The global financial crisis of 2008 is a situation that any individual will be familiar with, an event that shook the world and still having profound effects upon international economies worldwide. The causes of the financial crisis are subject to much debate amongst differing schools of economic thought. The most convincing arguments explain how financial deregulation, the US housing bubble and the use of financial innovation brought about the most comprehensive world recession since the great depression. The impacts of the financial crisis are widely reported as banks fail and global recession hits.
Causes of the Financial Crisis
Because of the magnitude and longevity of the financial crisis of 2008, much research has been conducted to the effect of establishing what exactly caused the financial crisis. There is much debate from differing macroeconomic schools about what contributed to the greatest recession in over 80 years. However it is largely agreed that some of the main causes that produced the financial crisis were; the US housing bubble, financial innovation and financial market deregulation.
The deregulation of financial markets in the United Kingdom and the United States began in the early 1980’s, triggering a process of gradual deregulation that lead up to the worst economic crisis since the Great Depression. Financial deregulation is the removal of or reduction in legal rules and regulations governing the activities of financial institutions (1). The use of regulation is needed, especially in financial markets, to protect the economy should markets malfunction and also to balance the interests of financial product suppliers and consumers.
The key deregulation of financial markets began with the Reagan administration in 1980. Legislation was passed that deregulated savings and loan companies in 1982, with the support of economists and financial lobbyists. Consequently, savings and loan companies were able to use depositors’ money to make investments, whereas traditionally, the investment banking was supported by partners own funds. As a result hundreds of savings and loan companies failed and by the end of the 1980’s the failure of the companies had directly cost the taxpayer $124 billion dollars (2).
Nearly two decades later in 1999, the United States Congress repealed the Glass-Steagall law after repeated lobbying by the financial sector caused by the Citicorp and Travelers merger. The Financial Services Modernization Act or alternatively the Gramm-Leach-Bliley Regulation that had required the separation of commercial and investment banking was rescinded. Subsequently, large commercial banks were able to buy and merge with investment banks and then utilise their customer’s deposits for risky investment purposes. The abolition of the Glass-Steagall act has garnered much attention in the debate surrounding the causes of the 2008 financial crisis. Some critics and economists have hailed it as the pivotal measure that produced the recession although others have even denied it had any effect. Nobel Prize winner Joesph Stiglitz noted that the measure to allow commercial and investment banks to merge ultimately transformed the cultures surrounding different types of banking. Writing for Vanity Fair magazine Stiglitz commented; “When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risk-taking”(3). According to Stiglitz the pertinence of the Gramm-Leach-Bliley to the 2008 economic crisis is a newfound culture in big commercial banks for high returns and maximisation of short-term profits.
Deregulation was also rife in the UK in the 1980’s, the Government under Margaret Thatcher was modernising banking regulation in the UK. The UK Building Societies Act of 1986 sought to reduce the monopoly power on mortgages