American and European Financial Crisis of 2008 Essay

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The 2008 financial crisis is considered the worst economic disaster to ever affect the world since the occurrence of the Great Depression of 1929. The crisis led to the collapsing of the financial system in the U.S. and other countries in Europe. Millions of people lost their jobs on either side of the Atlantic because of the financial crisis. Different authorities responded differently to curb the crisis in their backyard. This paper looks at the similarities between the crisis in the U.S. and the one in the Euro Zone while also outlining the difference between the two regions.

In the U.S., the financial crisis was mainly caused by deregulation in the financial industry. Banks were permitted to engage in hedge fund trading with derivatives. As a result, banks demanded more mortgages to support the business. Most of the financial institutions in the U.S. created interest-only loans that became affordable to borrowers who had questionable credit points. The demand for mortgages led to an increase in demand for houses that investors were trying to meet. Availability of loans allowed different investors attempt to grab a share of the lucrative business. The rise in the fed fund rates hit the homeowners with high levels that many people could not afford. The housing prices began to fall, and investors could not sell their houses to make payments for the loans. The increased liquidation in the financial sector led to the housing bubble that spread to Wall Street and other countries in 2008.

Similarly, the Euro Zone crisis that has culminated to numerous debts was caused by two main factors. The first is a lack of a mechanism to prevent the build-up of macroeconomic and fiscal imbalances in some countries. The second reason is a lack of common institutions to absorb shocks effectively. Lower borrowing costs increased the intra-eurozone capital flows as bank loans in various states. Cheap credit was not used in investment but was used to fund housing investments. Most of the countries in the Southern part of Europe ran large current account deficits and faced deterioration in the competitiveness. The housing boom hit peripheral countries such as Spain and Ireland, but the problem started with Greek when the government was unable to finance its debt.

The two regions had similarities in the ways they responded to the crisis.

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The United States had the Fed lowering the interest rates while also introducing some liquidity-enhancing schemes in the country to deal with the credit crunch. The U.S. also responded with an orderly takeover of Bear Stearns, which was one of the failed investment banks. However, the U.S. also focused on the private sector by adding legislation seeking to stimulate demand and ensure there are no mortgage closures. The Euro Zone also responded by having the ECB lower the main policy interest rate to enhance price stability in the Europe area. There were also measures to support the smooth functioning of the interbank market in the area to support the flow of credit to households and enterprises. The main difference between the Euro Zone and the U.S. is that 70% of the funding of homes and corporations in Europe comes from commercial banks whereas only 25% of the financing in the United States comes from banks.

The European debt crisis can hurt the U.S. economy if it weakens the firms that export their products to Europe leading to gyrations occurring in the U.S. stock markets. The crisis in the U.S. contributed to the troubles in Europe by weakening European banks with some requiring the inputs of governments for bailouts. Whereas the U.S. response has been swift and massive, the European response has not been forceful leading to problems in countries such as Greece and Spain. One of the main differences is that some financial institutions in the U.S.A. are independent of the federal government, but the ECB in Europe is under the management of the European Union. The fund established by the European Union to deal with the crisis was not enough leading to lower market confidence in the Euro Zone. In this case, it explains the extended debt crisis even after the U.S. economy started recovering.

Part II

A Greek employee who risks becoming unemployment or having his or her pay cut would not welcome any labor reforms by the government. The issue of inflation in the peripheral countries does not permit any peripheral country citizen to have a reduction in pay. Unemployment means reduced spending and people cannot pay their mortgages or….....

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