4.5.4 the global financial crisis Flashcards
What does the Global Financial Crisis refer to?
The decline in world GDP in 2008-2009.
What was the economy like before the financial crash?
Asset prices were high and rising, and there was a boom in economic demand.
There were also risky bank loans and mortgages, especially in the US where government securities were backed by subprime mortgages.
What does it mean for government securities to be backed by subprime mortgages?
These are bonds whose value is tied to the performance of a pool of loans made to borrowers with poor credit.
What was a result of the US having government securities backed by subprime mortgages?
House prices crashed in the US in 2006, and several homeowners defaulted on their mortgages in 2007. Banks lost huge funds and required assistance from the government in the form of bailouts.
What did the UK government do shortly after the financial crisis in attempt to increase consumer spending?
Used expansionary fiscal policy, cutting VAT from 17.5% to 15%. This led to less tax revenue, which led to an increase in government borrowing.
What were UK interest rates at when the crisis had just started in 2008? When did the Bank of England cut the interest rates?
5%. This got cut when the US bank Lehman Brothers became bankrupt.
What was the economy like by 2009? [3]
- Banks unwilling to lend
- Unemployment soared
- Firms and consumers had little confidence left
What did the Bank of England cut interest rates to in March 2009?
Historic low of 0.5%, and since the economy was still in recession, the bank employed a programme of QE.
What were contributing factors to the financial crash? [3]
- Subprime mortgages
- Moral hazard (too big to fail)
- Speculation and Market bubbles
Why was there asymmetric information with subprime mortgages?
Banks were not aware of how risky the loans were.
How have banks become more risk averse since the crisis?
There are tougher requirements to get a loan or mortgage.
What is a moral hazard?
A situation where there is a risk that the borrower does things that the lender would not deem desirable, because it makes the borrower less likely to repay a loan. Most commonly occurs when there is some form of insurance for the mistake.
Why has the financial crisis been regarded as a moral hazard?
The Banks might take more risks if they know the Bank of England or the government can help them if things go wrong, and it has been regarded as a moral hazard due to the degree of risk taking.
Why can systematic risk in financial markets can be seen as a negative externality?
Systematic risks are the risk of damage of the economy or financial market, for example the risk of the collapse of a bank. Since this costs firms, consumers, the economy and the market, it is akin to a negative externality.
When does a market bubble occurs?
When the price of an asset is predicted to rise significantly.
What are the effects of a market bubble?
It causes an asset to be traded more, and demand exceeds supply so price rises. The bubble then ‘bursts’ when the price steeply and suddenly falls to its ordinary level, causing panic and investors try and sell their assets.
It results in a loss of confidence and can lead to economic decline or a depression.
