Causes & Consequences of Financial Crisis - Assignment Example

CAUSES & CONSEQUENCES OF CURRENT FINANCIAL CRISIS TABLE OF CONTENT PAGES Introduction of Current Financial Crisis 03 Financial Crisis and Economy of UK 05 Financial Crisis and Economy of Australia 07 Financial Crisis and Economy of Asia 08 Conclusion 12 References 13 INTRODUCTION TO CURRENT FINANCIAL CRISIS: A large number of people are still unaware with the term financial and credit crisis. From an Economist view point, a financial crisis occurred when a conflict disordered the money supply and wealth of the economy, or in laymen terms we can say that, when a shortage of cash and liquidity prevails in the economy, it is referred to as financial or credit crisis (Krugman, 2001). The term financial crisis is applied to a number of scenarios or situations where the financial institution of a country abruptly looses a large part of their asset. The world suffered enormous number of severe financial crisis after the World War II but not a single one resulted in shrinking the world economy in an offense, like the current financial crisis did. Before the arrival of the current financial turmoil, the world’s economy as a whole was stagnate and was moving with a good pace. Almost all the economical indicators like balance of payment, Foreign Direct Investment (FDI), trade surplus, consumer price index and underestimated unemployment rate showed green signals in the long run for the economy. In July 2007, confidence of the people tumbled from the real estate market and mortgages, known as sub-prime mortgage crisis, from there the U.S market plunged in a severe recession. The mortgage crisis hit badly, the two biggest mortgaging firms Fenny Mae and Fredrick Mac and suppressed them to be default. Because of the default of the two giant mortgaging companies, the moral and confidence of the investors tumbled and the people were reluctant to invest in the real state sector, then the cash shortage occurred in the market in the year 2007, which pushed more industries towards the brink of bankruptcy (Appelbaum, 2009). In September 2008, financial institutions of USA suffered a severe loss first time after 2 to 3 decades, and urged the giant investment banks, Lehman Brothers and Morgan Stanley to go bankrupt, which had made the economy and financial environment a very difficult time for the economy of US as well as the economy globally (Sorkin, 2008). American International Group (AIG) had insured many billions of dollars of securities and loans pledged held by a number of banks around the world and after its failure, the money they have rendered became worthless. As per an estimate, the banks pledged over $50 billion in credit with the company which have been lost after the bankruptcy of the biggest group of USA, which urged the liquidity crunch to come on the screen. Before the financial crisis tsunami hit the world, the United States of America dominated the world with its strong economy and currency. A number of countries in Asia, Middle East, Russia and Europe were indulged with USA in exports and imports business and by the tumbled or deteriorated situation of USA, the said countries also envisaged a negative impact on their economy and from there the financial crunch spread globally like a forest fire. American economy mainly emphasizes on credit, albeit every household borrow money, homes and car loans recurrently that’s why the country didn’t impose any limit on the credit cards of the enterprises and not even on the individuals, which induced the major lending and investing institutions to envisaged a deeper recession, which was the worst after the World War II great depression. Citigroup is one of the victim of the severe financial constrain. The group recorded the biggest loss in the financial year of 2008 in its corporate history and slashed 30,000 to 40,000 jobs across the globe. Hundreds of thousands of jobs had been lost in USA as well as from the world, as every industry was cutting down its workforce to condense their expenses. Due to the dominating power and instinct of the USA, the country influences world’s economy as a whole and leaves a positive or negative impact on the economy with respect to the fluctuation in the economy of USA. More precisely, we can say that the current economical crisis and sharply decreasing US economy are the two sides of a same picture, as the USA plays a decisive role in the financial crisis. Nevertheless Obama’s administration came up with a stimulus package of $787 billion to keep the economy back on track. The Government of USA took some brutal actions to broaden the Income Tax slab for the corporations to 50 percent and imposed a limit on the remuneration of the Executives to $500,000 per year. After having a look over the commencement and major causes of financial crisis and its consequences on the US economy, now let’s take a look over the different dominating economies to get an idea about the impact of financial crisis on a particular economy and its consequences. CONSEQUENCES OF FINANCIAL CRISIS ON TOP ECONOMIES: Financial Crisis and Economy of United Kingdom: United Kingdom is among the biggest economies in the world and belongs to the top 4 economies of Europe. UK is the main victim of the current liquidity crisis because the financial sectors are the biggest industry in Britain, which are in severe distress due to the current financial turmoil. UK is one of the countries which are badly hurt by the credit crunch as almost every industry is continuously slashing jobs from the past 8 to 9 months. The rate of unemployment manifests a horrible figure and shows that over 6 million people lost their jobs due to unavailability of work and credit in the industries. The main threat for the UK economy is that their currency value is consistently collapsing against the major currencies in the world. Mounting unemployment rate, unavailability of adequate credit, declining stock market, deteriorating export and shrinking currency results in loss of confidence of the investors, as neither the enterprises nor the individuals are willing to borrow money form the banks. Although the banks of UK cut down their lending interest rate to 1%, but still they were unable to win the previous confidence and moral of the customers. The International Monetary Fund (IMF) has revised its Gross Domestic Product (GDP) for the country FY 2010 of -1.5% to -2.8%. Finance professionals thought a year ago that the UK economy is strong enough which had become particularly resilient to shock, but after the dwindling value of currency and continuously abating deposits in the banks, the perception doesn’t seem to be working for Britain. Recent strong actions by the UK government and Bank of England (BOE) seem to be worthwhile to stabilize the economy (Bernanke, 2009). Increasing the tax rate on the corporation up to 50% and guaranteeing every person under age of 25 who has been out of the job from last 12 months will be offered a job looks like a brutal and major action to bring the economy back on track. Financial Crisis and Economy of Australia: Australia has a very stable economy and, due to the country’s financial and political stability it is counted as the member of the United Nations (U.N), Commonwealth of Nations and G-20 major economies. The country mainly emphasizes on the exports as it is the main resource for them to strengthen their economy. Australian economy has been stagnate to 3.6% from the last 15 years, which shows that the country was going with a reasonable pace before the hazards of the liquidity crunch ruin the whole world. Statistical data reveals that the unemployment rate in 2007 was under control which manifested a figure of 4.6% but now it surpasses the rate of 7%, which shows how severely the country has been hit by the global financial crisis which deprived hundreds of thousands of people from their jobs. The export market all over the world tumbles badly and Australia is among those countries whose main resource of income is exports. The International Monetary Fund (IMF) sensed this thing of export plunging one year before and in the same year IMF predicted that the economy of the country would fall into recession in the year 2009. Unfortunately the prediction of IMF is right and the economical indicators show that the economy of the country is in danger zone because the Reserve Bank of Australia (RBA) intimated that the economy barely grew this year and it further pushed the unemployment and inflation rate to increase. RBA becomes aggressive now to attract the enterprises and foreign investments to give aid to their economy and in this regard, the bank has sharply cut down the interest rates to a record low of 3.25% which was 5-6% last year (IMF, 2007). After injecting into the economy twice by the stimulus packages of A$10.4 billion and A$42 billion FY 2007 and 2008 respectively gives some kind of relief for the economy to become viable but still it’s unable to halt the reserve bank of the country to cut its forecast of GDP growth FY 2010 to just 0.5 percent, which was previously (in November) predicted as 1.75 percent. Current economic situation of Australia does not seem to be good and if sharp fall in economy persists, then the outlook of the jobs will become worse than expected in future. To overcome the financial constrain which is expected, the worst after the great depression of 1930; Australian government took a remarkable step of pledging the money of their investors for three years. It means that the government is responsible for all the money deposit in the banks. The Australian Prime Minister Kevin Rudd said that the Government is with the industries and mainly with the financial institutions and we stand behind all the money that the Australian banks borrow from the foreign institutions by giving guarantee for all the deposits in the banks for 3 years. Australian Government also intends to pump another $4 billion in secondary market of mortgages. Recent decisive and brutal actions from the Australian Government will definitely enhance the moral and confidence of the investors as well as the depositors. Financial Crisis and Economy of Asia: We are all cognizant with the fact that Asia is the fastest growing region in the world, which has an impressive influence in economics, culture and politics. Since the year 1990, the contributions of Asia has been consistently increasing in the Gross Domestic Product (GDP) of the world; as in 1990, Asia contributed about 14% of world GDP. By contrast, in the year 2006 it surpasses from the contribution in GDP contributed by US which was 22% of the total world GDP and manifested a contribution of 24% in the world’s GDP. The continent has the largest reserves and the highest savings rate around the globe. United States of America and Europe also envisaged a heavy economic slowdown which has affected the demand of Asia’s export. The effects of price hikes in oil and food, leaves a negative impact on the Asian countries which has inevitably weakened the economic expansion of the region. Imperatively the financial institutions didn’t plunge much as the USA and UK banks did because of the tight regulatory requirements. The banking regulatory body in Pakistan and India imposed a limit on the usage of the credit card up to 1 million. Nobody is allowed to spent more money than that. Cash Reserve Requirement (CRR) ratio increased by 9% for both the countries in November 2008, to stabilize the country’s treasury and then they again cut the CRR to 5% after assuring that the financial sectors are safe enough to sustain. The State Bank of Pakistan (SBP) predicts the GDP of Pakistan for the upcoming fiscal year of 2.5% which was around 6% last year. On the contrary The Reserve bank of India (RBI) estimates that the Indian economy would have grown by 6.5 to 6.7 percent for the fiscal ended March 31, 2009 which is a sharp slowdown as compared with the previous four years, when the GDP manifested a figure of 9 plus percent. Nonetheless, current forecasting of the GDP is still among the best performance for any major economy in the world (Jack, 2009). Incredibly China is the country which is least bothered by the current financial crisis, mainly due to the volume of credit in their banking sector. The financial sector of China is very strong. Industrial and Commercial Bank of China (ICBC) is the largest bank in China, as far as the equity is concerned. The bank has deposits of over $3 trillion which makes it the number one bank around the globe. Some negative impacts of financial crisis sill envisaged that the country’s GDP contracted by 10.1% first time in 3 years, which is mainly due to the economic slowdown in exports all over the world and urged over 6,000 citizens to lose their jobs. Due to the strong financial health of the banks in China, the country is still in a satisfactory condition as compared to the other dominating economies. The people of China are least worried about any bankruptcy in the country yet. Some sort of threats can be seen which may slowdown the economy, which are exports and boosting consumer demands. Imperatively Wen Jibaro, who is the president of the country, announced a stimulus package of 4 trillion Yuan ($586 billion) to boost up the export graph and the demands of the consumers as well (Pimlott, 2009). Japan is the second biggest economy of the world and the largest economy of Asia, which is in severe downturn mainly due to the current financial crunch. It seems that the financial institutions of Japan are the main cause which pushed the country’s economy in an adverse situation. Bank’s poor credit discipline and Non-Performing Loan (NPL) are the main threats for Japanese economy. It is estimated that the country lost up to Yen 100 trillion merely due to the banking crisis. The Stock market of the country also manifested a vulnerable position as the Nikkei was at 8,000 in October 2008 compared to its peak of 39,000 in 1989. IMF forecast that the country’s economy will shrink more in the upcoming years, which ultimately leaves a bad impact on the unemployment rate. South Korea which is forth largest economy of Asia contracts 1st time in 2009 since 1998. The International Monetary Fund (IMF) has predicted that the country’s economy will decline by four percent FY 2009 due to the decrease in domestic demand and exports amid the global economic recession. South Korea’s export driven economy has been affected by the economic global slowdown with exports falling sharply and domestic consumer spending weakening, which suppressed Asia’s fourth largest economy to deteriorate first time from last 11 years. More than 200,000 people were expected to lose their jobs because of the economic downturn in the economy. South Korea’s government slashed its export growth target to a 51 years low because of the persistent global slump. The country’s export would fall 13.5 percent, according to the finance officials of South Korea which is the biggest drop since 1958. The government has become aggressive now and has responded to the slump and rising unemployment by offering stimulus program, including a $21.6 billion, supplementary budget announced last month to aid the continuously deepening economy. Hong Kong continues to be the world’s fastest economy according to the 2009 “Index of Economic Freedom”. Hong Kong has been rewarded number one position from last 15 years as no other economy has yet surpassed it. The economy is predicted to shrink by 3 percent in 2009 and now the country is forecasting that the GDP of the country would fall by 6.4 percent and 5.1 percent in the first and second quarter FY 2010 respectively. Hong Kong is among one of the countries, which mainly emphasizes on the exports trade and financial services, which are in the claws of severe recession and downturn. Hong Kong economy shrank 2.5 percent in the last quarter and is set for a downward spiral in the year 2009. To cope with the hazard of financial crisis tsunami, the Government of the country came up with some strategies. The Government announced a temporary cut on salary taxes and waivers on property fees. The Government also intends to create over 62,000 jobs and internships in the region and also willing to pump HK$39.3 billion ($5.1 billion) for capital works and to meet budget deficit. The budget of Hong Kong for the year 2009/10 with its $5.1 billion deficit, equal to 2.4 percent of GDP, which is definitely not adequate to boost such economy that remained export oriented with a big leakage effect. CONCLUSION: We are well aware of the fact that the current liquidity crunch is prevalent in the whole world and the global turmoil which is expected the worst after the 1930 great depression. The global financial tsunami has already precipitated an economic downturn that pertains and the substantial tumbling consumer confidence and sapping. Both developed and underdeveloped countries exert its extra bit of force to impel the economy of the entire world towards the deeper recession and downturn. The deepening credit problem has not only affected the financial sector, but also assaulted on the refinancing plans of many companies apart from the financial sector, or we can say that typically the trading and manufacturing sector. Finance experts, Gurus and Economists seems wonderfully optimistic on the fact that soon we will overcome on the crisis and will get the economy back on track and stabilize it before the arrival of 2010, but I must say its an uphill task for every country to completely avert the collision, from which we are suffering. Recently, G20 summit was arranged in London in which the top 20 economies of the entire world participated and came up with a remedy to overcome the liquidity crisis. A $5 trillion stimulus package has been announced which helps the discretionary economy to bounce back and become workable again. However the action of broadening tax rates and guaranteeing jobs, which Obama and Alistar Darling recently took to strengthen their economy, can be worthwhile up to some extent, but major actions must be take by the economies to completely eliminate the effects of the financial downturn. REFERENCES Richard, P. & Miller, M. 1999, The Asian Financial Crisis, Cambridge University Press. Krugman, Paul 2000, The Return of Depression Economics, W.W. Norton & Company. Australian Financial Review 2009, afr.com Financial Review, viewed 14 May 2009, Business Review Weekly 2009, BRW.com.au, viewed 14 May 2009, Houlder, V. 2009, “Recession pace to slow, says study”, 04 May, Financial Times, viewed 14 May 2009, Pimlott, D. 2009, “Service Sectors records small growth” 07 May, Financial Times, viewed 14 May 2009, Ewing, Jack 2009, “Economic Woes Raising Global Political Risk”, 10 March, Business Week, viewed 14 May 2009, Appelbaum, B, Leonnig, Carol D. & Hilzenrath, Davis S. 2008, “How Washington Failed to Rein in Fannie, Freddie”, 14 September, The Washington Post, viewed 14 May 2009, Gullapalli, D. & Anand, S. 2008, “Bailout of Money Funds Seems to Stanch Outflow”, 20 September, The Wall Street Journal, viewed 14 May 2009, Sorkin, Andrew R. 2008 “Lehman Files for Bankruptcy; Merrill Is Sold”, 14 September, The New York Times, viewed 14 May 2009, Bernanke, Ben S. 2009, “Lessons Of The Financial Crisis For Banking Supervision”, 07 May, FBR: Speech – Bernanke, viewed 14 May 2009, International Monetary Fund Report 2007, “Financial Market Turbulence: Causes, Consequences & Policies”,  IMF Global Financial Stability Report, viewed 14 May 2009, Read More