Global Financial Crisis: Implications And Causes

Discussion

Write an essay on Global financial crisis.

Global financial crisis have been pervasive phenomena throughout the history. During the twentieth century, the world experienced two major financial crises. People were seeing the first global financial crisis during the period of 1929-30 which largely affected developed nations such as America and Europe. Later in 1997, the second financial crisis was hit the emerging economies of Asia Pacific. The aftermath of this financial crisis has been broadly referred to as the “Great Recession”. From its beginning until its rock bottom in 2009, this financial crisis was responsible for the large obliteration of almost $20 trillion worth of financial assets purchased by the US households. During the phase of financial crisis, the rate of redundancy of US was upsurge from 4.7 percent to 10 percent. Furthermore, the average earnings of the people were drastically declined by 17.5%.

In this essay, the global financial crisis is going to be reviewed with evidence of the effects of the crisis to date. The theory of evidence will help to understand its impacts on the global economies. The widespread impacts of the latest global financial crisis underline the importance of having a solid understanding of crisis. Hence the purpose of the discussion is to understand what types of financial crisis the modern economy so far experienced and reviewing its implication in the financial and economic perspectives.

The 2007-09 global crises have been a painful reminder of the comprehensive nature of the crises. This kind of crisis not only hit the countries but it also negatively impacts on rich and poor ones. During that time the stock exchanges had been crashed and collective losses of the Paris, London and market of Frankfurt alone amounted above the 350 billion Dollars. The According to (Shiller and Robert 2012) this global financial crisis 1997 largely affected the capitalists of different nations; economies had upset the socialists economy of Russia as well. Peters et al. (2012) reminded that the intensity of the collapse was significant because it was started the downfall of the sub-prime mortgage sector of the United Nation. Due to this fact, the negative financial crisis extended towards “collateralized debt obligations”, “Mark-to-market losses on mortgage-backed securities and thus, related financial assets were destructed nearly $945 billion” (Karanikolo et al. 2013). Chor and Manova (2012) firmly stated that this was the biggest monetary loss in history after comparing the Japan’s banking crisis incurred in 1990. However, the Japanese banking crisis was occurred due to most the underlying causes which was identified later. According to Rey (2015), the regulatory authority of Japans was made numerous mistakes. The economist was made effort on liberalization however there were no appropriate adjustment of the regulatory environment. On the other hand, an excessive assets expansion in the periods of economic boom, weak corporate governance and regulatory restraint were all responsible for the Japanese banking crisis in general.

Possible Causes of Financial Crisis

Financial crisis is the unfortunate part of the global economy. The several numbers of financial crises over the last 40 years suggests a high degree of commonality. Taylor (2013) mentioned several repeat mistakes, made by many nations such as excessive exuberance, oversight, ineffective regulatory oversight, herd mentalities and in many cases, a sense of infallibility. Markets would yet again overlook the lessons from the past and was experienced even a nastier crisis in the global financial markets. Due to such crisis, the billions in losses and slow worldwide economy were manifested in the current European sovereign debt crisis. This has resulted severe impact on all the European nations because large numbers of financial institutions were collapsed and later this was considered as worst crisis since the Great Depression by many economists. According to Haas and Lelyveld (2014), this financial global crisis 2007 to 2008 was happened due to the wrong market function. However, Fratzscher (2012) argued that many of the incidents could have avoidable by market expert surveillance.

There are many market economists made different opinions regarding the cause of financial crisis of 2008-09. According to Bénétrix, Lane and Shambaugh (2015), this huge financial breakdown happened due to securitization whereas others said as a result of de-regularities within the financial system.  While there are several causes, however the prime issue is considered to be the crash of the “housing market of the United Nation”. The anatomy of the crisis identified by many researchers that the American housing market was picked up since 2006, and then suddenly dropped hugely by thirty percent (Kapan and Minoiu 2015). Many economists claimed that this was the largest decline since 1930 after identifying household debt which was reasonable increased over the previous decades.

The subprime mortgages exposed huge weaknesses in the markets of financial during the initial of 2007. Due to collapse of Lehman Brother, counterparty risk between banks upsurge sharply and the rates of interbank are also soared because banks virtually stopped lending to each other.

Figure 2: TED-spread soured

(Source: Lins, Servaes and Tamayo 2015)

According to Kuppuswamy and Villalonga (2015), the above mentioned global downfall has been considered one of the sharpest drop in global economic activities during the recent times.  Later the several developed economies were found themselves under the profound recession. Many nations have responded responsively after the “collapse of Lehman Brothers” sent a wave of fear around the world of financial market.

The seeming impotence of responses of policies and the variety of the negative financial news has raised multiple questions about the genesis of crises. Many financial market practitioners have identified deferent causes of global financial crisis. The possible causes of financial crisis are as follows:

Mark-to-market accounting: During the 1990s, the FASB and the Securities Exchange Commission had required public companies to value their assets at value of the market as opposed to the “historical cost”. This practice had been discarded during the Great Depression. According to Braun et al. (2015), these practice pushed virtually every national bank into the insolvency and hugely responsible for the global crisis. Cohn (2015) stated that the standards of FASB require institutions to report the financial securities at the fair value. However, many marketing practitioners of the regulation argue that this forces financial institutions to perceive losses based on the prices of “fire sale” that prevail in concerned market, prices assumed to be below  long term values of financials. The market confidence is being undermined due to such losses, and accelerates the identified triggers regarding the banking system.

Rating Agencies: Many economies said that the global financial shutdown could happen if the three rating agencies –Fitch, Moody, and Standard & Poor’s had classified subprime securities as the grade of investment. By this practice, the financial market could have been faced problems due to conflicts of interest as the agencies are being paid by issuers to rate the securities. According to Van Hoa, Harvie and Van Hoa (2016), poor economic models, lack of effective regulations, conflicts of interest are the main reasons for the failure of rating agencies. On the other hand, Korten (2015) stated that excessive reliance of market on ratings which has been reinforced by several legislative norms which are use the ratings create financial problems and confusions.

Lack of Accountability and transparency in Mortgage Finance: Many arrangements which are contractual provide option against issuers or sellers of bad mortgages or related securities. In this course, many non-financial mortgage lenders disastrous because they have to take back loans that defaulted. Because of the lack of participant accountability, the model of mortgage finance is considered as a huge generator of risk.

Finance through Off-Balance Sheet: There are many bank supervisors have actually encourage the off-balance sheet finance, by engaging in risky speculative investments. This kind of investment credited the contingent liabilities however, bank allowed to make more loans during the expansion and infrastructural development. Due to increase burden of contingent liabilities, the market may often lose confidence in the creditworthiness of banks. Furthermore this kind of the investment allows financial institutions to hold less funds against probable losses and virtually increased the global financial crisis.

Deregulatory legislation: There are many laws are practiced which allowed financial institutions to engage in “unregulated risky transactions”. Such law includes the “Gramm-Leach-Bliley Act”, “the Commodity Futures Modernization Act” and so on.

Mandated Government Subprime Lending: To help low-income borrowers, Federal mandates to engage irresponsible mortgage lending which indirectly exacerbate the financial crisis in the global market.

Financial Innovation: To sustain the competitive advantages, nations have often developed the new financial instruments. Sometime, the market or the system may not prepared when those infrastructure come under stress.

Human Frailty : Investors do not always make  right or optimal choice due to limited self-control. Regulators find difficulties in recognizing the behavioral finance consistently and that forces market towards the collapse or economic crash.

Leverage Excessively:  There are many investors used borrowed funds to gain the return on their capital. Excessive leverage increased the mispricing of risk and a credit bubble.

OTC Derivatives: The regulators and market participants are generally getting less information about the exposure of risks in case of OTC derivatives. Thus, there is a huge ambiguity about the extent and allocation of such losses.

Fragmented norms: A unified regulatory structure is missing in the global economic world. US financial instruction is isolated among several agencies. Each agency is responsible for a specific class of financial institutions. For this fact, there is no agency is in well positioned to observe budding system-extended problems.

Scarce systematic risk regulators:   There is a lack of authority in the global financial market. No supervisor had complete jurisdiction over the methodically significant financial statements. According to Kapan and Minoiu (2015), the global crisis of 2008 was happened largely because of this factor.

Securitization of loan : The originating financial institutions does not hold securitized loans. Thus there is a less incentive to monitor the standards of underwriting and increased financial confusion and influences the global crisis.

Credit Default Swaps: In 1990, the JP Morgan Chase, the fancy financial instruments was developed which allowed institutional investors and bank to insure against loan defaults. Many of the practitioners used this to proclaim an end to credit risk. However, Gruber   and Kamin (2015) argued that the credit risk is just replaced by the counterparty risk and thus the global crisis may be increased.

These are the above possible cause of the global financial crisis identified by many market practitioner and economist after reviewing the previous downfall of the global financial market.

Chor and Manova (2012) claimed that many of the financial crises are avoidable. On the contrary, Rey (2015), proclaimed that there are few risks which cannot be restricted. For instance, behavioral finance is completely depends on choice of investments of the investors. According to Haas and Lelyveld (2014), an effective political contribution or a strong political leadership is the core elements for the nation to secure finance from any debacle. Furthermore, a few financiers may prosecuted their financial role negatively and commit frauds. On the other hand, the short term investment horizon may lead the financial crisis which needs to be avoided. The case of GFC 2007-08, has been highlighted the danger of “imperfect market behavior”. In that case the safety measures must be maintained or followed by the nation’s financial infrastructure and legislative laws (Bénétrix, Lane and Shambaugh 2015). There are many financial institutions are well capitalized and can successfully managed the risks, however, the users must avoid levels of high debt, ineffective or misuse of financial instruments and regulatory oversights and so on. In this way, the nation’s economy can avoid the great recession.

Conclusion

By the reviewing the impact of the global financial crisis, the study has successfully depicted the severe results which can lead the great recession of the economy. The deregulation that preceded the financial crisis has been practiced by many decades. However this can be avoided by an effective banking system and a strong systematic regulating mechanism. 

References

Bénétrix, A.S., Lane, P.R. and Shambaugh, J.C., 2015. International currency exposures, valuation effects and the global financial crisis. Journal of International Economics, 96, pp.S98-S109.

Braun, S., Coglianese, J., Furman, J., Stevenson, B. and Stock, J., 2015. Understanding the decline in the labor force participation rate in the United States.

Chor, D. and Manova, K., 2012. Off the cliff and back? Credit conditions and international trade during the global financial crisis. Journal of international economics, 87(1), pp.117-133.

Cohn, T., 2015. Global political economy. Routledge.

Fratzscher, M., 2012. Capital flows, push versus pull factors and the global financial crisis. Journal of International Economics, 88(2), pp.341-356.

Gruber, J.W. and Kamin, S.B., 2015. The Corporate Saving Glut in the Aftermath of the Global Financial Crisis. FRB International Finance Discussion Paper, (1150).

Haas, R. and Lelyveld, I., 2014. Multinational banks and the global financial crisis: Weathering the perfect storm?. Journal of Money, Credit and Banking,46(s1), pp.333-364.

Kapan, T. and Minoiu, C., 2015. Balance sheet strength and bank lending during the global financial crisis. Available at SSRN 2247185.

Karanikolos, M., Mladovsky, P., Cylus, J., Thomson, S., Basu, S., Stuckler, D., Mackenbach, J.P. and McKee, M., 2013. Financial crisis, austerity, and health in Europe. The Lancet, 381(9874), pp.1323-1331.

Korten, D.C., 2015. When corporations rule the world. Berrett-Koehler Publishers.

Kuppuswamy, V. and Villalonga, B., 2015. Does diversification create value in the presence of external financing constraints? Evidence from the 2007–2009 financial crisis. Management Science.

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Shiller A and Robert J. 2012 The subprime solution: How today’s global financial crisis happened, and what to do about it. Princeton University Press

Taylor, J.B., 2013. Getting off track: How government actions and interventions caused, prolonged, and worsened the financial crisis. Hoover Press.

Van Hoa, T., Harvie, C. and Van Hoa, T., 2016. The causes and impact of the Asian financial crisis. Springer.