What Is the Result of the Credit Crunch a Recession or a Depression - Report Example

Topic:  What is the result of the credit crunch a recession or a depression? Effects of Credit Crunch The effects of credit crunch were considerably destructive for the financial institutions. Most of the investment banks were suffered a lot. They had no choice either to reduce the value of their assets or to file for bankruptcy. For many investment banks, even the value reduction of assets did not prove to be sufficient enough to protect them for the severity of the global financial crunch. It looked as the investment banks were struggling to fight for their existence; they were trying to stay alive and remain a part of the financial world. But, for many banks, their lives saving attempts were insufficient to protect them from the effects of the credit crunch. As a result, many investment banks had no choice left in the period of 2007 to the year of 2009; willingly or unwillingly, many declared their bankruptcy. In the initial face of the credit crunch, the financial and investment banks faced the harshness and severity of the financial crisis, the entire situation was so disappointing that many disappeared from the international financial circle and mergers, acquisitions, liquidations, bankruptcies and nationalization were the only options left for them (The WTO Doha Round and Regionalism, 2009). Definitions-Recession and Depression ‘Recession is when your neighbour loses his job; depression is when you lose yours’ (Ronald Reagan (1980) as saying, quoted by Eslake, 2008). Interestingly, there is no official or generally accepted criterion to identify a difference between a ‘recession’ and a ‘depression’. Recession is defined as a period in which a significant decline in occurs across the economy, particularly in real GDP, real income, industrial production, employment and wholesales-retail sales; additionally recession period may last more than a few months (National Bureau of Economic Research). On the other hand, depression is defined as a period of a more severe and harsh decline and downturn in an economy’ gross domestic product; sometimes, some economists determine and provide a standard demarcating a particular point to highlight the occurrence of depression. A 10-per cent decline or more is considered to be a point indicating the presence and occurrence of depression (Comerford & Sean, 2008). On the face of it, the period of recession is comparatively less than the period of depression. For instance, some economists are of the view that the recession may occur and last for two to three quarters. And its impacts could be limited to some particular sectors of an economy. As a result, recession could put negative impact on the index of employment and may trigger some sort of unemployment in some specific economic sectors of the economy. On the other hand, the period of depression tends to be larger and wide spread. The Great Depression of 1929 did not continue for one or two years; rather it constantly showed its pressure on the economy throughout the decade on the 1930s. Additionally, depression tends to be wide spread in an economy. It almost hit negatively to each economic sector of an economy. Causes of the Great Depression The decade of 1920s considerably experienced consumers taking on more debt in America. In this period of decade, according to Bernanke (1983) the outstanding amount of real estate mortgages sharply increased from the level of $11 billion to the level of $27 billion. The debt instalment also saw a sharp increase due to a wide spread availability of consumer goods. Due to the facility of credit and other forms of debt, many consumers facilitated their needs by increasing their purchases of household appliances, cars, homes and other basic necessities that they liked (Parker, 2007). This cause came from the consumer side that were mostly showing their consumer confidence on the economy of the America. On the other hand, the stock market was touching new psychological heights. And on each passing day, the stock market had something more than the previous day figures. There were some reasons; for instance, Parker (2007) explained that the speculative excesses were responsible for driving the stock market boom, and after some period of time, the Federal Reserve initiated the contractionary efforts in the early year of 1928. The consumer confidence in the decade of 1920s showed the over-confidence or the level of consumer confidence that was more than the required level. Since many people of America had easy access to money in the shape of short term and long term loans, besides there were no severe loan conditions that hinder or put some tabs on the purchasing behaviour and purchasing choice, it created a situation that subsequently materialised and transformed into what today known as “the Great Depression of 1929.” Additionally, the decade of 1920s was the first decade to see the end of the World War One. Many Americans did not have much time to spend during the period of the WW-I as they were in a state of war as a nation. Soon after the official declaration of the end of the World War-I, a psychological push was there to lubricate the needs of purchase. This psychological push was so great that many Americans and even the regulatory authorities were not more concerned about the aftershocks of the over-confidence showed by the consumer behaviour in America. But, they were happy with the current level of economic growth and economic prosperity on the land of America. The attitude of over-confidence showed its presence not only from the side of consumer behaviour but also from the side of regulatory authorities like the Federal Reserve. Also, many speculators lubricated the minds of investors with the possible abnormal returns by pushing many investors to invest in the stocks. This created an abnormal optimism across the stock market. The investors were mostly driven by the speculation. Since they were experiencing an unusual growth and returns in the stocks, the small and institutional investors undoubtedly did not waste time to investing into the stocks. The wave of speculation was felt positively by the each and every small and institutional investors who were not only observing the stock market touching a new level of heights each time, but also experiencing the occurrence of more returns on the stocks. Besides, the magnitude of the Great Depression of the 1929 was large and wide spread. During the period of 1929 to the year of 1933, the Gross Domestic Product (GDP) of America fell by 46 per cent (Snell & Ron, 2009). And in the same period, the prices declined by 72 per cent from the level of 1929. Unemployment was also sharply increased, during the period of 1929 to the year of 1933, the unemployment jumped from the level of less than 4 per cent to the level of 25 per cent. Not only this, the level of unemployment remained in the double-digits till the year of 1941, when the most of the employment was required and created by the defence spending required by the Second World War (Snell & Ron, 2009). Causes of the Recession of 2007-2009 The events in the financial and housing markets considerably contributed in the recent session of recession. In the period of late of 1990s and till the period of early 2000s, many under-developed and developing countries were putting a large amount of their savings into the banks and other financial institutions of the United States of America (Shomali & Giblin, 2010). The increased demand for the purpose of safe assets declined returns on those types of investments (Shomali & Giblin, 2010). Due to this low level of returns, many investors were unable to satisfy their demand of required level of returns. As a result, when they did not find any way to satisfy their higher yield demand, they initiated to take more risky investment with the potential of higher returns. This provided a base for the innovative and higher risk investments (Shomali & Giblin, 2010). Additionally, mortgage finance saw much increase in its activities. Most importantly, the subprime loans and real estate bubble in the United States of America grew substantially and became the root cause for the credit crunch and global financial crisis (Lannuzzi & Berardi, 2010). Also, the Fed of Greenspan, in order to upgrade and increase labour market and economic system, adopted and issued the lower interest rate to the level of 1 per cent after the attacks of 9/11. Udell (2009) explained that the supply and availability of sub-prime loans was more accessible and wide spread than ever before. The sub-prime loans are such types of loan which increase the risk of default and non-payment. Since the sub-prime loans were extended and given to those who were less equipped to repay them; as a result, this type of situation directly or indirectly increased the risk of non-payment. The worst of all was that the most of large and big financial institutions did not avoid extending sub-prime loans; rather they became part of that system by fully and considerably accepting the loan requests for the sub-prime loans. As a result, all these above mentioned factors provided causes and gave a situation for the global credit crunch. References 1. Iannuzzi, E & Berardi, M., 2010, Global financial crisis: causes and perspectives. EuroMed Journal of Business, 5(3), 279-297. 2. Udell, GF, 2009, "Wall Street, Main Street, and a credit crunch: thoughts on the current financial crisis", Business Horizon, Vol. 52 pp.117-25. 3. The WTO Doha Round and Regionalism, Kluwer Law International, 2009, "From the Board", Legal Issues of Economic Integration, Vol. 1 No.36, pp.1-5. 4. Snell, Ron 2009, "The great [begin strikethrough]depression[end strikethrough] recession: as bad as the economy is, its not the 1930s. That era brought hard times and changed the role of government in American life.(Cover story)," State Legislatures, National Conference of State Legislatures, High Beam Research. 5 Mar. 2011 . 5. Comerford, Michael Sean 2008 "Recession or depression? Definitions are vague.(Business)," Daily Herald (Arlington Heights, IL), Paddock Publications, Inc. High Beam Research, 5 Mar. 2011 6. Bernanke, B 1983, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression”, American Economy Review, 73(3), 257-76. 7. Parker, R 2007, “The Economics of the Great Depression: A Twenty-First Century Look Back at the Economics of the Interwar Era, Northampton, Massachusetts: Edward Elgar Publishing Inc. 8. Shomali, H & Giblin, G R 2010, “The Great Depression and the 2007-2009 Recession: The First Two Years Compared,” International Research Journal of Finance and Economics, Is. 59. 9. Eslake, S 2008, “What is a difference between a recession and a recession?” Available at: [http://www.anz.com/resources/e/4/e459fa004e4a38ffa19bab93c5571dd1/CO-Article-Difference-Recession-Depression-Nov-2008.pdf?CACHEID=aca11a804e472a119579b56672659df2] [Accessed on 5 March, 2011] http://www.anz.com/resources/e/4/e459fa004e4a38ffa19bab93c5571dd1/CO-Article-Difference-Recession-Depression-Nov-2008.pdf?CACHEID=aca11a804e472a119579b56672659df2 Read More