The global economic crisis of 2008: a review of the causes

The global economic crisis of 2008 is the crisis that began as the U.S. "subprime" crisis in the summer of 2007 but ended up spreading to a number of other advanced nations through their direct exposure to U.S. subprime assets, loss of confidence in asset valuation, and the drying up of wholesale financial markets (Althingi Special Investigation Commission, 2010; Blundell-Wignall et al., 2008; Norberg, 2009; Reinhart and Rogoff, 2008). This crisis exposed the "home-grown" financial imbalances existing in a number of countries, which are normally the result of overreliance on funding wholesale purchases by the banking sector and asset bubbles in the residential property markets. This crisis was caused by numerous factors that include:

Deregulation: deregulation was a major cause of the global financial crisis, and as Robert (2008) noted, five distinctive regulatory failures led to the 2008 Great Economic Recession. These regulatory failures include the failure to manage the U.S. trade deficit. The housing bubble was fueled by cheap credits with low interest rates (people wanted to own more credits). Secondly, the government also failed to intervene to pop the housing bubble. As a result of the influx of capital from China, the U.S. Federal Reserve kept the interest rate low. The third facet is financial deregulation and unchecked financial innovations. Traditionally, banks make and hold mortgages, but the new era witnessed both bank and non-bank institutions holding loans and selling them to others. On the fourth angle, private regulatory agencies failed by not assessing the CDOs of corporations and providing necessary guidelines to investors (thus, investors were exposed to higher risk). Finally, there was no control over predatory lenders. From the four levels of critical thinking, it can be seen that the government didn’t understand the effects of these deregulations and, as such, were core victims.

Conflict of interest: Another significant issue that arose as a result of deregulation is conflict of interest.People left what they promised to do and did what they thought would generate more profits (all for selfish reasons), as demonstrated in the movie. Major bank officials, for example, offered huge credits to themselves and other top personnel who opened their private lending institutions (in order to gain personal interests), while politicians who criticized the borrowing practices also sought large loans to fund their political campaigns.In essence, the entire system was a mix of having a common ground of operation while also doing something else.This pushed risky credits into the market at cheap interest rates and exposed real estate (a major source of collateral) greatly. In the end, it made it virtually impossible to control the impact of the recession.

Mental model: as Walter et al. (2014) noted, the mental model of reasoning and thinking is based on defined mental rules. This mental rules theory attempts to explain how subjects reason about what happens in different cases by attributing subjects to roles such as models ponens ("if" and "else" situations) and modus tolens (the denial of modus ponens). Thus, if, through rain, the floor will get wet and, by getting wet, the floor will become slippery, then rain makes the floor slippery according to modus ponens, which is based on the notion that the possibility of the floor being slippery depends on certain conditions. When viewed, it can be seen that the mental model affected the borrowing patterns of individuals. Since the credits are now easily accessible at low interest, people use them as a fast means to acquire assets. In the end, they (both individuals and corporations) were exposed to the financial bubbles that brought about the 2008 recession.

References

Althingi Special Investigation Commission (2010), ―The Report of the Special Investigation Commission (SIC)‖, http://sic.althingi.is/ (2010-05-03).

Blundell-Wignall, A, Atkinson, P, and S. H. Lee (2008), The Current Financial Crisis: Causes and Policy Issues, July 2008. Bank for International Settlements, 79th Annual Report, 1 April 2008-31 March 2009, Basel, Switzerland, June 29, 2009.

Norberg, J. (2009), Financial Fiasco: How America's infatuation with home ownership and easy money created the economic crisis, Cato Institute.

Reinhart, C. and K. Rogoff, (2008), ―This Time is Different: A Panoramic View of Eight Centuries of Financial Crises‖ National Bureau of Economic Research Working Paper 13882.

Robert, W. (2008). Deregulation and the Financial Crisis. Huffington Post. Available at: http://www.huffingtonpost.com/robert-weissman/deregulation-and-the-fina_b_82639.html [Accessed on: 26-08-2015].

Walter, S., Andr´e, V., Walter, S., and G´ery, D. (2014). The Mental Models Theory of Reasoning: Refinements and Extensions. Available at: http://www.princeton.edu/~harman/Papers/MentModRev.pdf [Accessed on: 26-08-2015].