2008 Credit Crunch 1

STUDENT NAME

DEGREE

PROJECT SUPERVISOR

PROJECT TITLE The Causes and equences of the 2008 Credit Crunch

DATE

KEYWORDS Financial Crisis

Credit Crunch

Risk Management

Investment Management
 2008 Credit Crunch 2

Table of Contents
Chapter 1: Introduction.....................................................................................................................

1.1 Background to Context...........................................................................................................

1.2 Aims and Objectives...............................................................................................................

1.3 Research Questions.................................................................................................................

1.5 Structure of Report.................................................................................................................

Chapter 2: Literature Review............................................................................................................

2.1 Introduction............................................................................................................................

2.2 Financial Crisis.......................................................................................................................

2.3 Recent Financial Crisis...........................................................................................................

2.4 Summary.................................................................................................................................

Chapter 3: Research Methodology....................................................................................................

Chapter 4: Findings and Observations..............................................................................................

4.1 Introduction............................................................................................................................

4.2 The Causes of the 2008 Credit Crunch...................................................................................

4.2.1 Greediness.......................................................................................................................

4.2.2 The Decline of the Housing Market.................................................................................

4.2.3 Inadequate credit and Risk Management.........................................................................

4.3 Effects of the Credit Crunch...................................................................................................

Chapter 5: Conclusion......................................................................................................................

List of References.............................................................................................................................
 2008 Credit Crunch 3

Chapter 1: Introduction

1.1 Background to Context

The economy of the world is facing one of the most drastic conditions due to the financial crisis

which started in 2008 from the financial sector of the United States and quite rapidly spread to other parts

of the world (Barbu 2010). Although the entire world has been affected by the financial crisis, the United

States of America and Europe have been the worst hit regions of the financial crisis causing many

financial services organisations and banks to either go bankrupt or merge with other organisations in

order to survive. The financial crisis has affected all countries of the world in one way or another either

directly or indirectly. The financial crisis did not appear from the no where it was building up since late

last century and many economists and experts were hinting that risky practices in the financial sector may

eventually lead to drastic conditions and a failure of the entire economic system. As the financial services

sector is the backbone of a country’s economy and serves as the barometer of the economy and

disruptions and failures in this sector eventually disrupts the entire economy and causes an economy wide

financial breakdown. There are several reasons for the financial crisis but the main trigger or catalyst of

the breakdown was the phenomenal decrease in real estate prices in United States which started in later

stages of 2007 (Friedrichs 2009). A major part of the financial sector was heavily reliant on the mortgage

industry and the decline in the housing sector made it difficult for banks and financial institutions to

refinance loans and mortgages which resulted in a widespread phenomenon of foreclosures and

bankruptcies. The mortgage crisis also referred to as the sub prime mortgage crisis emerged due to risky

and illogical decisions made by financial institutions and banks which financed and refinanced mortgages

without completely considering the financial stability of home owners. Most of the U.S. banks and

financial firms had invested quite heavily in mortgage backed securities earlier referred to as sub prime

mortgages due to the high risk of these securities (United Nations Publications 2009).
 2008 Credit Crunch 4

1.2 Aims and Objectives

The primary aim of this research is to analyse and evaluate the causes and consequences of the

2008 financial crisis and credit crunch which started in the United States of America and spread to other

countries and regions of the world. The aims and objectives of the current research will be achieved by

thoroughly reviewing the literature present on the issue and analysing the data collected from various

sources such as journal articles, books, periodicals and websites.

1.3 Research Questions

The aims and objectives of the current research will be achieved by analyzing data from various

sources and the research will also enable the researcher to answer the following research questions.

1. What are the main reasons and effects of a financial crisis?

2. What were the main causes of the financial crisis and credit crunch which started in 2008?

3. How has the financial crisis affected various sectors of the economy?

4. What are the short term and long term implications and effects of the financial crisis and

credit crunch?

1.5 Structure of Report

This dissertation report is divided in various chapters and the overall format and structure of the

report are explained below.

Chapter 1: Introduction

The first chapter of the dissertation report is the Introduction chapter which provides the

background to context of the chapter, aims and objectives, research questions which will be answered

during the research and the structure of the dissertation report.

Chapter 2: Literature Review

The second chapter of the dissertation is provides a comprehensive review of the literature found

on the financial crisis and the causes and effects of financial crisis based on literature and data collected

from sources such as books, periodicals, websites, journal articles and websites.
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Chapter 3: Research Methodology

The research methodology chapter is the third chapter of the dissertation which deals with the

explanation of the methods and techniques used for collecting, analysing and evaluating data in the

current research.

Chapter 4: Findings and Observations

Chapter 4 of the dissertation presents the findings and observations of the researcher with respect

to the causes and effects of the financial crisis.

Chapter 5: Conclusion

The fifth and last chapter of the dissertation is the conclusion chapter which provides the overall

conclusion arrived at after performing research on the causes and effects of the financial crisis.
 2008 Credit Crunch 6

Chapter 2: Literature Review

2.1 Introduction

The last decade has seen organisations growing larger and stronger at a very rapid rate by

incorporating modernised ways of doing business and implementing various strategies. The situation of

banks and the financial services sector was quite similar as well as banks and financial institutions saw

phenomenal growth in a very short period of time. Although this growth was quite rapid is was based on

artificial means and the fundamentals were quite weak as a majority of these companies were

implementing window dressing strategies and boosting profits using risky and illogical strategies which

were beneficial were short term profits but were rendering these organisations quite weak for the long

term. The financial positions of the organisations were manoeuvred with unethical strategies which led to

short term benefits and the long term consequences of these practices were ignored and the bubble of this

financial mismanagement eventually burst in 2008. This chapter presents a review of the literature based

on financial crisis in the following sections (Mankiw 2008).

2.2 Financial Crisis

The financial crisis is commonly treated as the collapse of an economy where both specific

organisations and entire industries are affected severely in the short and long run simultaneously. The

financial crisis usually starts from a single industry or economical sector were almost all organisations of

that industry face severe financial problems and the resulting panic and havoc spreads to other sectors of

the economy creating a domino effect where each industry starts failing one after another (International

Monetary Fund 2008). Some financial crises are also resultants of significant crashes in the stock market,

bursting of financial and economical bubbles and entire countries going into default. As the financial

services sector of the economy is the most fundamental sector and termed as the backbone of the

economy any problems in this sector result in economy wide implications. The 2008 credit crunch and

financial crisis also started from the financial sector and quickly spread to other sectors of the economy as

well which is explained in the following section (Organisation for Economic Co-operation and
 2008 Credit Crunch 7

Development 2010).

2.3 Recent Financial Crisis

Hildebrand (2008) analysed how the credit crunch of 2008 evolved and examined the effects of

the sub prime mortgage crisis not only on the economy of the united States of America but on the entire

global economy as well. His research concluded that the vague characteristics and practices of banks,

improper risk and credit management and too much reliance on bad or sub prime mortgage securities led

to the financial crisis which the entire world is facing right now. He also recommends that government

and regulatory bodies like central banks need to formulate and implement policies which prevent any

future crisis similar to the 2008 credit crunch and need to provide a framework for investment planning

and management for banks and financial institutions.

Bartram, Brown and Hunt (2007) also studied a sample of 334 banks which made up over 80

percent of the entire banking equity of the world and presented a fascinating empirical study based on a

cross sectional analysis of these banks. Their research provided an evaluation and examination of 28 large

banks doing business in various developing and developed countries of the world and how financial crises

of five different characteristics have affected the regulatory frameworks implemented in these banks.

Their research concluded that the reaction towards these policies was endogenous and may be deficient

for tackling with a financial crisis of a global proportion.

Acharya (2009) examined the shifting of systematic risk among the financial institutions which

was mainly responsible for the credit crunch which started in 2008. His research explained that as there is

limited liability in banks any harmful externality of failure of a particular bank may cause aggregations

and chaos in the economy resulting in a risk to banks across the whole sector and economy. This

particular research also presented the regulations of a prudential bank which can be implemented

collectively for recommendations for regulation and policy formation in the future.

2.4 Summary

This chapter has covered the review of literature based on data collected from various sources
 2008 Credit Crunch 8

such as books, articles and websites. The chapter explains that financial crisis should be considered as an

element which creates disruptions in the entire economy and organisations, institutions and banks are

affected in various ways as a result of the financial crisis. Then financial crises are caused by a variety of

reasons and different theorists have examined financial crisis in various ways. This chapter covered the

explanation of the financial crisis along with theories presented for the credit crunch while the next

chapter of the research presents the research methodology applied for the collection and analysis of data

to derive a logical and effective conclusion.

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Chapter 3: Research Methodology

In order for the research to be effective a research needs to devise and implement an effective

research strategy and methodology. This chapter of the research explains the research methodology

devised for the research along with the strategy for collecting and analysing data. The current research

implements an inductive approach of research where a research hypothesis is formulated based on the

data acquired and included from various sources and generalised conclusions are made at the end of the

research (Rodwell, Noblet, Steane, Osborne and Allisey 2010). The research is mainly based on data

acquired from secondary sources such as books, reports, journal articles and websites. The researcher has

implemented the qualitative approach of research to analyse and evaluate this data due to the qualitative

characteristics of this data as it cannot be measured or quantified by any means (Gelo, Braakmann and

Benetka 2008). This implies that the entire research methodology incorporated in the current research

includes a group of inductive and qualitative approaches to research which are implemented to analyse

data acquired from several secondary sources to find the causes and effects of the 2008 credit crunch and

financial crisis. This chapter of the research presented the research methodology while the next chapter

will present the findings and observations of the researcher with respect to the causes and effects of the

credit crunch which started in 2008 affecting not only on a single economy but at a global level and on

different sectors of the economy.

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Chapter 4: Findings and Observations

4.1 Introduction

This chapter presents the findings and observations of the researcher regarding the causes and

effects of the financial crisis and credit crunch which started in 2008 in the banking and financial sector

of the United States of America and eventually spread to other sectors of the economy and to other parts

of the world as well. The causes of the credit crunch along with the short term and long term effects of the

credit crunch are explained in the following sections.

4.2 The Causes of the 2008 Credit Crunch

The credit crunch starting in 2008 did not just appear out of nowhere but was cooking for quite a

long time ready to explode and in the later parts of 2008 it erupted and caused significant damage to

economies throughout the world. There are several reasons for the credit crunch and financial crisis which

started in 2008 and some of these reasons including greediness, housing sector decline and poor

management of risk and credit which are explained below (Commission on Growth and Development

2010).

4.2.1 Greediness

Greed is the desire for more and more irrespective of the resources available at one’s disposal and

this characteristic has been found in human beings since the advent of time. The greed factor affects not

only a single person but entire nations as well where the greed for more eventually results in wars and

conflicts (Friedl 2006). It is a known phenomenon that the wants of human beings are never satisfied and

the satisfaction of one want leads to a birth of a new want. In order to satisfy their needs people start

spending more and more and if they are given a free hand to spend and worry about payments later they

tend to spend even more. The entire economy of the United States is based on plastic money or credit

cards where the people spend quite freely and generously without considering or realising how payments

on these expenditures will be made later (Zandi 2009). This mind set has evolved into companies and
 2008 Credit Crunch 11

organisations where poor credit and risk management strategies were implemented which eventually led

to a financial breakdown as the entire economy which was based on this phenomenon collapsed. The

greed factor is rooted in the economy to such an extent that many experts have also challenged the

capitalistic economy as a whole (Patrick 2008).

4.2.2 The Decline of the Housing Market

One of the main factors causing the credit crunch was a significant decline in the housing sector

of America. The housing sector which was one of the best performing sectors of the United States

economy fell to 5.25 million in 2007 while the average sales price plummeted to a level of 4.2 percent

with $211,700 (British Broadcasting Corporation 2007). This significant decline in the housing sector

resulted in an increase in mortgage rates and homeowners found it very difficult to acquire mortgages and

change their homes using mortgages.

4.2.3 Inadequate credit and Risk Management

It has been explained in an earlier section that the entire economy of the United States is

based on plastic money and credit and people spend more than they can actually afford. This

mind set is also brought into organisations and is reflected in the decisions made by company

officials and executives (Mankiw 2008). The banks and financial institutions of the country did

not implement adequate credit and risk management strategies which eventually led to a credit

crunch. Many economists and experts perceive the credit crunch as more of a short term nature

rather than a long one and expect that the financial outlook for 2010 would be much better

(Eghbal 2008).

4.3 Effects of the Credit Crunch

The credit crunch has severely affected several sectors of the economy not only in the

United States of America but other regions of the world as well. The United Kingdom is the

second worst affected country after the United States of America where many companies have
 2008 Credit Crunch 12

either gone bankrupt or had to be rescued through government funding (Ambachtshee, Beatty

and Booth 2008). The credit crunch has created a situation where organisations in various sectors

find it quite difficult to obtain finances from banks and financial institutions to run operations

smoothly. As the credit crunch has affected consumers, retail companies are facing the worst

sales levels and are also running very low on profits or are facing huge losses due to which major

cutbacks and downsizing steps have been taken (Wei and Tong 2009). The organisations

functioning in United Kingdom and other parts of Europe are quite heavily reliant on

international trade with the United States and any problems in the U.S. economy directly impact

the U.K and European economies (Copsey and Haughton 2009). The financial crisis has deeply

impacted both the private and public sector as organisations are witnessing huge losses and

nearing bankruptcy and have to take drastic measures such as downsizing, cost cuts, salary

decrements, closure of branches and departments or even suspension of business and operations

(Gokhale 2008).
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Chapter 5: Conclusion

The findings and observations of the researcher in the previous chapter imply that the

financial crisis has been caused by several reasons and has affected the economy and

organisations functioning within the economy quite severely. The major causes of the 2008

credit crunch were found to be greediness, significant decline in housing prices and improper

risk and credit management while the effects of the credit crunch are quite significant for both

the short and the long run. The credit crunch has not only caused many banks to go bankrupt or

be acquired by other banks, but several other organisations from various sectors such as

hospitality, tourism, retail, airlines, services, manufacturing and transportation have also been

severely affected by the credit crunch. It is thus concluded that the causes of the credit crunch are

rooted in factors such as greediness, inadequate risk and credit management and decline in

housing prices and the implications may be seen well ahead in the future. The governments of

several countries like United States of America, United Kingdom, Germany, France and

Switzerland have devised different bailout plans to save their respective economies otherwise the

notion of failed capitalistic system will be confirmed. It is recommended based on the findings

and conclusion that the regulatory bodies and central banks of these countries should devise a

regulatory framework and a set of rules for best practices which should be implemented in the

entire financial and banking sector so that future cases of credit mismanagement can be avoided

which may eventually lead to a credit crunch or financial crisis.

 2008 Credit Crunch 14

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Barbu, C. (2010). Does The Economic Crisis Affect Oltenia's Environment? Journal of Applied

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Eghbal, M. (2008, October 24). Global Financial Crisis: Decline in Short-term but Recovery by 2010.

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 2008 Credit Crunch 15

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