The causes of the crisis remain ambiguous, with many theories and assumptions offered by economists and governments around the globe. While a significant amount of literature has been published regarding the attributing factors of the 2008 financial crisis, this article attempts to simplify them into a few basic points:
1. The collapse of the Icelandic Banking System
2. Speculative asset demand a.k.a. The UK’s Bank Run
The Icelandic Banking crisis has been cited as the flashpoint for the recession hitting Europe; the three biggest Icelandic banks collapsed in the wake of substantial difficulties in refinancing short-term debts. This led to detrimental effects to the UK’s economy, where over GBP 840m had been invested in Icelandic banks by local and federal authorities.
Speculative Demand is defined as the demand for financial assets which is not otherwise affected by actual transactions. For example, if, say… a well-known news provider reported on a bank applying for a liquidity loan from the Central Bank of England because it was unable to repay short-term loans attributed from the massive reduction in demand for securitisation of sub-prime mortgages, it sends a clear message out to the bank’s customers, who then decide that it would be most prudent to withdraw their savings from said bank with great urgency. More customers, privy to the withdrawal habits of their fellow account-holders, decide to jump on the withdrawal bandwagon to safeguard their savings.
This is precisely what occurred in the case of Northern Rock, with the BBC’s Robert Peston reporting on the bank’s predicament, leading to the bank’s run and its subsequent nationalisation. The bursting of the US’s subprime mortgaging bubble was a key player in this sordid affair of imprudent choices; look out for this in the next few posts.
Guest Post by Clement Chew