Hailey College of Commerce

Subject:
Introduction to Finance
Submitted by:
Tayyaba Tariq
Roll No:
BSAF20-028
Section:
A
Submitted to:
Sir Sarfaraz Khalil
 Global Financial Crisis of 2007-08
Financial crisis of 2007-08 is also called Subprime mortgage crisis, severe contraction of
liquidity in global financial market that originated in United States as a result of collapse of U.S
housing market. It threatened to destroy the international financial system, caused the failure of
several major investment and commercial banks, mortgage lenders, insurance companies, and
saving and loans associations, and precipitated the Great Recession (2007-09), the worst
economic downturn.
Causes:
The precipitating factor for the Financial crisis of 2007-08 was the bursting of the United States
Housing bubbles and the subsequent subprime mortgage crisis, which occurred due to high
default rates. Some or all other factors that contribute to crisis are as follow:
 The immediate cause that has been attributed to the collapse of real estate market in
United States and the resulting real estate loan (mortgage) defaults. When the markets for
real estate began to falter in 2006, many of the homebuyers with subprime mortgage
began to default. As the economy contracted during the recession, people lost their jobs
and could no longer make their mortgage loan payments, resulting in even more defaults.
 To enhance the problem, securitization provides liquidity to the mortgage market and
make it possible for banks to loan more money to homebuyers.
 Widespread failure in financial regulations and supervision, dramatic failure of corporate
governance and risk management at many systematically important financial institutions,
including too many financial firms acting recklessly and taking too much risk.
 Combination of excessive borrowing, risky investments, and lack of transparency by
financial institutions and by households that put the financial system on a collision course
with crisis.
 The default rates by homeowners, particularly those with subprime credit, led to a rapid
devaluation of mortgage-backed securities including bundled loan portfolios, derivatives
and credit default swaps. As the value of these assets plummeted, buyers for these
securities evaporated and banks who were heavily invested in these assets began to
experience a liquidity crisis.
 Credit rating agencies and investors failed to accurately price the financial risk involved
with mortgage loan and governments did not adjust their regulatory practices to address
changes in financial markets.
 As banks began to give out more loans to potential home owners, housing prices began to
rise. Lax lending standards and rising real estate prices also contributed to the real estate
bubble. Loans of various types (mortgage, credit card, and auto) were easy to obtain and
consumers assumed an unprecedented debt load.
 Mortgage backed securities and collateralized debt obligations which derived their value
from mortgage payments and housing prices, greatly increased. Such financial innovation
 enabled institutions and investors to invest in the U.S. housing market. As housing prices
declined, these investors reported significant losses.
 Falling prices also resulted in homes worth less than the mortgage loans, providing
borrowers with a financial incentive to enter foreclosure
 Financial institutions, assumed debt burdens while providing the loans and did not have a
financial cushion sufficient to absorb large loan defaults or losses. These losses affected
the ability of financial institutions to lend, slowing economic activity.

Effects of crisis:

10 years after the start of the financial crisis, the country’s gross domestic profit was
approximately 7 percent lower than it would have been had the crisis not occurred,
representing a loss of $70,000 in lifetime income for every American. Approximately 7.5
million jobs were lost between 2007 and 2009, representing a doubling of
the unemployment rates, which stood at nearly 10 percent in 2010. Although the
economy slowly added jobs after the start of the recovery in 2009, reducing the
unemployment rate to 3.9 percent in 2018, many of the added jobs were lower paying and
less secure than the ones that had been lost. Those who had suffered the most, the
millions of families who lost their homes, businesses, or savings; the millions of workers
who lost their jobs and faced long-term unemployment; the millions of people who fell
into poverty.