Running Head: 2007/2008 Financial Crisis

Accounting: The causes of 2007/2008 Financial Crisis

Student Name

Md. Mahmudul Hasan

Student Number

200909081

University---Course--Section Number

Qatar University English post foundation 2

Submission Date

July 30, 2013

Teachers Name

Dr. Nawar Hago

global economy has witnessed several financial disasters in the past. Many countries are

suffering from recession because of the devastating effects of the financial crisis. According to

the article Financial Crisis 2007/2008 Overview (n.d.), the 2007/2008 financial crisis is known

as the biggest and worst financial incident since the great depression of 1929, which has

restructured the modern economic system. The article explained about the severe effects of the

2007/2008 financial crisis on the global economy. Some of the consequences of the financial

crisis are the stock market crash, the collapse of the large financial organizations, the bailout of

the banks, high unemployment rate and severe downturn in economic activity in many countries.

So, what are the causes behind the 2007/2008 financial crisis? This is a very important question

which needs an answer because, finding the causes will give solutions to prevent the problem in

the future. There are several causes behind the breakdown of the highly sophisticated modern

economic system, but the three main causes of financial crisis in the modern economic system

are the real estate bubble and subprime lending crisis, conflict of interest and greed.

The housing bubble takes place when the price of the real estate increases for a specific

period of time and then suddenly declines astonishingly, thus eventually causes economical

crisis. Wilson (as cited in Rahn, 2010), argued that the main cause of the financial crisis was the

real estate bubble, driven by United States government in a pursuit to increase the

homeownership of the citizens. Here the author explained about the role of the housing bubble in

causing the financial distress in United States. The economy of United States was severely

affected by the housing bubble because a major part of their economy was based on housing

loans. The lenders were giving subprime loans to the people who were unable to pay the debt,

mainly because the lenders were selling those loans to the investment banks. Then the investment
Running Head: 2007/2008 Financial Crisis
3
banks packed all kinds of bad loans into something called collateralized debt obligations (CDO)

to sell them to the investors. The investment banks paid the ratings agencies to rate their

securities as good as possible, to motivate the investors to buy those securities. Those securities

were nothing more than a package of deception and junk. According to Ver Eecke (2013), the

lack of government regulation and control on mortgages and asset backed securities is the key

reason behind the subprime crisis. Here the author explained how the government failed to

prevent the subprime lending crisis. The government had reduced the interest rate and circulated

cheap money everywhere. As a result, people with bad credit history were interested to take

loans because they mistakenly believed that housing prices would never go down. To make

things worse, the prices of the houses plunged suddenly and many large financial institutions had

to file for bankruptcy. For example, the global financial system was on the verge of collapse

when Lehman Brothers filed for bankruptcy which was one of the largest investment banks in the

world. The fall of Lehman brothers made it clear that the financial system was faulty and

mismanaged. The government should apply strict rules and regulations on the credit rating

agencies and the investors need to be more risk-averse to avoid such problems in the future.

Conflict of interest occurs when there are multiple interests between people or

organizations which lead them to misleading activities. The rating agencies are supposed to rate

securities such as, bond, mortgage-backed securities and collateralized debt obligations fairly.

But they often provide bias ratings because of having conflict of interest with the firms that

arranges and sells the debts. The consequence of the bias decision later makes the financial

market volatile. Many large rating agencies such as, Moodys and Standard & Poors were

alleged for giving AAA ratings to the poor securities because conflicts of interests were involved

(Smith,2008). This means that the rating agency had conflicts of interest and their models were
Running Head: 2007/2008 Financial Crisis
4
faulty which eventually circulated very risky securities in the financial market. The rating

agencies had conflicts of interest because they also provide varieties of other financial services to

their customers. When the same customers buy multiple services, the rating agency gives them

favors by accepting their misleading requests. Rating agencies were also alleged for taking

additional money from the investment banks to give the best possible ratings to the junk bonds.

Investors are buying these securities and later facing huge losses which are reducing their

confidence. The lack of confidence from the investor ultimately slows down the economy.

Conflicts of interest is also very prominent among the auditing firms.

Greed is probably the major cause behind all the incidents that lead to the financial crisis.

Both general people and financial institutions are ignoring ethics because of their extreme hunger

for money. Despite the lack of transparency, investors are taking higher risk to make larger

profits but most of the time it results in disaster. The financial institutions are engaged in

unethical activities to raise their profit and people are taking loans with bad credit history to

improve their standard of living. According to Reavis (2012), in the last 25 years people have

increased their standard of living by borrowing more money from the financial institutions. This

shows that the greed of general people is actually causing the financial instability. People who

are borrowing money are unable to pay their debt on time; as a result they are looking for another

loan to pay their previous loan. The lenders are not supposed to give loans to the people who

already have debt, but because of the hunger for money, they are giving subprime loans and

selling those subprime loans to the investment banks. That means the lenders do not have to

worry about anything because they sold those subprime loans to the investment banks. The

investment banks pay illegal money to the credit rating agency, to get good ratings for their bad

securities. The greedy investors invest on those securities without proper analysis and suffer at
Running Head: 2007/2008 Financial Crisis
5
the end. From the above consequences, it is clear that people are misusing the complicated

financial system because of their excessive greed for money.

In Summary, 2007/2008 financial crisis is caused by many factors, but the three main

causes are, the housing bubble, conflict of interest and excessive hunger for money. The financial

tragedy began with subprime lending crisis and later engulfed the whole financial system.

Conflicts of interest inside the financial institutions and excessive greed for money played

significant role in the progress of the collapse. The investors have witnessed one of the most

terrifying and unstable markets of their life. To overcome such kinds of crisis in the future,

people need to apply the principal of ethics in their financial activities. The financial institutions

need to be more transparent and accountable to their customers and the government should apply

strict rules and regulations to prevent any kind of fraud by the financial institutions.

[Word Count 1177]

References
Running Head: 2007/2008 Financial Crisis
6
Financial Crisis 2007/2008 Overview. (n.d.). Retrieved from

http://www.wallstreetoasis.com/financial-crisis-overview

Rahn, R. (2010, November 15). What Caused the Financial Crisis. The Washington Times.

Retrieved from http://www.washingtontimes.com/news/2010/nov/15/what-caused-the-

financial-crisis/

Reavis, C. (2012). The Global Financial Crisis of 2008: The Role of Greed, Fear, and Oligarchs.

Retrieved from https://mitsloan.mit.edu/LearningEdge/CaseDocs/09-093 The Financial

Crisis of 2008.Rev.pdf

Smith, E. (2008, September 25). 'Race to Bottom' at Moodys, S&P secured Subprime's Boom,

Bust. Retrieved from http://www.bloomberg.com/apps/news?

pid=newsarchive&sid=ax3vfya_Vtdo

Ver Eecke, W. (2013). Ethical Reflections on the Financial Crisis 2007/2008. New York:

Springer Berlin Heidelberg.