ECON 501

Homework # 2

Presented By
Mai Hamad Al-Binali
55789/1998
 In January 2008, the United States began showing signs of a weakening economy. The
prior years of bad mortgage investments created by the lenient credit practices finally began to
catch up with investors. Credit markets that had traditionally been shut off from previous clients
began to get lax on their terms and home ownership was broadened. The loose credit practices in
the credit markets also created a vast increase in the amount of credit borrowed by homeowners.
The quickly rising home prices lured some homeowners to take out loans based on the
assumption that the increase in home prices would last a long time. However, house prices did
not continue to rise and eventually leveled off; causing a massive increase in defaults and late
payments in subprime mortgages. The effect of this was soon felt by mortgage-backed securities
whose value dropped which in turned caused what has now been described as, the worst
financial and macroeconomic crisis since the Great Depression.

In early 2008, the first signs of the mortgage crisis began as the homes sales started to
drop dramatically. The first bank to publically remark on the housing market was the HSBC;
which predicted in February 2008 that it would suffer larger than anticipated losses from the
rising default and subprime mortgages in the United States. Their prediction would soon come to
fruition, as 2008 proved to be a devastating year for many investors.

In April 2008, New Century Financial a top subprime mortgage lender files for
bankruptcy and cut 3,200 jobs. The devastation soon spread to hedge funds as they were then
forced to dump their bad assets. Two of the large hedge funds were run by Bear Stearns. Soon
turmoil felt in the credit markets begins to be felt by Wall Street, as five of the top 3 investment
banks would end up failing. In May, 2008 investment bank Bear Stearns is purchased with the
help of the Federal Reserve and JP Morgan at $10 a share. In September 2008, the Federal
government announces it will take over Fannie Mae and Freddie Mac. The companies were
previously US’s largest purchaser of mortgages from banks. This proved devastating for Lehman
Brothers as their stock soon dropped due to the bad debt bought as securities.

Shortly following the collapse of Lehman Brothers, AIG the largest insurer for
companies that purchased mortgage-backed securities announced its collapse. The government
would soon intervene by giving AIG 150 billion from the treasury. Its collapse was feared by the
government to have far-reaching effects. Following the devastating collapses of major banks, the
Dow Jones reacts drastically.

In October 2008, the U.S. senate approves a 700 billion bailout bill that would buy the
tarnished assets by creating The Asset Relief Program (TRAP). The government hoped that this
would help the financial sector regain its strength by allowing the financial institutions to sell the
assets to decrease their debt to capital ratios. This in return, would help improve their financial
situation and increase investor confidence in the institutions and, markets. Another important
goal of TARP was to create incentives for banks to begin lending to each other, consumers and
businesses.

As 2008 comes to a close, our financial crisis becomes global as other economies begin
to show signs of financial stress. Our banking institutions are closely linked to other countries.
According to the International Monetary Fund, “Emerging economies are now so closely
integrated with advanced economies that financial stress transmits rapidly and forcefully, with
financial linkages a key channel of transmission.” The US mortgage crisis, started to effect
European economies. Western banks had previously controlled lending to other emerging
economies, with emerging European countries as the main recipient of bank lending flows. The
drought of capital inflows has affected many emerging European economies.

During 2008, Asian countries began to report a drop in their GDP. Southeast Asia
suffered extensive unemployment as labor-intensive export jobs such as construction, farming
garment workers and tourism were cut. China which had previously allowed its currency to
appreciate along with the American dollar faced an economic crisis as the American dollar began
to depreciate. The Chinese government acted by artificially cheapening the renminbi or the
standard Chinese currency. The Chinese central bank head, Zhou Xiaochuan stated in a 2010
conference, that the pegging of the renminbi to the American dollar was a special foreign
exchange mechanism used to respond to the world financial crisis.

China’s currency stabilization along with a large stimulus program began to take effect
in 2009. In 2009, the Chinese economic growth exceeded the 8 percent target set up by the
government. The Chinese economy is beginning to recover yet there are concerns over the
artificially low currency. President Obama has addressed concerns with this by explaining that
while the Chinese exports remain cheap, competing companies cannot compete with the
artificially low prices. Some economists have blasted China for not taking into consideration
other countries that cannot compete with china’s foreign trade.

Latin Countries also suffered from the economic crisis due to the developing close ties
with America. Mexico which depended heavily on the US for manufacturing trade was hit hard
by the recession, suffering a negative change rate in their GDP growth of over 10% . Exports all
over Latin America began to fall; Venezuela which depended on oil as their main export was hit
hardest with a 42% fall in exports. The economic crisis was especially hard on Mexico because
the US provided half of all foreign Mexican investments and buys 85% of its exports which
provided jobs for millions of Mexicans.

The global economic crisis hit Greece’s financial system as well. When our economic
crisis spread Greece was left vulnerable due to years of lax financial regulation, unrestrained
spending and cheap lending. With a national debt now bigger than the country’s economy,
Greece’s credit rating sunk to an all time low and left it unable to pay its debt. Investors were
unwilling to invest in Greece. Some economists are worried that Greece will need to be bailed
out further damaging the Euro’s reputation. Germany as well as 16 other countries have stepped
up offered a rescue plan that involves spending around 20 billion Euros to help out Greece.

In Qatar, the effect of the global economic crisis was felt mostly in the real state sector,
with too much supply and less demand prices dropped sharply. In the hydrocarbon sector (oil and
gas) the effect was felt in financing major project due to the west’s banking crisis. However by
2010 this effect is reducing gradually and coupled with recovering oil prices, Qatar’s economy is
recovering.

In April 2009, members of the word’s 20 leading economies met at London for the G-20
Summit. Economic issues were to be addressed and an action plan to revive the global economy
was to take place. Major goals were to be set including a 1 trillion dollar pledge to help out the
global economy. A pledge for financial regulation and fairness in the competition of financial
executives was made. Global governments are taking action to try to restore economies
devastated by the US banking crisis. Rescue plans including the newly enacted Eurozone rescue
set to restore the Euro have gone into effect. It is clear that economic stability will be a long and
difficult process but global governments are willing to keep working to stabilize their economies.
References

Subprime Crisis a Timeline. CnnMoney (September 2008) Web (May, 2010)

Gerardi, K, Goette Lorenz and Meier, Stephen. Financial Literacy and Subprime
Mortgage Delinquency:Evidence from a Survey Matched to Administrative Data. April 2010
Federal Reserve Bank of Atlanta, Research Department.

US Energy Information Administration Independent Statistics and Analyisis. (May 2009)

Wines, Michael. New York Times, (March 2010) “China’s Bank Chief Says Currency Is Unlikely
to Rise”

Nothwehr, Erin. Emergency Economic Stabilization Act of 2008 The University of Iowa Center
for International Finance and Development (December 2008)

Rapid Spread of Crisis Reflects Close Global Economic Ties. IMF (April 2009) Web.(May,
2010) http://www.imf.org/external/pubs/ft/survey/so/2009/res041609a.htm

Green, Duncan, King, Richard and Miller-Dawkins, May. The Global economic crisis in
developing countries. Oxfarm Research Report (January 2010)

La Botz, Dan. Financial Crisis Hits Mexico: Social Crisis on the Horizon? Monthly review,
August 2008.

Greece’s Financial Crisis Explained. (May 2010) Web.( May 2010)