Description of Crisis
During the 2008 crisis the housing bubble of US crashed which led to the large number of default. The main issue of the crisis was that the banks did not think that the housing bubble would crash and the housing prices would fall dramatically. In all the bank’s models they never assumed that the housing prices can crash. This was one of the major reasons why they were not able to predict the crisis.
Economic Issues used to address the impact
The main issue which was used to handle the crisis is the many banks had exposure in AIG and AIG had given insurance to many individuals and firms. If AIG had defaulted then it would have led to other firms defaulting as well the individual customers would have suffered even though they have no part to play in the crisis. Thus the government assessed the impact of the bankruptcy on the economy. Also Lehman Brothers had already defaulted which had created a havoc in the economy. The economy of US had entered into recession and the number of people losing their job was huge. Also government of US had to take some action to prevent the bankruptcies. If AIG had defaulted on their payments then there could have been a domino effect and it would have been difficult for the US to control the financial meltdown of the economy. Many financial institutions had huge investments or were insured by AIG. Hence default of AIG would have put them in jeopardy. Thus the US government and Federal Reserve did not want another bankruptcy and they wanted to save the economy from going into severe depression. Even though AIG had been negligent and should not have been ideally given the bailout money, US economy was going through the bad phase.