A) Contributing factors: o sub-prime mortgages o moral hazard (too big to…

The idea

The 2007-2008 Global Financial Crisis was driven by multiple interconnected factors. Sub-prime mortgages were issued to borrowers with poor credit histories, leading to massive defaults when interest rates rose. The belief that major banks were 'too big to fail' created moral hazard, encouraging excessive risk-taking as institutions expected government bailouts. Speculation and market bubbles, particularly in housing, artificially inflated asset prices. A toxic organisational culture within banks prioritised short-term bonuses over long-term stability. Ultimately, this led to a severe credit crunch, causing a collapse of lending to businesses, which triggered a deep global recession as firms could not finance their daily operations.

What earns the marks

• Identify sub-prime mortgages as high-risk loans that triggered the crisis when borrowers defaulted.
• Explain how the 'too big to fail' perception led to moral hazard and reckless lending by financial institutions.
• Describe how speculation drove unsustainable market bubbles in housing and complex financial derivatives.
• Analyse how a flawed organisational culture incentivised short-term profit and ignored long-term systemic risks.
• Link the financial sector's distress to the real economy through the collapse of lending to businesses (the credit crunch).

Common mistakes and how to put them right

• Confusing sub-prime mortgages with standard mortgages.

  Put it right: Sub-prime mortgages are specifically loans given to individuals with poor credit ratings at higher interest rates.

• Misunderstanding moral hazard as just 'taking risks'.

  Put it right: Moral hazard specifically refers to taking excessive risks because the negative consequences will be borne by someone else (e.g., the taxpayer).

• Assuming the crisis only affected banks.

  Put it right: The collapse of interbank lending caused a credit crunch that severely restricted lending to non-financial businesses, causing a wider economic recession.

Exam tips

• Ensure you can define each contributing factor clearly and explain how they interacted to cause the Global Financial Crisis.
• Use the concept of moral hazard to evaluate the effectiveness of government bailouts and subsequent financial regulations.
• When discussing the impact of the crisis, explicitly connect the failure in financial markets to the collapse of business lending and the resulting fall in aggregate demand.