The global financial crisis sent shockwaves across the globe. Observers cite an institutional failure, while others believe that cultural and social factors played a leading role in the near collapse of the economy. Serious questions were raised regarding the handling of the capital markets. The decline in the limitation of liability for over a period of thirty years and the extent of market deregulation remained questionable. Issues regarding what exactly went wrong came up in the lead up-to the last US elections as the Democrats accused the Republicans for facilitating the emergence of the economic problems. The elections are mentioned here based on the intense heat that the credit crunch generated.
The most baffling question revolved around the role of deregulation in the crumbling of the credit markets. The often-touted attitude of 'light touch' has been linked to the fall of the Northern Rock in the UK. On the other hand, in the United States, the long running history of deregulation coupled with financial plutocracy was seen as a major contributing factor to the economic slump. In light of this, a review of the factors that contributed to the financial crisis follows in order to reach a conclusion whether institutional or cultural/social factors were responsible for the economic concerns. The paper also compares and contrasts the approaches taken to managing the crisis by the American, British and European authorities respectively.
Although Congress was informed about the dangers the markets were facing, especially the derivative markets, the proper measures were not instituted. The failure by the Congress and other regulative authorities to take action allowed the derivative markets to collapse. The collapse of the derivative markets triggered the financial crisis. Based on this realisation, the institutional framework failed and in the process facilitated the occurrence of a financial meltdown (Kotz 2009, p. 310).
A shadow banking system played a role in the occurrence of the financial crisis. Shadow banking grew out of securitization of assets coupled with the integration of the system into the capital markets. The system hugely affected the United States. When firms engage in the shadow banking approach, the capital markets become inseparable from the banking sector.
The issue of leverage is also critical in understanding the outbreak of the credit crunch (Reinhart & Rogoff 2005). Allowing the leverage positions to skyrocket exposed the firms to huge risks, an aspect that became real when the asset prices began falling. However, high leveraging meant that small price falls would lead to winding up of companies. If the institutions had regulated the leverage positions and ensured they were at the acceptable scales, then the risk could have been reduced.
The surge in subprime lending was a major contributing factor to the occurrence of the financial meltdown. The subprime issue is another reflection of the inadequacy of the institutions responsible for guiding or controlling the financial markets. The subprime surge played a significant part between the periods of 2004 and 2007. At the time, subprime lending rose from its normal scale to previously un-witnessed levels. In the wake of such developments, the lending markets were compromised. Dubious transactions thrived in markets that operated outside the regulations that guided operations within the industry. The preference of the free market enterprising persuaded the authorities to ignore credible warnings (Bogle 2005). Thus, for example, a warning by the former Federal governor, Edward Gramlich, was ignored.
The emergence of the housing bubble in 2007 and 2008 presented a significant turning point in the credit markets. If the authorities had taken the correct measure to regulate the financial markets, then the housing bubble could have been avoided. In addition, the regulatory mechanism should have regulated takeovers, mergers, and bankruptcies. Offering such regulation could have helped in restoring confidence in the markets.
Some observers would point out that the action by the Federal Reserve to scale down the Federal funds rate was the actual trigger of the financial problems (Brigo & Torresetti 2010). The move by the Federal Reserve pushed the US economy into unbearable levels of uncertainty. After the horrific move, interest rates in the country went tumbling down by almost 75 percent. Further losses in the Dow Jones market compounded the problem. Although the move was critical in stemming the economy, it actually triggered the recession.
The other issue of concern was letting Lehman go. The question of letting Lehman Brothers sink suffices because the authorities bailed out other players such as the Bear Steams. Based on the action, the authorities did not see the value of protecting the Lehman Group. After letting Lehman Brothers collapse, the picture was clear that the economy was in trouble. After the collapse of Lehman, lending was frozen. In effect, the move slowed the economy.
Social and cultural issues also emerge as contributing factors to the credit crisis. The high leverage is attractive to high risk takers. The investors were willing to gamble. This indicates that the society was moving away from its cultural way of life by upstaging accepted confines of doing business. In short, the society had become greedy and was seeking opportunities that offered the highest rates of interest. This shift allowed the financial institutions to take advantage.
The growing levels of debt in the society also presented a significant contributing factor to the global financial problems. A good percentage of citizens were seeking funding from financial institutions for various investment purposes. More significantly, the chase to own homes among the middle class was a huge factor that facilitated the occurrence of the credit crunch.
Based on the above issue of home ownership, it became apparent that societal classification was another factor that paved way for the credit problems. Owning homes gave people a higher social status. As such, the middle class in the UK and the US sought the opportunities to access funds for purposes of home construction. In the process, the mortgage industry and real estate boomed. Since, the move was unsustainable, in the end, the housing bubble also contributed to financial meltdown (Blinder 2009).
Transformation of the banking institutions was also an issue. More specifically, the purpose of banking was shifting as the sector reflected a high level of proprietary trading (Ferguson 2009). The changes in the capital markets cut across a big percentage of the economy sectors in most countries. Famously, the widespread changes were duped the 'global financial services revolution'.
The role of politics in the economic slowdown is also visible. The US Congressional politics revolves around dollars. Discussions on financial matters are also premised on dollars even outside the United States. Switching focus to the UK, party politics are modelled on pounds. In the UK, the decline of mass membership led to the expansion of City financing. The review of the causes of the financial crisis establishes that both institutional and cultural/social factors played a significant role.