Banks and financial institutions in the developed countries are not restricted from spending more than what they can afford. This led to the domination of speculative activities in the economy. Speculators are only interested in short term gain from the economy. Thus the long term yield on assets is not properly ensured. In the process of globalization, the role of the nation-state has been undermined by the economies. Due to the lack of fiscal intervention of governments for ensuring sustaining growth, global finance and de-regulation were adopted by the economy as an alternative paradigm and it led to the booms and bust in the global economy. A sound long term macroeconomic policy was not adopted by the countries and thus the financial and economic stability affected badly and the conditions of financial crisis emerged.
Financial market instability in the economy is the result of defaulted free market system and capitalism. It causes booms and bust conditions in the global economy. The defaults in the operations of banking and monetary system are another root cause of the crisis situation.
The rising protectionism among various countries led to the rejection of free trade and thus the export opportunities were greatly reduced. As a result of the decreased export opportunities in the economy, the national income also reduced greatly. It led to a contraction of the GDP together with currency devaluation. (Global economic crisis- a different view 2009).
Excess liquidity in the market: Unsound methods of debt financing adopted by major central banks generate excess liquidity in the market. Through their irresponsible actions in the economy, increased debt financing without proper guarantee for returns has highly increased. The resulted in sudden cash flow in the economy created a more risky environment. Due to the financial recession, the returns to financial institutions were restricted and thus bad debts rate highly increased. It affected their financial position badly. (Karam 2008).
Stock market crash: Subprime mortgage loan and excess credit creation led to a speculative economic environment. Due to the baseless marketing actions, the stock market faced a severe crash situation which affected the entire economy badly. When the speculative borrowings increased it forced the banks and other lenders to tighten credit. As a result, the availability of money in the economy contracted, and even to companies that can afford, a loan was restricted and thus the economy subsequently contracted.
When analyzing the nature of the banking systems in the countries, it revealed that the baseless lending actions of the banks are the root cause of the current crisis. Through the expansion of easy credit, boom and bust cycles created in the US economy. Due to the uncontrolled monetary policy adopted by central banks and endorsed by the political regulatory through the application of mechanisms of fiat money and fractional reserve banking, there emerged an uncertain economic boom and bust cycles. (The global financial/ economic crisis 2008).
The financial crisis is started with the mortgage issue. The uncontrolled subprime borrowings and subsequent depression in the value of the homes lead to a financial imbalance in case of mortgage lenders. The subprime mortgage crisis leads to the destruction of the financial position of the banking organizations. As a result of these crises, credit availability in the financial market is badly affected.