School of Management and Business

MARKETS CONSUMPTION AND STRATEGY MMM7320 (2013-14)

The 2007 Credit Crunch and the Future of Capitalism

Assessment 1: Group Project

Submission date: 7th of November 2013

Rafal Leja
Hang Nguyen Hoang Thanh
Yingying Tang
Jiaying Ding
Tian Zhao
Boxiong Xue
Executive Summary

This report investigates the case study of the U.S. Credit Crunch in 2007- 2008 and the future of capitalism. The report discusses the causes and impacts of the financial credit crunch on the economies and then it follows with the discussion on the future capitalism and role of government intervention. Underpinned by Invisible Hand Theory (Smith, 1980), the idea of free market with individuals holding the right to earn whatever the markets pay to them is analyzed. However, the impacts of credit crunch in 2007- 2008 and the recession onwards suggest the need of government intervention to restrict the level of risk taking by financial institutions and thereby prevent the foreseen crisis.

Table of Contents

1. Introduction

Since 2007 the worldwide economy has bee facing one of the worst financial crises in the contemporary world. According to Reinhart and Rogoff (2009), a financial crisis is usually followed by a drastic economic depression which consequences are usually very disturbing for prosperity of the country. The financial crises can have both national and external roots, and can influence private and public sectors.

The 2007-2008 crisis was mostly notable for its influence on the banking segment that started in the USA from the fiasco of banks such as Bear Stearns, Northern Rock and then influenced banks in Europe (Campello, 2010).

It is worth mentioning that the crisis in the United States of America was the most significant due to the scope of the US economy. Although its main origin was in USA, roots of it can be found worldwide (Campello, 2010). In addition, the 2007-2008 crisis was not only concerning inadequately estimated mortgage loaning and bankers’ desire to earn high profits but also it was one of series of crises that have been influencing worldwide economy since 1970s (Acharya and Philippon, 2009).

Moreover, there is an argument that governments did not control the salaries and very high bonuses of the people working in the financial sectors that could have had an impact on the aforementioned financial crisis (Milne and Wood, 2008).

This case study report is divided into three parts: Case Background, Theory Background, and Questions. The aim of this report is to identify and explain, basing on the theory, the main causes of the 2007 onwards credit crunch and answering the following questions:

Q1. Why do some people argue that individuals should be free to earn whatever the market pays them? What are the economic arguments for big differences in earnings?

Q2. Why might high salaries in the financial sector give cause for concern?

Q3. Why was it argued that the pursuit of individual remuneration by many people in the financial world created the conditions for the recession that engulfed the world from 2008 onwards?

Q4. How might governments intervene in financial markets to make them more efficient?

2. Case Background

2.1 Financial Crisis

In early nineties global economy seemed to be stable and governments believed that development and wealth would remain. However, Wetherly and Otter (2008) stated that economic nature needs to be prepared for unpredicted.

According to Wetherly and Otter (2008) there was a small group of extremely rich individuals and there was a concern about the gap between executive pay and the rest of people that work. In 2001 there was a critique regarding British Government not taking actions upon very high salaries of people working in the financial sector. Consequently, that was one of the very first causes of the financial crisis in UK (Wetherly