Lehman Brothers And The Financial Crisis - 1365 Words

When the crisis began in the mid-2007 caused by sub-prime bubble, uncertainty among banks about the creditworthiness for their clients and customers deteriorated as they had majorly invested in very complex and overpriced financial products. As a result, the interbank market became volatile and risk premiums on interbank loans increased. Banks faced a serious liquidity problem, as they experienced major difficulties to revolve their short-term debt. At that stage, policymakers still perceived the crisis primarily as a liquidity problem. However, it was widely believed that the European economy would be largely safe to the financial turbulence. The real economy, though slowing, was thriving on strong fundamentals such as rapid export growth†¦show more content†¦Faulty investments and real estate and banking bubbles had cost some citizens their savings, particularly in majorly impacted countries such as Spain. During the credit crunch, many commercial European banks lost money on their exposure to bad debts in US (e.g. subprime mortgage debt bundles). The credit crunch caused a decrease in bank lending and investments; this resulted in a serious recession (economic downturn). European house prices fell due to credit crunch and recession which increased the losses of many European banks. The recession caused a steep deterioration in government funds. As a result of negative growth, the government received less tax: (high unemployment leading to less income tax; less people spending lead to less VAT; less company profits lead to less corporation tax etc. The government also had to spend more on unemployment benefits). GDP fell (see chart below) and debts rose rapidly, resulting in increase in Debt to GDP ratio (see chart below). Unemployment figures were at 5% in Germany at the lower end, while it reached 27% in Greece and Spain. In an increasing number of countries a vicious cycle developed. Financial instability slowed economic growth, which resulted in lower tax revenues and increased governments’ debts. Due to higher debts, the cost of borrowing for governments rose and financial instability increased. More focus on budget deficit and less on the level of government debt, lack of surveillance of competitiveness and