Since the Great Depression of 1929, the financial crisis of 2008 has been the most serious economic catastrophe. As described by the Guardian, the financial crisis is the ‘three weeks that changed the world’. It started becoming noticeable in September 2008 when several large US financial firms began to fail. It led to a recession which is when housing prices fell by more than 30 percent – which was more than it did during the Great Depression. It had many long-term effects, many of which are still present, the unemployment rate in the US was still above 9 percent two years after the recession ended.
Why did this all happen? The US government encourage home ownership. People were buying expensive houses using money from abroad, which caused house prices to increase. Mortgage companies lent money even if the borrower did not have a good credit, these were called subprime loans – they have a higher risk of defaulting. However, after a while housing companies built too many houses which caused the price of houses to decrease (when supply is greater than demand, prices fall) and the value of a lot of the houses decreased below the value of the mortgage debt. This meant that the homeowners were unable to sell their houses – this is what we call negative equity.
By 2007 and 2008, the whole system started to collapse. Banks started to realise that they were holding onto many worthless debt instruments and the US economy started to freeze up. In September of 2008, Lehman Brothers filed for bankruptcy and this was the largest filing in history, and at the time of its collapse it was the fourth largest US investment bank with 25 000 employees worldwide. It had $639 billion in assets and $619 billion in debt.
Banks were bundling up mortgages together and selling the packages to other banks or investors. The packages included mortgages from prime borrowers who would pay back the loan, along with mortgages from subprime borrowers who had a high risk of defaulting. However, the banks were selling these packages as if they only included prime mortgages and were making money. Although this was meant to reduce the risk, it meant that many institutions had bought mortgage packages that were worth less than what they had bought them for. Other countries were also affected from this issue, in the UK the Northern Rock became their first casualty – too many loans were not being repaid so savers started to withdraw their money.
The UK government soon bought Northern Rock (guaranteeing savers their money) and soon bought most of Royal Bank of Scotland and parts of Lloyds Bank. This fall in lending by banks led to a fall in consumer spending and investment leading to a fall in GDP and a rise in unemployment. Due to the rise in unemployment, government spending related to welfare payments (i.e. unemployment benefits) rose. Governments had to rely on institutions such as the European Union to lend them the loans that they needed.
Banking started out in Britain with the medieval goldsmiths: wealthy people needed a safe place to put the gold. So they stored it with goldsmiths who had safe vaults. Banking comes into place when the goldsmiths realised they could make loans to people who wanted to trade or get involved in big construction projects. The goldsmith worked safely on the basis of one key point - not everyone would need to get their gold back once. Which is what banks of the modern era rely heavily on. The idea of banking was really popular in Northern Italy's. By the late 1600s the idea of banking had been developed in Britain. Many were set up by quakers, who were ought to be trustworthy due to the high reputation in society. After a gradual process banks began to grow and acquired similar names we see today - Barclays,Lloyds etc. All these banks offer very similar services being distinguished only by offering different interest rates
Modern day banking has very slight change to what the goldsmiths did. Banks take deposits from people and businesses that wish to save and lend to people, businesses and lend to people, businesses and governments that wish to borrow. They operate on a large scale and rely on the fact that not all of their customers will want to withdraw their deposits at once. This process encourages economic growth and helps to raise standard of living.
There are three mains ways banks make money: by charging interest on money that they lend, by charging fees for services they provide and by trading financial instruments in the financial markets. To encourage people to keep their money in a bank, the bank will pay the deposited interest. The banks lend money to customers at a higher rate than they pay to depositors. This is where banks make most of their money. ‘Lending’ can take form in forms of overdraft, bank loans and mortgages. Interest rates can be fixed or variable depending on the terms on the agreement, a variable rate depend on financial crisis. Loans and mortgages aren't given out to everyone, credit checks and various other methods are used to check if the borrower is able to pay the money back. After the financial crisis in 2008, banks were warned to be more careful about lending that they used to be and to avoid lending to too many risky borrowers.
Banks also create an efficient payment system. The uses of cash has declined in recent years as the popularity of cards and cheques increased - to top off the use of ‘contactless’ really starting to change the way we pay for our purchases. With ATM’s, debit cards and online bank transfer, the situation changed completely from what it was. Many high street banks are starting to close due to an increase in people using online banking and telephone banking. Even though companies such as Apple and Google are changing the way we purchase things, the use of traditional cards will be continue to be widely used and the concept of ‘paper money’ will not disappear for some time.