Global Financial Crisis Basics
Synopsis
Whilst at that time the subprime collapse seemed catastrophic, the reduction in the subprime market was in essence relatively limited and was a localized event. The effects of the event though did not in fact remain limited and localized.
The Basics
There has since been an expected cumulative loss of $4,700 billion in world output associated with the crisis. The loss in world output represents a figure that is close to twenty times greater than the loss experienced in the collapsed subprime market.
Though this loss is considerable, the impact on the decrease in stock market capitalization from July 2007 until November 2008 alone was calculated to have been $26,400 billion which was one hundred times greater than the loss on the subprime market in the United States where the crisis actually began.
Two questions have to be asked. How was it possible for the subprime crisis in the United States to occur and how was it possible for such a relatively limited and localized crisis to have been able to cause a crisis of such magnitude to world earnings?
The basics would indicate that there were fundamental flaws existing in the scrutinizing of the subprime market. Very importantly, the risk of the assets was understated and the balance sheets of the derived securities were not transparent to those buying into the risk.
When the crisis began there were two amplifying mechanisms behind the crisis which accelerated the rate of collapse, firstly there began the sale of assets to satisfy liquidity and this was followed by the rapid sale of even more assets to re establish capital ratios.
The fact that the crisis rapidly spread globally was the result of the interconnectedness between banking institutions both nationally and internationally and the high levels of leveraging of the financial system as a whole.
