Financial Crisis

The financial crisis of 2007-2009 had a major impact on the world economy. The repercussions were severe, the bursting of the subprime mortgage bubble resulting in the collapse of major financial institutions, global stock market crashes, economic downturn, foreclosures and rising unemployment. One of the causes attributed to the crisis is deficiencies and mismanagement in the banking system. During the property market boom, loan providers did not exercise prudence, and engaged in high-risk lending practices that eventually resulted in the subprime mortgage crisis. Mortgage-underwriting standards were being weakened because banks were providing loans to customers with high-risk credit worthiness. The housing bubble burst caused financial institutions that invested heavily in real-estate related securities to face massive losses, and there were significant threat to the global economy. Therefore, governments were forced to aid the banks by implementing a bailout stimulus package. Opinions on the bank bailout are divided, and this paper attempts to reason whether governments should bailout banks or allow them to fail, by focusing on the events of the U.S. financial crisis of 2007-2009.

There are two schools of thought regarding this issue. Proponents of a pure free market economy would argue that the market will adjust itself over time, and government intervention is unnecessary and unwelcomed in a free economy. However, banks are a major source of finance in the economy. Due to the fragile nature of banking as a result of the incongruity between the liquid debt that they hold in the form of deposits that can easily be taken out, and assets in the form of loans that cannot be easily converted to cash, they are vulnerable to sudden losses of funding (Economist, 2007). Therefore, to prevent bank runs and cash shortages, government regulation is required to a certain extent

During the financial crisis, many large American banks were facing the prospect of insolvency...