Global Financial Crisis of 2008-2009 - Case Study Example

Running Head: THE GLOBAL FINANCIAL CRISIS OF 2008-2009 The global financial crisis of 2008-2009 Student Name Institution Date The global financial crisis of 2008-2009 Introduction This was a global economic crisis that got severe in the late 2000s spreading mostly in the industrialized nations. The impacts of the global financial crisis started in the mid 2007 with the full impacts being felt in 2008. During this time, the stock markets had fallen in most places of the world, there was a collapse of some of the largest financial institutions globally, and governments even in the most wealthy nations started strategizing on financial rescue to save their financial systems. This was a great concern worldwide since it affected almost everyone in the interrelated countries. The crisis was linked to careless lending habits by the financial institutions and this was encouraged by the government and securitization of mortgages in the US. This crisis had many severe economic consequences such as unemployment, reduced international trade, and increased prices in the basic commodities. The economic recession was announced in December 2008 by the National Bureau of Economic research in the United States (Copestake, 2010). This global financial issue has been blamed on several factors including greed, inadequate regulation, and oversight in the United States of America among other factors. This essay therefore looks at how these factors contributed to the global financial crisis of 2008 to 2009 and other contributing factors. Causes of the financial crisis of 2008-2009 The global financial crisis was mainly caused by the credit processed in America that the government had initiated to increase the borrowing and lending activities of its citizens. Credit plays a big role in the economy of the United States when it is utilized properly. However, the credit facilities were faced with greed, poor regulation and oversight among others. Corporate Greed Greed has been thought to be one of the factors that contributed to the global financial crisis of 2008-2009 in America. This is based on the facts given by Congleton (2009), who blames it on mortgage housing deal. In his article on the public choice journal, he explains that mortgage brokers contributed to the issues since they could determine whom to give the loan, and then passed the responsibility to others. People started taking risky mortgages which were still being approved by the brokers. To meet this responsibility, the brokers packaged them with other mortgages to resell them as investment. Many people therefore took the loans hoping that they could flip them to get profits or pay them later at a cheaper price. Copestake, (2010) also supports the fact by stating that banks then feared the unknown. This is because they did not know who owned what. Banks could also not lend to each other due to the fear that the borrowers could default the loans, or that the banks themselves could default. They even avoided recording the market price of their assets in their accounting books for the fear of being perceived as bankrupt. These financial institutions therefore suffered due to the greed of the brokers and the borrowers. Many people therefore became rich quickly and they were longing for more. Brokers were therefore actively selling the loans so long as the buyer could just say that he or she could afford it. The brokers were just selling the mortgages, reducing the sale and them packaging them with other mortgages that were backed with assets. This was like a time bomb that would later explode. It is this greed for profits and intoxicating success that resulted in collapse of many financial institutions. Inadequate Regulation Critics such as Tapiero, (2010).argue that the financial regulatory framework that was in function was not in line with the innovations that were taking place in the financial sector. Other factors blamed on deregulation were changes in law and some enforcement that were placed in the financial system. These include: In 1982, the then US president Ronald Reagan signed a law that allowed for adjustable rate on the mortgage loans. This began deregulation in banking leading to savings and loan crisis that was there in early 1990s. In 2004, the net capital rule that regulated the ability of brokers to meet their financial responsibilities of their customers was relaxed upon by the Securities and Exchange Commission in the United States. This allowed the investments banks to raise the amount of debts they were acquiring aggravating the growth in mortgage supported securities supporting the subprime ones. In this case, the investment banks were regulating themselves and this also contributed to the global financial crisis in the United States (Nanto, 2010). Poor regulatory measures by the government also resulted in excess global liquidity. . This was due to both internal and external liquidity factors such as the fast increase in reserves of the foreign exchange in the central bank reserves in countries such as China and others exporting raw materials such oil. This was due to unregulated trade that resulted in excesses and a lot of savings in these countries since they started experiencing increased growth are in 2000. Another cause of increased global liquidity was expended credit facilities as a result of reduced interest rates by the central banks in the United States. Financial oversight In order to promote business activities in the United States, the US government took a policy that encouraged deregulation of the financial institution. This ended up in less oversight of their activities and information was not being properly disclosed concerning the many activities that the banks started undertaking together with the other coming up financial institutions. Those who made the policy failed to realize the crucial role played by shadow banking system. The shadow banking system, made up of non-depository banks such as investment banks and the hedge funds, increased in size considerably after 2000, and played a crucial role in offering necessary credit facilities to the businesses (Nanto, 2010). The shadow banking system experienced a bank run in 2007 and 2008 when its investors ceased to provide money to its entities with fear that it might become insolvent. This was due to failure by the policy makers to realize its importance in the financial system. According to Wessel (2010) in the Wall street journal, these financial entities had become as important as the commercial banks but they were under similar regulation as other banks. These financial institutions incurred large debts as they continued to issue the loans as dictated by the policy and they did not have any other financial cover for the defaulted loans. The losses due to lean defaults affected their lending ability thus slowing down their financial activities. This affected even the key financial institutions driving the central banks and the government to bail out funds to restore their faith and continue lending. When the major financial institution in the United States failed and experienced buyouts, the administration of George Bush decided to save the situation by bailing out $700 into the US financial system. However, this was at first rejected by the US house of representative since it was seen as to benefit the culprits. Other European countries such as Britain started to nationalize some of the collapsing banks in efforts to restore confidence. However, the United States initially resisted this move since it went against the inflexible free market view that US bared. At last Bush Administration decided to buy shares in the collapsing banks. This was the oversight that happened in that the government decided on a policy to help growth of businesses but instead of using the shadow banking system in doing this, it involved all financial institution, thereby spreading the loses of loan default to even the key financial institutions in the country. Other causes of the global financial crisis of 2008-2009 Apart from the above discussed factors, there were other factors that contributed to the global financial crisis of 2008-2009. These include easy credit conditions and poor pricing of risks among others. The move by the US governments to have the banking system reduce the interest rates was to encourage people top borrow so that they can improve their businesses and also due to fear that deflation may occur. However, this was overdone until the rates went too low. This resulted in the current account deficit growing up to 5.8 percent of the GDP. To finance this deficit, US had to borrow large amounts of money from countries trading in surpluses in US and this resulted in large amounts of foreign capital flowing in US. As people borrowed more money, demand for various financial assets grew thus raising their prices and decreasing the interest rates. There was a flood of funds in US with other countries’ governments buying their treasury bonds. The households also used those funds to purchase housing and financial assets with financial institutions investing in mortgage-backed securities. The adjustable-rate mortgages (ARM) increased making the rates more expensive to be afforded by the home owners. This also led to deflation in the housing bubble since the rates of the assets moved inversely to the interest rates. The value of housing and financial assets in the United States also declined considerably after the bursting of the housing bubble (Books, LLC 2010). Pricing of risks is the premiums required by the investors to enable them to take extra risk measured by interest rates. This resulted in the financial crisis because for some reasons, those involved in the markets failed to correctly measure the risk that was inbuilt with the financial advances such as the mortgage-backed securities (MBS), and the Collateralized Debt Obligation (CDO). This means that they failed to understand the impact it will have on the overall financial system stability. Most things were done on estimation. Example, the AIG insured responsibilities for some financial institutions by use of credit default swap (CDS). This deal involved AIG taking a premium in exchange for a commitment to pay money to one party in case the other party defaults the payment. But in all these commitments, AIG did not have adequate financial back up to support its commitments. The crisis moved out of hand and the government had to take it over in 2008. This called for taxpayers in the United States to pay more than $180 billion to enable the government to back up the AIG in 2008-2009 (Gore, 2010). The other factor that was blamed on the global financial crisis was sub-prime banking. Boatright (2010) explains sub-prime banking as issuing loans to the most risky group of consumers and with terms that are different from those of the prime loans. Some critics such as Tapiero, (2010) blamed this on the Clinton’s administration claiming that he pushed Fannie Mae, the largest mortgage underwriter in US by then, to expand lending loans to the low and average income consumers who later defaulted. Conclusion The financial crisis of 2008-2009 affected so many countries in the whole world including the Arab nations (Sharma, 2010). Countries experienced inflation and deflation, plus other negative impacts such as unemployment and high cost of living. The main source of the crisis was the United States due to poor economic regulation that resulted in many financial institutions giving credits, most of which were defaulted. This poor economic regulation resulted in the government allowing easy lending of mortgages that were undertaken by many people who later defaulted. However, greed also played a role in the issues of mortgages as people took more that they could be able to repay. The US government also made a mistake of oversight where to boost businesses, they allowed more financial institution to give credit, a role that was initially being done by the Shadow Banking System. When defaulting started taking place, it affected several financial institutions resulting to a major crisis. The government was therefore forced to take the responsibility of helping in the recovery of those institutions and all this resulted into a global financial crisis. The major causes of the global financial crisis were originating from financially unethical decisions by the Government of the United States. References Copestake, J. (2010). The global financial crisis of 2008–2009: an opportunity for development studies? Journal of International Development. Volume 22, Issue 6, pages 699–713. Gore, C. (2010). The global recession of 2009 in a long-term development perspective. Journal of International Development. Volume 22, Issue 6, pages 714–738. Wessel, D. (2010). "Did 'Great Recession' Live Up to the Name?” The Wall Street Journal. Sharma, S. (2010).The Arab world amidst the global financial crisis of 2008- 2009. Contemporary Arab Affairs, Volume 3(1): 38 – 52. Congleton, R. (2009). “On the political economy of the financial crisis and bailout of 2008- 2009,” Public Choice, 140: 287-317. Nanto, D. (2010). Global Financial Crisis: Analysis and Policy Implications: Journal of Economic review. Vol. 12 (3): 94-101. Tapiero, C. (2010). Risk Finance and Asset Pricing: Value, Measurements, and Markets: Volume 563 of Wiley Finance. 403-412. Boatright, J. (2010). Finance Ethics: Critical Issues in Theory and Practice: Volume 11 of Robert W. Kolb Series in Finance. Vol. 11. (4) 2 Books, LLC. (2010). Late 2000s Global Financial Crisis: Late-2000s Recession, Financial Crisis of 2007-2010, 2008-2009 Icelandic Financial Crisis. 8(5). 345-365. Read More