–Shantnu Bansal (Class of 2022, IBS Hyderabad)
On September 15th, we will mark the twelfth anniversary of the collapse of the investment bank, Lehman Brothers, which foretold the world’s most fathomless and colossal economic and financial crisis, namely the Great Recession or the Global Financial Crisis since the Great Depression of 1929. It drove the world’s banking system towards the verge of collapsing. £90 bn eroded from Britain’s biggest company in a single day and even the cash machines ran out. This verifies the degree of fear and uncertainty in the minds of people all around the world. Innumerous people lost their jobs, roughly 2.5 million businesses were devastated, and approximately four million homes were foreclosed. From food insecurity to income inequality, many had lost faith in the system.
Now over a decade later, many are still wondering what has changed and more importantly, how this type of economic disaster can be avoided in the future. It’s difficult to define the exact cause but the collapse of the American housing market was one of the greatest factors. It started a chain reaction that led to the bankruptcy of the Lehman Brothers firm and soon had the crippling effect on the American and European economies.
Scenario in the early 2000s
Interest rates were so low that many Americans borrowed money to buy houses causing house prices to increase rapidly. This episode is known as the U.S. housing bubble and lasted until early 2006 when house prices peaked. The burst of that bubble is considered one of the main causes of the Great Recession. It started as a crisis in the subprime mortgage market and slowly snowballed into a global collapse. The world economy experienced plummeting house prices and a sharp increase in the unemployment rates at 10% in 2009 and only recovered to pre-crisis levels in 2016.
The recession officially ended in 2009 but its immediate effects last much longer than that. The crisis brought the bank’s potential shortcomings tonight for the first time for millions of people around the world.
Today’s crisis
The crisis is a reminder that policy matters. The events of 2008 were essentially caused by the decisions made years before by the regulators, politicians and policymakers. It’s been a decade since the crisis and regulators insist that the global financial system has been altered since then. They say that safety measures have been enhanced and the current system is stronger. Some problems have indeed been solved but concerns are still looming.
Probability of crisis occurring
Well, the short answer is yes. Even though a lot has changed and many new rules are being enforced, the financial system is still managed by the same governing bodies and power is still highly centralized. Many banks are offering high-risk loans once again and although the default rates are low today, that could change very quickly.
With fiat currencies like dollar and pound, the amount of money in circulation increases unpredictably because central banks and governments can decide when to make new money but when the money supply increases too fast, nations may be subjected to economic disasters caused by hyperinflation.
Alternative solution
In 2008, as the world was feeling the shock of the financial crisis, a solution to many of the issues with the existing system was being devised. Bitcoin, unlike, fiat currencies, is decentralized. This means it’s not controlled by governments or central banks. Instead, the creation of new coins is determined by protocol, a predefined set of rules.
Although it has been a decade since the catastrophe, people have not forgotten how vulnerable the banking system is. The suspicion remains but this is probably one of the reasons that led to the creation of cryptocurrencies.
Reference: https://www.americanprogress.org/issues/economy/reports/2017/04/13/430424/2008-housing-crisis/
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Well Written