted both financially and economically Many financial institutions here went bankrupt to the point of becoming a financial crisis in some countries such as Iceland, Russia The region's largest economies, Germany and Italy, fell into recession, and the UK, France, and Spain all reduced growth The euro area officially fell into its first recession since its founding.
Latin American economies are also closely related to the US economy, so they are also negatively affected when short-term capital flows withdraw from the region and when oil prices plummet Ecuador approaches the brink of a debt crisis.
The economic growth of regions in the world slowed down, causing a decrease in the demand for oil for production and consumption as well as a decrease in oil prices This in turn hurts oil-exporting countries At the same time, due to concerns about instability, food speculation broke out, contributing to high food prices during the end of 2007 and early 2008, forming a crisis in food prices global reality Many stock markets around the world experienced severe stock devaluation Investors shifting their portfolios to strong currencies such as the US dollar, Japanese yen, and Swiss franc have caused these currencies to appreciate against many other currencies, making it difficult for investors to invest exports from the United States, Japan, and Switzerland, and caused currency disturbances in some countries, forcing them to seek help from the International Monetary Fund Korea fell into a currency crisis when the won continuously depreciated since early 2008.
At the end of 2007, Vietnam attracted FDI with a record of 17.8 billion USD, economic growth reached 8.4% However, because of the impact of the extreme weather, our country cannot avoid many difficulties.
First of all, on credit and liquidity issues of the banking system: The State Bank since the beginning of 2008 has always pursued a tight monetary policy Rising inflation pushes interest rates up (sometimes up to 20%/year, fluctuation range is 150%), but many businesses are forced to accept this interest rate to survive Credit growth dropped sharply, only fluctuating in the range of 0.56% - 0.7% Some blue-chip stocks also dropped sharply, such as SSI: -84%, FPT: -78%.
Price movements: The price of fuels soared to the top, the whole world was on red alert about the energy crisis Gold prices floated up and down quite erratically, the gold index rose the highest at 220 points Investment also caused food prices to increase rapidly, rice exports increased up to 26.7%, in the face of complicated situations, like many other rice exporting countries, Vietnam temporarily stopped exporting.
Real estate market: The real estate market froze, the prices of real estate dropped by 40%, many businesses in this field fell into a deadlock when their products could not be sold and had to bear high interest rates from the bank.
Regarding export activities: The export growth rate decreased markedly, because the US is Vietnam's large market accounting for 20% of export turnover, because the US is in crisis, so it spends less and imports are also limited At the same time, two other markets, Japan and the
EU, were also negatively affected, so they were forced to cut spending.
Inflation: In Vietnam, inflation increased sharply in the first half of 2008, the inflation rate was about 2.86%/month However, in the second half of the year, the situation is more positive, only about 0.38%/month Thanks to the shift of the Government's priority target from prioritizing economic growth to prioritizing inflation control.
RESPONSES OF THE FEDERAL RESERVE AND THE GOVERNMENT
As soon as the secondary housing credit crisis broke out, the Fed began to intervene by lowering interest rates and increasing MBS purchases Until the situation developed into a financial crisis in August 2007, the US Federal Reserve (Fed) continued to conduct monetary easing measures to increase liquidity for financial institutions Specifically, the interbank overnight lending rate has been reduced from 5.25% over 6 installments to 2% in less than 8 months (September 18, 2007 to April 30, 2008) This interest rate then continued to decrease and on December 16, 2008, it was only 0.25%, a rare near zero interest rate.
The Fed also conducts open market operations (buys back US government bonds held by financial institutions in this country) and lowers the rediscount rate In mid-December 2008, the Fed announced plans to implement quantitative easing.
In December 2007, the US Government created and assigned the Fed to host the Term Auction Facility program to issue short-term loans with maturities ranging from 28 to 84 days at the highest interest rates paid by financial institutions through auction As of November
2008, $300 billion has been lent by the Fed under this program The Fed also made mortgage loans to financial institutions totaling 1.6 trillion as of November 2008.
On February 13, 2008, President George W Bush signed the Economic Stimulus Act of
2008 under which the government will introduce a $168 billion aggregate stimulus program mainly in the form of personal income tax rebates.
In the face of a severe financial crisis, the Bush administration submitted a $700 billion fiscal package to Congress Initially, the US House of Representatives was rejected by a majority of US Democrats, saying that it was impossible to waste money to save too many troubled financial institutions But after the plan to use $ 700 billion was adjusted to spend on programs that serve a large number of people to stimulate consumption (such as assistance for the unemployed, nutritional support for the poor and the elderly) low income, infrastructure development), thereby revitalizing the economy, it was approved by the Senate On October 3,
2008, President Bush signed the Emergency Economic Stabilization Act of 2008 authorizing this $700 billion stimulus package.
SOME BIGGEST CRISISES IN HISTORY
Credit Crisis of 1772
This crisis arose when UK banks declared insolvency The British Empire grew enormously wealthy between 1760 and 1770 as a result of commerce and a huge number of colonies throughout the world As a result, in order to grow credit and generate enormous profits, British banks have loose lending practices.
On June 8, 1772, a significant partner of British banks, Alexander Fordyce, escaped to France to avoid his massive debt When word spread, thousands of people queued in front of banks to withdraw money.
The bank collapsed, becoming insolvent, and 20 other banks went bankrupt The crisis also affected the majority of Europe This is claimed to have triggered the "Boston Tea Party" and the American Revolution.
The Great Depression 1929-1939
This crisis was precipitated by the early 1920s speculative stock market bubble Millions of individuals went to the stock market in the hopes of becoming wealthy quickly They invest all of their assets and even borrow from banks The bubble is expanding and becoming out of control.
On October 24, 1929, the stock price list abruptly collapsed, and the American stock market was in pandemonium Fear immediately swept through the streets of New York and across the country.
Following this tragedy, the stock market crashed, hundreds of thousands of investors lost everything, and many banks and corporations went bankrupt The fallout of the financial crisis continued to wreak havoc on the American economy for the next ten years Following this tragedy, the stock market crashed, hundreds of thousands of investors lost everything, and many banks and corporations went bankrupt The fallout of the financial crisis continued to wreak havoc on the American economy for the next ten years.
Owing to the escalating crisis with the US, the Gulf nations (OPEC) declared a halt to the transport and export of oil to the US and its allies.
Because of this catastrophe, there was a serious scarcity of oil, and the price of oil surged.Lack of energy supply, excessive energy prices, economic stagnation, and growing inflation.
Several Asian nations, including Thailand, Malaysia, the Philippines, Indonesia, Korea, and Japan, witnessed significant economic expansion in the 1990s, particularly in the banking sector Foreign cash has poured in, largely in the form of short-term financial investments.
Nonetheless, the value of the local currency was tightly related to and dependent on the US dollar at the time, and manufacturing was similarly geared toward exporting to the American market This promotes rapid economic growth while remaining unaffected by changes in the US currency.
In the mid-1990s, the Fed increased interest rates, the currency rose, and foreign investment flooded into the United States East Asian countries continue to hike interest rates in order to retain investors, causing the native currency price to rise as well Yet, because this economic progress is wholly dependent on outside factors, domestic manufacturing capability cannot keep up.
As a result, beginning in July 1997, the Thai Baht was widely traded on the market, leading the Baht's value to plummet rapidly The Thai government attempted to acquire local currency but was unable to resolve the issue The problem began in Thailand and extended through ASEAN countries before reaching Korea and Japan.
The government was unable to control and monitor the banking system The lengthy period of finance industry liberalization is cited as a contributing factor by the research and criticized the regulators for not taking further action The financial sector fell apart Everyone in the system, from the major financial institutions to ordinary borrowers, was taking on too much debt and risk To invest in riskier assets, the institutions were taking on enormous debt loads. Several homeowners were also taking out loans they couldn't afford But it's important to keep in mind that this severe systemic failure occurred because of human error in a system made up of people Some people weren't sure what was going on Some people will completely ignore the issues And some were merely ethical, spurred forward by the enormous sums of money at stake From the above information, financial crisis is a big problem that needs to be curbed to protect the global financial system
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