The UK Economic Crisis - Assignment Example

Name: Tutor: Course: Date: The UK Economic Crisis Introduction A major contributor to the dropping economical condition of UK was the presence of the 2007/2008 global financial crisis that hit the UK with a shock. Economists failed to predict the occurrence of this event and if so, it was taken so lightly that the country had to suffer. Among the major sectors of the UK economy that were affected included the real estate sector, the banking sector, the debt situation of the nation, the LIBOR benchmark interest rate index, the employment sector and the export and imports sector (Nützenadel and Torp 4). To understand the scope of effect that was generated, it is important to expound on the four requisites for effective market discipline and he role they play in financial crisis in the UK. Body Question One Real Estate Sector The real estate sector and the housing market experienced a steady rate of growth before the occurrence of the financial crisis in the UK. At this point, the prices of real estate buildings and houses recorded the highest levels in over two years. To understand the implications of the crisis on the real estate and housing sector, economists tried to connect the situation with the causes of the crisis (Nützenadel and Torp 121). During periods of economic prosperity, it is possible that the economic drivers fail to influence the operations and management practices in terms of pricing on the housing sector. Initially, the UK mortgage market was dominated by increased builder societies. The entry of financial institutions and insurance companies changed the situation in the housing sector from a building society to mortgage products that resulted to increased competition. Before the crisis, many new mortgage holders bought their houses through high loan to value mortgage instruments owing to the favorable terms offered. With the sudden occurrence of the crisis, lending dropped while prices of mortgage housing increased to offset the deficits that resulted from the crisis. Most of the mortgages offered to the clients in the UK employ variable interest rates. The minute proportion of fixed rate mortgages rarely becomes variable after one year of their issue. In this respect, the rates of paying for housing are controlled by the base rate offered by the banks. During the year 2007/2008, mortgage providers faced a constant rate of default payments and descent owing to the inability of the people to match to the requirements of interest rates. Any rise in the economic factors within the housing and real estate sectors reflects an increase in the prices of housing. On the contrary, a decrease in interest rates allows household to meet their fiscal responsibility and results to high demand for homes. Although a number of factors may affect the access to housing and real estate, the crisis in 2007/2008 caused prices to rise above the expectations of the consumers. Banking Sector The first distinguished occurrence indicating a possible financial crisis in the United Kingdom occurred in 2007. The BNP Paribas cited a total disappearance of its liquidity and blocked extraction of three enclosed funds. The implication of this crisis in the banking sector was not recognized instantly (Nützenadel and Torp 55). However, it soon led to an experience of terror as shareholders, savers and depositors attempted to liquidate assets deposited in highly leveraged financial institutions. The purchase of assets provides a significant form of liquidity for the banking sector to run its activities within the local, domestic and international realm. One of the major banks that were affected was the Bradford and Bingley Building Society that was forced to sell all its assets and shares to the Spanish Grupo Santander Bank to offset an imbalance in their books of records and assure the clients of a competent banking system designed to counter such crises. The UK’s largest mortgage lender, Halifax Bank of Scotland was forced to engage in combined business as a means of securing the future of the banking sector that lowered its ability to recover at a faster rate. Despite this condition, the banking sector was forced to increase its interest rates on their lending that led to a drop in the corporate credit of the consumers. LIBOR Problems Before the onset of the financial crisis in the UK, the bank markets were culminated with increased developments owing to the developments that hade been experienced in the banking sector. However, after the financial crisis, economists identified that the stability of the financial system was at an increased risk that warranted immediate action. A major threat that would be noted is on the liquidity state of the dominating banks in the nation as well as the monetary transmission mechanism (Nützenadel and Torp 39). An interruption of the bank market has substantial effects on the financial system considering that the bank rates affect a wide range of lending rates for households and firms. Libor issues are related to the difference between credit risks and the rate of index swaps. This system is used in the design and delivery of a risk-free rate by banks and other financial institutions. During the crisis period, Libor was used to capture the funding costs based on the rates of borrowing and bids by the institutions. Because of this evaluation, the Libor analysis was identified with discrepancies causing deviation from other funding rates. It resulted to a perception that the banks lending rates were associated with elevated credit risks. Country Debt United Kingdom has suffered the greatest recession during the period between 2007 and 2008 that led to a prolonged period of low and negative growth reflected through an increase in the debt of the country. During this period, financial institutions have experienced increased advantage from the number of risky investments they engage in (Nützenadel and Torp 35). Arguably, this is meant to reduce the rate of resilience in the onset of losses. They were forced to employ the use of complex financial instruments that violated their ability to perform competently and credibly based on the perception of the consumers. For instance, the use of securitization of their balance sheets and derivatives was a complex approach that could not be monitored by the regulators and the creditors. However, it places the institution at a greater risk if discovered that would imply scrutiny or even closure. Some companies were also identified insolvent in a greater scale but used these instruments to divert their agenda. Labor Market and Unemployment The labor market and employment sector in the UK was adversely affected by the onset of the economic and financial recession in 2007/2008. The initial changes were seen in the later years through an increase in the number of unemployed people. Compared to other sectors of the economy, the labor sector experienced a slower rate of response to the changes. Approximately 3.3% of jobs were lost in the second quarter of 2008 in the UK. Companies reduced the number of workers to match with the reducing rate and scope of profits (Sowerbutts and Zimmerman 2016). Output of each worker also reduced significantly that reflected an implication to the entire employment sector. Reduced collective claim usually supplies through to employment. Therefore, lower demand means that companies do not need similar labor input and force as before to produce goods and services. The precise moment of the transformation and the hub of the impact in the employment market, vary based on the causes of a downturn. Question Two Availability of Information The financial crisis in UK may be associated with inappropriate decisions by the banks to fail in disclosing complete and concise information regarding the nature of risks that are imminent with borrowing and lending (Haven et al. 2016). Some economists have associated the cause of the economic crisis because of inadequate public disclosure by banks. Investors are often unable to identify the risks that banks often deal with as they implement systematic procedures to elevate the nature of the UK economy. Investors perceive that banks work in the best interests of its clients and will act in full disclosure to ensure that they are kept aware of the risks. During the recent UK economic crisis, investors identified that the banks failed to avail the required information. Therefore, planning and designing the mitigation strategies to counter the effect of the risks was impossible. In respect to the effects of the crisis, banks are required to avail the necessary information related to the funding risks, grouping structures, methods of valuation, annual and intra-annual data as well as the financial interconnections. The funding risks are associated with the possibility that the bank may default in raising new funds and repaying the creditors in case of a financial crisis (Sowerbutts and Zimmerman 2016). Granting the clients access to this information will help them understand the implications of engaging with the specific banks. The grouping structure helps investors understand the position of the institution within the UK economy and their ability to counter such threats. Accesses to grouping structure enables the client understand the risks that are associated with the grouping level. Availing information related to the valuation procedures helps clients understand the theoretical as well as statistical procedures involved in allocating funds. Failing to avail this may be associated with improper banking systems and a complete failure in ascertaining competence. This as in the case of the UK where companies failed to disclose the position or value in the economy cost them increased credit risks. Ability to Process Information Correctly This level depends on the competence and assurance of the banks to avail the required information to the clients. However, most banking institutions avail false information that costs the investors and depositors a greater deal. In this case, they fail to avail relevant information that may be plausible and provide a guideline to the risks that are imminent (Haven et al. 2016). Releasing irrelevant and bulky information to the clients eliminates the possibility of determining the risks that prove viable during various economic crises. For instance, some UK banks release increased information regarding the projections of a positive future while failing to consider the implications it may have to the depositors and savers. Truthful and honest delivery of information is associated with informed and strategic formation of the mitigation systems based on evidence based approach. Investors possess various sills that enable them identify with the conditions within the banking sector such as analysis and future planning. Once the issue proves to be a challenge, they often employ the use of outsourced experts to provide their view. In some cases, the views of external experts such as credit rating agencies may differ from the precise investors (Haven et al. 2016). However, the major issue that arises with this procedure is the risk of herding behaviour. A conclusion made by a ranking bureau to promote or demote a bank could result to increased number of investors altering their verdict of the relegated company’s debt. Investor Incentives Investors consider an analysis of the risks that they may face and incorporate the in the pricing strategies. In some cases, it is possible that the financial and economic risks that are not covered by the banks during venturing into new avenues (Haven et al. 2016). This violates the market discipline mechanism that allows investors to perceive risks based on an evaluation of the banking system. The UK financial crisis of 2007/2008 was a clear illustration of failure to consider the risks that are perceived by both the investor and the banking sector. Moreover, dominating banks fail to consider the role played by smaller banks in the economy, which tends to undermine the purpose of other investor input (Sowerbutts and Zimmerman 2016). Therefore, allowing the demise of smaller banks implies acceptance to higher economical costs of accessing lending and borrowing that translates to limited investment and limited performance. Once smaller banks fail to match to the credit risks, the UK government was forced to redirect resources and workforce into rebuilding the competence of the sector. This shifts the attention of the investors into evaluating the insolvency of the government rather than the respective bank (Haven et al. 2016). Economists argued that once banks ail to consider the overall implications of insolvency and bankruptcy of the national banks, the investors might prefer international institutions based on the incentives they offer. In terms of assets, smaller banks own reduced amount of assets that may fail to match compensation in case of credit risks. Investors often evaluate bank debt as being less uncertain than their balance sheets would suggest. This results to a decrease in banks’ monetary costs. Failing to inspect the UK bank’s credit ratings by investors represents the inability to examine the scope of lending and the risks related to the bank. Exercising Discipline It is more likely that the most common observation remains that market prices in the UK could not offer any significant insight on the impending risks through alerting the bank decision makers or regulatory parties on the in retrospection massive build-up of risk in the financial system. However, bank equity investors may have acted incompetently through withdrawing their investments on banks that failed to consider altering their credit and lending policies, which would imply and advantage caused by booming asset prices and a perception of low risk based on market-based measures (Haven et al. 2016). In this case, they preferred banks that increased their advantage and employed the use of short-term funding to lower costs. Investors failed to influence the positive decisions on the part of bank managers that would represent positive behavior as well as discipline in the banking sector. Failing to consider the position of various bank investors in respect to other investors implied a lack of discipline in the system. Investors in tenable debt or government-insured trading deposits may react more imperceptibly to the risks that the bank is experiencing. Conclusion United Kingdom is among the global nations that have been associated with increased financial crisis since 1992. The crisis has been associated with adverse effects to the economy of the nation although it has tried to implement a number of strategies that will improve its condition as a dominating nation, the crisis seemed to have affected its ability to expand and improve on innovation. However, economists have tried to develop a system that will help them identify the causes and implications of various elements within the United Kingdom through past and future analysis of the financial condition of various sectors of the economy. Works Cited Haven, E, Philip Molyneux, John O. S. Wilson, Sergei Fedotov, Meryem Duygun. The Handbook of Post Crisis Financial Modelling. Palgrave Macmillan, 2016. Nützenadel, Alexander, and Cornelius Torp, eds. Economic Crises and Global Politics in the 20th Century. Routledge, 2016. Sowerbutts, Rhiannon, and Peter Zimmerman. "Market Discipline, Public Disclosure and Financial Stability." The Handbook of Post Crisis Financial Modeling. Palgrave Macmillan UK, 2016. 42-64. Read More