The Global Financial Crisis (GFC).
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Reflect on our class discussion and documentary regarding the Global Financial Crisis (GFC). Explain the
sequence of events that lead to the GFC. If you could remove one events in this sequence, do you
believe the Global Financial Crisis would have still happened?
Now, think about your country of origin (i.e., China, India, Bangladesh, etc…). Do you think this same
sequence could cause a crisis there? Would removing the same event have the same expected impact as
in the case of the US economy?
Sample Solution
The Global Financial Crisis (GFC) was a major economic downturn that occurred from 2007-2008 which had far reaching effects on economies around the world. The sequence of events leading up to the GFC includes a variety of factors; however, some of the key drivers can be traced back to certain policies and activities in the US housing sector prior to 2006. This began with government policies encouraging relaxed lending standards for homeownership including interest only loans and adjustable rate mortgages (ARMs). These measures enabled many lower-income households with less than perfect credit scores to access home ownership opportunities who otherwise would have been excluded from traditional loan products.
This period also saw a rapid expansion in mortgage backed securities (MBSs) whereby assets such as these were bundled together and sold off by banks, allowing them to take advantage of higher returns than those available through traditional savings accounts. At this time ratings agencies, who were responsible for assessing the riskiness of such investments based on their underlying components, gave MBSs high marks due to limited defaults seen in recent history which led investors to believe they were low risk compared to other securities.
However, when defaults began rising sharply starting in 2006 due largely because borrowers had taken out ARMs whose rates had increased significantly it triggered a chain reaction which resulted in losses for many financial institutions holding large amounts of MBSs and ultimately culminated in one of worst recessions since the Great Depression.
In my opinion if one event could be removed from this sequence I would say it is important that there was more effective oversight over both lenders’ practices as well as ratings agencies ensuring that lending standards remained tight even during periods where demand was high while still allowing individuals with poorer credit scores access home ownership opportunities. Had these measures been implemented effectively then I do believe we could have avoided at least some aspects of what transpired during the GFC such as severe losses incurred by banks due to risky investment decisions driven by overly optimistic assessments about their underlying assets.
