FINANCAIL MARKETS AND INSTITUTIONS

SUBMITTED BY
FARIHA ZAFAR

ROLL NO
2021-BCOM-020

SUBMITTED TO
MS. NADIA JAMEEL

Overview of the Global Financial Crisis

The 2008 Global Financial Crisis (GFC) was one of the most significant economic
downturns in modern history, causing a ripple effect that devastated economies
worldwide. To fully understand its impact, recovery measures, and prevention
strategies, let's break it down in more detail.

1. How the Crisis Affected Economies:

The financial crisis of 2008 began in the United States, but its effects quickly spread
across the globe. Here’s how it unfolded and affected economies:

U.S. Housing Market Crash: The crisis originated from the U.S. housing bubble,
where property prices were rising unsustainably. Banks and financial institutions had
been providing loans to people with low creditworthiness, called *subprime
mortgages. These loans were bundled into complex financial products called
mortgage-backed securities (MBS) and sold to investors globally. When housing
prices collapsed, many homeowners defaulted on their loans, leading to massive
losses for investors and financial institutions holding these securities.

Bank Failures and Bailouts: In the U.S., some major financial institutions
collapsed. The most notable was the bankruptcy of “Lehman Brothers”, one of the
largest investment banks. Others, like Bear Stearns and AIG, had to be rescued by
government intervention. The crisis caused a credit crunch as banks stopped lending
due to fears of bad debts, which in turn impacted businesses and consumers.

Stock Market Crashes: The panic from financial institutions’ failures led to a
massive sell-off in global stock markets. Trillions of dollars in wealth were wiped out
as stock indices in the U.S., Europe, and Asia plummeted.

Recessions Across Economies: As the financial sector faltered, so did businesses

dependent on credit. This led to massive layoffs, reduced consumer spending, and a
sharp contraction in economic activity. In the U.S., GDP contracted by 4.3% from the
peak in 2007 to the trough in 2009, marking the worst recession since the Great
Depression. Many European economies also went into recession, with some, like
Greece and Ireland, facing severe debt crises.

Global Trade Slowdown: As consumer demand collapsed, so did global trade.

Major exporters like China, Germany, and Japan saw their economies slow due to
decreased demand for their goods. Developing countries faced reduced foreign
investment and weaker demand for commodities.

2. Economies Most Affected and Their Aftereffects:

The crisis had varying impacts on different economies, depending on their exposure
to global financial markets and how integrated they were into the global banking
system.

United States

The U.S. was at the heart of the crisis, and its economy suffered deeply:

Unemployment: At the height of the crisis, unemployment in the U.S. surged to 10%
as businesses closed or reduced their workforce.

Foreclosures: Millions of Americans lost their homes due to foreclosure, with housing
prices dropping dramatically.

Financial Sector Collapse: Major financial institutions like Lehman Brothers failed,
while others like Bank of America, Citigroup, and Goldman Sachs required massive
government bailouts.

GDP Decline: The U.S. economy shrank by about 4.3% from 2007 to 2009. It took
several years for GDP growth to return to pre-crisis levels.

European Union
The European Union (EU) was also significantly impacted due to its financial links to
the U.S. and its own internal vulnerabilities:
Banking Crisis: European banks, like those in the U.S., had invested heavily in U.S.
mortgage-backed securities and faced huge losses. This led to banking collapses,
especially in countries like Ireland and the UK.

Sovereign Debt Crises: The financial strain in Europe exposed underlying fiscal
weaknesses in countries like Greece, Italy, Portugal, and Spain. Greece, in
particular, was unable to repay its debt and required massive bailout packages from
the EU and International Monetary Fund (IMF). Other countries like Ireland and
Portugal also needed bailout assistance.

Austerity Measures: Many European countries had to implement strict austerity

measures, including deep budget cuts and tax increases, to stabilize their
economies. This led to social unrest and long-term economic stagnation in some
countries.

Iceland

Iceland’s banking system collapsed entirely, with its three largest banks failing in
2008 due to their overexpansion into foreign markets. Iceland’s economy contracted
severely, and the government had to seek an IMF bailout.

Emerging Economies

Emerging markets like China, India, and Brazil were affected, but less severely.
While these economies faced a slowdown due to reduced demand for exports and
commodities, they did not experience the same financial turmoil as the U.S. or
Europe. China, in particular, was able to maintain growth through a massive
domestic stimulus program.

3. How Economies Recovered

The recovery from the 2008 crisis was long and uneven, with different countries
taking different approaches. Some of the key strategies included:

United States
Monetary Easing: The U.S. Federal Reserve cut interest rates to near zero and
introduced *quantitative easing (QE). QE involved the Fed buying large amounts of
government bonds and mortgage-backed securities to inject liquidity into the
financial system. This helped stabilize banks, reduce borrowing costs, and
encourage lending.

Government Stimulus: The U.S. government, under the Obama administration,

passed the *American Recovery and Reinvestment Act (ARRA) in 2009, which
included a $787 billion stimulus package. This aimed to create jobs, invest in
infrastructure, and provide tax relief to stimulate demand.

Banking Reforms: The *Dodd-Frank Wall Street Reform and Consumer Protection
Act was passed in 2010 to prevent future financial crises. It imposed stricter
regulations on banks, increased oversight of financial markets, and created the
Consumer Financial Protection Bureau (CFPB) to protect consumers from predatory
lending practices.

European Union

Austerity and Bailouts: In Europe, countries like Greece, Ireland, and Portugal had to
implement harsh austerity measures in return for bailout packages from the EU and
IMF. These measures included cutting government spending, raising taxes, and
reforming pension systems.

European Central Bank (ECB) Intervention: The ECB launched its own QE program
and reduced interest rates to stimulate the Eurozone economy. It also provided loans
to struggling banks to prevent their collapse.

Reforms: The EU implemented banking reforms, including the creation of a

*banking union with centralized oversight of banks in the Eurozone to prevent future
financial instability.
Emerging Economies

China, in particular, launched a massive $586 billion stimulus package to boost

domestic consumption and infrastructure development. This helped cushion the
global economy by maintaining demand for commodities and manufactured goods.

4. Preventing Future Scandals

To prevent a repeat of the 2008 crisis, many countries introduced significant

regulatory reforms:

Stricter Banking Regulations: Global financial regulations were tightened,

including the introduction of *Basel III standards, which required banks to hold more
capital and reduce their risk exposure.

Stress Testing: Banks in the U.S., Europe, and elsewhere are now regularly
subjected to *stress tests to assess their ability to withstand financial shocks.

Consumer Protections: The Dodd-Frank Act and similar legislation in other

countries introduced stronger protections for consumers, including more transparent
lending practices and limits on predatory lending.

5. Why Pakistan Was Not Affected Badly

Pakistan’s economy was relatively insulated from the 2008 financial crisis for several
reasons:

Limited Financial Integration: Pakistan's banking sector had minimal exposure to

the complex financial instruments, like mortgage-backed securities, that caused the
crisis in the U.S. and Europe.

Domestic Focus: Pakistan’s economy was primarily domestic-focused, with sectors

like agriculture and manufacturing playing a more significant role than global
financial markets.
Low Foreign Investment: While foreign direct investment (FDI) plays a role in
Pakistan’s economy, it is relatively small compared to developed countries. This
reduced Pakistan’s vulnerability to the global credit crunch.

Stable Banking Sector: Pakistani banks were not deeply involved in the global
financial market and were well-regulated, so they did not face the same risks as
banks in the U.S. or Europe.

6. U.S. Mortgage Crisis and Economic Collapse

The U.S. housing market collapse was the primary trigger for the 2008 financial
crisis. Here’s a deeper look at how it happened:

Subprime Lending: Banks in the U.S. provided mortgages to high-risk borrowers

(subprime borrowers), often with little regard for their ability to repay. These loans
were bundled into *mortgage-backed securities (MBS) and sold to investors.

Housing Bubble: During the early 2000s, housing prices in the U.S. rose
dramatically. This created a bubble, as people believed prices would continue to rise
indefinitely.

Collapse of the Bubble: When housing prices began to fall, many borrowers could
not repay their loans, leading to massive defaults. This caused the value of
mortgage-backed securities to plummet, leading to huge losses for banks and
investors worldwide.

Systemic Risk: The collapse of Lehman Brothers and other major financial
institutions led to panic, as the interconnectedness of global financial markets
caused the crisis to spread. This resulted in a massive economic contraction.

Conclusion
The 2008 financial crisis caused widespread economic damage, primarily due to the
collapse of the U.S. housing market and the financial sector’s exposure to risky
mortgage-backed securities. While countries like the U.S. and Europe faced deep
recessions and banking crises, other nations like