Adams
It is difficult to predict about what is going to happen in the future, inevitably, because of uncertainty, likewise how long the Global Financial Crisis will last. The U.S. subprime crisis became worldwide and lead to a recall of the previous crises, like the 1998 Asian Financial Crisis and further, date back to the Great Depression in 1929.
The present crisis bears little resemblance to that of the 1929, fortunately according to Ben Bernanke`s analysis about Great Depression: Ben Bernanke (1983), "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression", the crisis that time was unleashed by a collapse of production and consumption, amplified by a drastic reduction in credit supply (the Fed failed to act as lender of last resort). Nonetheless, the only one aspect that no one can neglect (about the similarity) is that its epicentre is the United States.
The credit market froze, the global economy is in a downturn spiral and no one guarantees that the remedies for the crisis, which is being taken right now, is working to reverse the movement effectively or just to protect the economy from getting worse. Amid the crisis, it is useful to disentangle the causes of the crisis. According to a paper written by Tito Boeri and Luigi Guiso, August 23, 2007, there are 3 factors that contribute to the outburst of subprime mortgage crisis worldwide.
First, low financial literacy is one factor. Only 66.66% of Americans know the law of compound interest, this problem happens not only in financially backward countries but also in the U.S., and merely 50% of them are familiar with the effects of inflation on the costs of indebtedness. Because of low financial literacy of people, banks and intermediaries have advised their clients to invest in financial assets ill-suited to their ability to bear risk, they exploited those American financial illiteracy.
Second, the financial innovation during the last 10 years and the securitization that it produced. Indeed, the advantage is that by making an illiquid credit liquid, the efficiency gain; longer-term positions and higher return for investors is achieved. However, those innovation and securitization weaken the incentives of banks and financial intermediaries to monitor the behaviour of the original borrower or to screen them carefully.
The last factor is, according to Tito Boeri and Luigi Guiso, the legacy of the "central banker of the century, Alan Greenspan". In response to the 1998 Asian financial crisis and the post 9/11 recession, the monetary policy of low interest rates was introduced by Greenspan. The short-term interest rates was set at 1% and was maintained in the next few years at levels significantly below equilibrium.
The interest rates of 1%, lowest level in 50 years, resulted in low returns on traditional investments and pushed investors, lenders, and financial intermediaries to take bigger risks to get better returns (reallocation of portfolios towards more lucrative but riskier assets). Simultaneously, mortgage loan increased, house prices appreciated, ultimately encouraging the additional extension of credit; the home value of real estate seemed almost guaranteed.
The financial instability comes along with the short-term movement of interest rates. If the interest rates have been unusually low for a long time, and then return even just to its normal levels , the critical moment that the bankers or policymakers have to consider happens. To put it simply, wide and fast variations from low to high interest rates have a minus impact on financial stability.
Some economists, analysts, scholars, and students who study economics argued that without Greenspan`s monetary policy, the present crisis probably would have never occurred. To me, they are maybe right, but maybe wrong, because this kind crisis happens once in a century, the future is invisible for mankind. Nobody knows what is going to happen, uncertainty makes life a meaningful one, nevertheless.
(Source: The subprime crisis: Greenspan`s legacy by Tito Boeri and Luigi Guiso, an article of Section 1: Why Did the Crisis Happen?, page 37~39)
The present crisis bears little resemblance to that of the 1929, fortunately according to Ben Bernanke`s analysis about Great Depression: Ben Bernanke (1983), "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression", the crisis that time was unleashed by a collapse of production and consumption, amplified by a drastic reduction in credit supply (the Fed failed to act as lender of last resort). Nonetheless, the only one aspect that no one can neglect (about the similarity) is that its epicentre is the United States.
The credit market froze, the global economy is in a downturn spiral and no one guarantees that the remedies for the crisis, which is being taken right now, is working to reverse the movement effectively or just to protect the economy from getting worse. Amid the crisis, it is useful to disentangle the causes of the crisis. According to a paper written by Tito Boeri and Luigi Guiso, August 23, 2007, there are 3 factors that contribute to the outburst of subprime mortgage crisis worldwide.
First, low financial literacy is one factor. Only 66.66% of Americans know the law of compound interest, this problem happens not only in financially backward countries but also in the U.S., and merely 50% of them are familiar with the effects of inflation on the costs of indebtedness. Because of low financial literacy of people, banks and intermediaries have advised their clients to invest in financial assets ill-suited to their ability to bear risk, they exploited those American financial illiteracy.
Second, the financial innovation during the last 10 years and the securitization that it produced. Indeed, the advantage is that by making an illiquid credit liquid, the efficiency gain; longer-term positions and higher return for investors is achieved. However, those innovation and securitization weaken the incentives of banks and financial intermediaries to monitor the behaviour of the original borrower or to screen them carefully.
The last factor is, according to Tito Boeri and Luigi Guiso, the legacy of the "central banker of the century, Alan Greenspan". In response to the 1998 Asian financial crisis and the post 9/11 recession, the monetary policy of low interest rates was introduced by Greenspan. The short-term interest rates was set at 1% and was maintained in the next few years at levels significantly below equilibrium.
The interest rates of 1%, lowest level in 50 years, resulted in low returns on traditional investments and pushed investors, lenders, and financial intermediaries to take bigger risks to get better returns (reallocation of portfolios towards more lucrative but riskier assets). Simultaneously, mortgage loan increased, house prices appreciated, ultimately encouraging the additional extension of credit; the home value of real estate seemed almost guaranteed.
The financial instability comes along with the short-term movement of interest rates. If the interest rates have been unusually low for a long time, and then return even just to its normal levels , the critical moment that the bankers or policymakers have to consider happens. To put it simply, wide and fast variations from low to high interest rates have a minus impact on financial stability.
Some economists, analysts, scholars, and students who study economics argued that without Greenspan`s monetary policy, the present crisis probably would have never occurred. To me, they are maybe right, but maybe wrong, because this kind crisis happens once in a century, the future is invisible for mankind. Nobody knows what is going to happen, uncertainty makes life a meaningful one, nevertheless.
(Source: The subprime crisis: Greenspan`s legacy by Tito Boeri and Luigi Guiso, an article of Section 1: Why Did the Crisis Happen?, page 37~39)
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