FINAL ASIGNMENT IN INTERMEDIATE MACROECONOMICS THE UNITED STATES FINANCAL CRISIS IN 2008

Overview of the economic crisis in the United States Let take a glance at the United States -a country with a developed economy, which account for roughly 20% global economy according to

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VIETNAM NATIONAL UNIVERSITY

UNIVERSITY OF ECONOMIC & BUSINESS

FINAL ASIGNMENT

IN INTERMEDIATE MACROECONOMICS

Course code: 202 INE20102-E 4

TOPIC:

THE UNITED STATES FINANCAL CRISIS IN 2008

Lecturer: Phan The Cong, Assoc, Prof Dr Student: Tran Thi Thu Trang

ID student: 19051242

Hanoi, July 2021

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The financial system is one of the most important parts of the economy The existence of the financial system is an indispensable element of the market Even a small change in this system can turn into a big wave affecting both the economy of each country and the world economy Therefore, if a financial crisis occurs, the consequences will be huge and have extremely dangerous consequences for the global economy

Entering the 21st century, the world economy is developing continuously, developed countries such as the US, Japan, and the EU region always achieve an increase in GDP and GNP The growth rate is always from 2% - 3% a year However, accompanying that development is the risk and danger

of the financial crisis along with the inevitable recession of the economic development cycle after the years of maximum development With the seeds of the crisis in the past, 2007 marked a recession, starting the signs of crisis of the world economy Spending within a few months of the end of 2007 and the beginning of 2008, the whole world witnessed the shaking of the US financial system - which is considered the most powerful power in the world This is considered the most serious crisis to occur in the past 80 years Hundreds of billions have been dissipated, the contagion has spread and affected the whole world for many years

Therefore, the essay will learn about “The United States financial crisis in 2008” with the hope that it can help people better understand the crisis with its causes and impacts on the global economy Thus, we will have a more detailed view of the crisis and from there will find out lessons as well as solutions to help the economy avoid the risks caused by the crisis Thereby, each country will find for itself appropriate policies to help overcome the crisis and develop its economy

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1 Theory of Financial crisis

Discussing the development of a country, economy plays an important role in evaluating their development after long a period of upheaval and long development, therefore it's undeniable that almost country have to experience economic fluctuations and crises when developing their country

According to Market Business News, the definition for’’ economic crisis’’ is a situation in which a country’s economy deteriorates significantly during the crisis, GDP is typically declining, liquidity dries up, and property and stock market prices plummet It is an economic downturn that gets worse and worse

Financial crisis occurs when financial markets crash caused by adverse selection and moral hazard become acute in financial markets, rendering these markets incapable of capital mobility efficiency from savers to potential investors The result was an economic downturn

- Signs of the Financial Crisis:

 Commercial banks failed to return depositors' deposits

 Borrowers, including A-rated customers, were also unable to repay the bank's loans in full

 The government abandoned the fixed exchange rate regime

 Financial liberalization

 Weaknesses in the financial system, especially domestic banks

 Poor supervisory institutions

- Types of financial crisis:

 Banking crisis: When a series of customers want to withdraw their deposit to the bank before, the bank will have difficulty in lending The main source of loans of the bank is from customers' deposits Therefore, when a series of customers ask to withdraw their deposits, the bank is very likely to go bankrupt when the previous loan amount has not been recovered If this situation spreads, a crisis is likely to occur

 Crisis in financial markets: Because some government policies and speculative bubbles lead to

a crisis situation in the financial markets For example, when the state issues money to cover debts, or when people rush to buy certain financial goods to speculate

 World financial crisis: Countries with strong currencies have their currencies devalued Or the inability of a certain country to repay its national debts will cause a widespread currency crisis

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 Financial crisis in economic groups: The crisis occurred in economic groups due to the following reasons: incorrect investment, failure to recover the invested capital, failure to pay the loan, being affected by the general crisis

2 Overview of the economic crisis in the United States

Let take a glance at the United States -a country with a developed economy, which account for roughly 20% global economy (according to Business Insider posted on 22.6.2019) and back to 2007-2009which marked an important milestone in the US economy, especially in 2008 when approximately 84,000 US workers losing their jobs each month from January to September According to Investopedia, the financial crisis began as usual with good intentions but after deal with the bursting of the dot-com bubble, a series of corporate accounting scandals, and the September 11 terrorist attacks, the Federal Reserve lowered the federal funds rate from 6.5% in May 2000 to 1% in June 2003 in the purpose of boosting financial by creating the monetary available to the businesses and consumers at make a loan

or debt from the bank

The result was an upward in home prices because the debtor took advantage of the low mortgage rates Even subprime debtors who had lack of money or credit were able to perform the dream of buying a home The banks then sold those loans on to Wall Street banks, which packaged them into what was billed as low-risk financial instruments such as mortgage-backed securities and collateralized debt obligations (CDOs) Soon a big secondary market for originating and distributing subprime loans developed Fueling greater risk-taking among banks, the Securities and Exchange Commission (SEC)

in October 2004 relaxed the net capital requirements for five investment banks—Goldman Sachs (NYSE: GS), Merrill Lynch (NYSE: MER), Lehman Brothers, Bear Stearns, and Morgan Stanley (NYSE: MS) That freed them to leverage their initial investments by up to 30 times or even 40 times

3 Causes of the economic crisis

It’s can be said that the financial crisis in the US was from the collapse of Lehman Brothers bank on 15/09/2008 with the loan of roughly 619 billion USD has a stroke on both United States and worldwide financial According to the balance report, Lehman used a high-leverage business model that required it

to raise billions of dollars every day to open After the world financial crisis in 1997, many people no longer had confidence in their country's banking system, they considered the US a country with a stable financial background, so in 2002-2006 when monetary was cheap, and interest rates are very low so people are encouraged to consume and easy to get credit Therefore, people were excited to borrow money to buy a house This phenomenon led to the housing credit crisis Some semi-public banks in the real estate industry boldly lend money to make a profit, as is the case of two semi-public banks Fanny Mae and Freddie Mac

In mid-2006, when the US Federal Reserve Bank (FED) raised interest rates to hedge against inflation The investment bubble, real estate speculation began to burst because many people borrowed money beyond their means, now could not pay their debts and their houses were foreclosed on Only then did

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people discover that, among the debt packages in circulation, there were many "bad debts" it had invested heavily in high-risk real estate and subprime mortgages When these markets turned worse, Lehman couldn’t raise enough cash to stay in business

For more details according to the Financial News of BBC reports in October 2008:

 On 16/3/2008, Fed accepted JPMorgan Chase a loan of 30 billion dollars to acquire Bear Stearns

 On 7/9/ 2008, the United States government took over 2 banks named Freddie Mac and Fannie Mae

 Then in 15/9 Lehman brothers applied for bankruptcy with a loan roughly of 619 billion dollars, Bank of America accepted to repurchase Merrill Lynch with over 50 billion dollars

 Finally, on Sept 16, 2008, the Reserve Primary money market fund "broke the buck." That meant its shares, normally worth at least $1, were only worth $0.97.10 Investors lost confidence

in the money market fund when it announced losses of $785 million in Lehman’s commercial paper

 On Sept 18, 2008, Paulson and Bernanke met with congressional leaders to explain that credit markets were only a few days away from a meltdown They asked for $700 billion to bail out the banks, which would allow the Treasury Department to buy shares of troubled banks; It was the fastest way to inject capital into the frozen financial system

Therefore, from the bankrupt of Lehman Brothers, the finance of the US getting worse and worse therefore the economy begun a crisis Moreover, the financial crisis started from indirect and direct reason:

After the collapse of the Lehman Brothers bank, the US economy entered a difficult time The first factor started in 2001 Inflation slowed down and interest rates fell, especially after the 9/11 terrorist attacks But the current financial crisis also begins here That was the time when the Fed pumped money into the US economy and gradually reduced the basic interest rate from 3.5% a year in August

2001 to 1% in mid-2003.Monetary easing has generally made it easier to borrow money from banks and lower costs for the entire economy, but it has also devalued the currency and led to inflation Moreover, the Fed has kept interest rates so low for too long

The second factor is that low-interest loans stimulate home buying In 2006-2007, commercial and investment banks eased home loans for less reliable borrowers The Fed did not control these "double-edged sword"-like realities As a result, anyone can get a home loan, even if they are least able and even unable to repay the loan Low- interest rates caused many people to rush to buy houses, blowing

up the real estate "bubble" Rising house prices made banks feel safe to give money to those who could

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not pay their loans because banks assumed that, if borrowers defaulted, they would foreclose on their homes for their value pushed higher Things went fine as long as house prices kept going up, but once home prices peaked and started to fall, lending conditions tightened, and banks suddenly found themselves owning homes whose value is not enough to cover the value of the loan

The third factor is the answer to the question of why a powerful financial system is in trouble when real estate credits (formed by home loans) in the financial market the US itself is only about 500 billion USD - a small number compared to the capacity of the market?

To answer the above question, many economists analyze: First of all, we have to start explaining leverage in the business When the business is profitable, anyone can think of borrowing more money

to develop the operation This is called the leverage effect of borrowed money But when borrowing, there must be something as collateral In the U.S financial system, this security is often a package of debt or a note that stipulates that an asset will become liquid, cash, at maturity

Imagine that the debt package is a "cocoon" with many layers, inside containing many types of real estate credit debt The real estate finance company took a commission from the customer after taking the note, they sold the deed to another financial group This consortium gathers those debentures into packages like a cocoon, inside there are all kinds of bad and good and uses them as collateral to borrow more money to continue doing business in other fields Banks and financial investment complexes have exchanged these "rotten cocoons" in tangled relationships like silk without being able to know exactly how bad and good inside The bank's balance sheets were filled with mortgages, encircled in complex forms that made risk assessment extremely difficult Firms that specialize in asset valuations are also dubious and are bullish on valuations

When home prices peak, loans slow down and home prices start to fall The housing "bubble" burst

in the last months of 2007 and banks with large mortgages were forced to publish reports of huge losses After seeing the true value of the property they hold, no one wants to embrace those "rotten cocoons" anymore The real estate credit crisis that led to the crisis of the debt market is the bond market As a result, illiquid banks or financial institutions fall into a situation known as a technical default - having assets that can't be converted to cash because they're outstanding In addition to the panic of the people, because they are afraid that the bank will default, their deposit will be lost, so they pull together to withdraw money, leading to bank bankruptcy as in the case of Bear Stearns- the first-class bank in US financial market The Fed's easing monetary policy, which began late last year to avoid an economic slowdown, has now caused inflation, not helping the US economy recover Oil, food, and gold prices rose to historic highs and the dollar also depreciated to unprecedented levels Many analysts believe that if the monetary policy continues to accelerate, it will not be able to prevent the risk of collapse, but will also create a situation of inflation and economic decline

4 Impacts

4.1 Financial impacts

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The biggest and heaviest consequence is to destroy the productive forces and push back the development of the world economy First of all, for the United States In the United States, the financial crisis turned into an economic crisis, production declined, unemployment increased, thus being considered a "3 in 1" crisis The crisis bankrupted a series of banks and financial companies, including leading banks and financial companies in the United States Bear Stearns - one of the leading securities brokerages and investment banking groups on Wall Street, has been operating for 85 years in the US financial market, suffered heavy losses when the housing market fell, on March 16 2008 declared bankruptcy, was bought by Morgan Chase for $2 a share Lehman Brothers, the fourth-largest investment bank on Wall Street with 158 years of operation, on September 15 2008 had to file for bankruptcy protection due to losses, total debt amounting to $ 768 billion Bankruptcy losses also occurred with a series of other large banks and financial companies such as Indy Mac Bancorp Inc, Freddie Mac, and Fannie Mae, Merrill Lynch & Co, City Group, National Bank of Commerce, Bank of Clark Country

4.2 stock impacts

The US stock market wobbled, many stocks fell dramatically Before the bankruptcy, shares of Lehman Brother bank fell 94%, shares of Freddie and Fannie fell 90%; from the beginning of 2008 to March 2009, AIG's shares fell 79%; shares of City Group, Bank of America, Goldman Sachs fell more than 60%, etc All four important indexes of the US stock market, namely the Dow Jones, S&P 500, Nasdaq, and FTSE indexes all fell seriously, a dramatic decline The sharpest decline since the 1930s Production and consumption in the US also fell into a very difficult situation The auto industry, one of the most important manufacturing sectors in the U.S economy, saw sales plummet The top three American automakers, General Motors, Ford, and Chrysler, all suffered heavy losses In January 2008, Nortel Networks Corp, one of the largest telecommunications equipment corporations in the US, in February 2008, Lyondell Chemical, one of the largest chemical manufacturers in the US, had to file the insurance claim After the financial crisis, the agencies had to change their policies after the economic recovery Because large corporations are affected, they have to change their policies on employees, human resources and reduce production output to limit losses Since then, the problem of unemployment has become a concern

4.3 Unemployed

According to the report of the US Department of Labor, unemployed workers are mainly concentrated in the service sector, accounting for 80% of the labor force, with 273 thousand people, followed by the manufacturing and manufacturing sectors (149 thousand people) due to the bad impact

of the automobile manufacturing industry, the construction industry (101 thousand people), the retail sector (67 thousand people) Some fortunate people were not fired, but their working hours were reduced In December 2008, the average number of hours worked per week for American workers fell 0.2 hours to 33.3 hours, the lowest level since the index was introduced in 1964 The rapid increase of Unemployment in this country has surprised many economists In fact, the unemployment rate in 2008

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was 0.2% higher than economists predicted Unemployment increased due to the economic recession,

on the contrary, the unemployment rate also created a negative impact on the US economy According

to the financial report, the economic recession and a serious decline in consumption caused a series of large US retail companies such as Circuit City Store Inc, Sharper Image Corp, Steve & Barry's LLC, Macy Inc, Ann Taylor Stores Inc … go bankrupt or file for bankruptcy protection Production stagnation, layoffs caused the unemployment rate in the US to increase month by month and reach a 25-year high, from 2.59 million people in 2007 to 3.84 million people in 2008 and 4.61 million people

2008 in February 2009

From the US, the crisis has shaken the financial market, the stock market, bankrupted many banks, financial companies, many large economic groups in many countries around the world, causing financial services to decline seriously reduced international trade, financial and investment relations, and the world economy in general Royal Bank (Scotland), Kaupthing, Landsbanki, Glitnir (Iceland), Northern Bank, mortgage lender Bradford & Bingley (UK), IKB Bank, DZ Bank, Deutsche Bank, Saxony LB (Germany), Yamato Life Insurance Co (Japan)… and many other banks were victims of the

US financial crisis, forced to seek help from the government or nationalized by the government

Research by the Asian Development Bank (ADB) shows that in 2008, the global economic crisis cost the world's total financial assets a loss of 50 trillion USD, of which developing countries in Asia were hit the hardest with total losses amounting to $9.6 trillion, which is higher than the total GDP

in a year for these countries Although only more than 20 countries have officially declared themselves

in recession, the reality is that most countries in the world are affected, experiencing difficulties and slowing growth to varying degrees According to a forecast of the World Bank (WB), in 2009, the world economy will grow by only 0.9%, the growth rate of OECD countries is -0.3% (in which, the US

is - 0 9%, euro area - 0.6%), the growth rate of emerging and developing economies is only 4.5%… World economic forecast of the International Monetary Fund, Organization for Economic Co-operation and Development (OECD), Citi Group, or Reuters also had a similar downward trend

Another consequence of the current global financial crisis and recession is the bankruptcy of the liberalizing economic policy that the United States has carried out for many years and wants to impose

on the world After the crisis, in the US and around the world, the economic policies of governments will be more balanced between market regulation and state regulation; the state's economic intervention and regulation in the economy will be more; The State's supervision over business activities of enterprises, especially the financial system, banking, and the stock market will be stricter than at present

From there we can see, the financial crisis caused the US to have heavy economic and employment consequences thereby posing challenges, forcing the US to seriously change its policies

4.4 The capital impacts

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According to the financial report, the economic recession and a serious decline in consumption caused a series of large US retail companies such as Circuit City Store Inc, Sharper Image Corp, Steve

& Barry's LLC, Macy Inc, Ann Taylor Stores Inc … go bankrupt or file for bankruptcy protection Production stagnation, layoffs caused the unemployment rate in the US to increase month by month and reach a 25-year high, from 2.59 million people in 2007 to 3.84 million people in 2008 and 4.61 million people 2008 in February 2009