Causes of the slumps in the financial system

First, the financial system is lack of control. The basis of the classical economic theory is the efficient market theory considering that government economic intervention should not do too much (Freund & Weinhold, 2004). Developing countries such as China have been regarded as non-market economy countries. However, the role of government regulatory is important sometimes. The U.S. government once supported and sponsored enterprises to provide mortgage loans. At last, the government’s deregulation to economy stimulated the competition of banking industry like the mortgage industry. In order to attract new customers, managers provided zero deposit loans to first-time buyers. These government measures led to potential problems for the financial crisis. Government negligence and lax regulation to this phenomenon greatly promoted the mortgage and financial recession.

Second, financial innovation has increased the risk of the financial markets. With a loose policies and systems, to maximize the benefits becomes a rational person's goals to pursuit, and the innovation of financial product has brought huge profits to the financial industry. Bank has also joined in this process: mortgage in the balance sheet was easily stripped out and it was packaged into tradable bonds MBS (mortgage-backed securities), and then MBS were packaged into different credit risk CDOs (collateral loans). Finally it was sold to investment companies. After that, banks derived substantial transaction fees. In this transaction, the transaction object has not only limited to bonds, stocks and commodities, but credit. For example, a financial product obtaining a credit guarantee of a bank or an insurance company is marked by the AAA credit in order to be easy transaction. These new financial products themselves are a great risk.

Finally, investors improve the financial market risks and accelerate the recession of financial system. A large number of new financial products get the attention of investors. This directly causes a demand for credit products. It can be sure that it comes from the U.S. lower interest rate lower than the rate of inflation, while prices of house and other assets are high. Investors prefer using low-interest loans to buy houses and financial derivative products. With a large number of financial products flooding the market, individual investors and institutional investors feverishly purchase the products. At last, the potential crisis spread to the financial system.