Causes, Consequences, and the Government Responses of the Current World Financial Crisis - Literature review Example

? An examination of the current global financial crises: the causes, consequences and government responses in the United Kingdom and China Module: Economic Environment of Business Student Name: Student ID: 12019017 Group Number: 2 Lecturer’s name: Vivien Ojadi & Helen Stamps Global financial crisis refers to the time of economic difficulty witnessed by consumers and markets. It is the worldwide credit, according to Anderson and Timmons (2007), trade and currency crisis that began in late 2008. The financial crisis started between 2008 and 2010 and was because of the housing bubble and subprime mortgage lending in America. It is no longer a secret that the people responsible for making sure that the financial system is stable in the United States helped because the 2007-10 crises. The Financial Guardians in the US and Europe established policies that encouraged adverse credit allocation, and a lot of risk taking by their financial institutions. They still stood by the same policies even after learning of the impending financial problems. Financial Guardians in the United States have at many times chose and maintained policies that have always led to the crisis. This counter reacted to the crisis by adding other rules and establishing newer regulatory boards with more powers granted by the Congress. Anderson and Timmons (2007), give an example evident where the regulators never reacted to the extra ordinary increase in the financial institutions advantage. This could not react to the movement of assets worth trillions of dollars from banks balance sheet. This shows how the regulators did not do their work. Increasing the regulators power without checking the problem and trying to regulate it helps in solving nothing. The aim of this essay to examine the causes, consequences, and the government responses of the current world financial crisis faced in the United Kingdom and China. Firstly, the essay will explore the situation in the United Kingdom and European Country. Secondly, it will focus on the causes, consequences and the government response of the financial crisis in China. Finally, there will be a made comparison of the situation in the United Kingdom and China. When the crisis broke out, it gets believed that the United Kingdom economy would not fall to the financial turbulence. This was because of the thriving real economy that was strong on export growth and substantial financial position of businesses and households. However, according to Anderson and Timmons (2007), this changed in late 2008, following the rescue of Fannie Mae and Freddy Mac, the subsequent bankruptcy of the Lehman brothers and the growing fear of the Insurance power house, American International Group (AIG) dragging down leading financial institutions in United Kingdom and the United States of America in its wake. Market valuations of financial institutions disappeared; panic emerged in stock markets as investors ran for the sovereign bonds. The financial crisis was now a reality. Banks became forced to restrain credit allocation. Asset markets fell rapidly in UK. With the trade credit getting expensive, firms saw their sales fall and stockpile up. The huge exposure of United Kingdom to America’s subprime problem was soon evident in 2007 when BNP Paribas froze the resurrection of three investment funds, claiming inability to correctly value the structured products. Because of this, the risks between financial institutions grew drastically as shown by the high interest rates charged by the bank amongst themselves for short term loans. Still at this point, the observers were still not alert that the systematic changes will create a problem. According to Adrian & Shin (2008), in 2008 with the fall of America’s Bear Steams and Northern Rock Bank and Landes Bank in UK things took a turn. When Lehman Brothers filed for bankruptcy in 2008, Ted spreads leaped to unprecedented high. Investors became more wary of the risks involved in bank portfolios, and it became extremely difficult for banks to increase capital through shares and deposits. According to Allen and Douglas (2007), the institutions that could no longer finance themselves had to restrict their lending and sale assets at relatively lower prices. The drop in the prices of the assets fell reducing lending and capital further. The impending economic downturn further increased the credit risk, eroding bank finances further. In the European nations, the hard lending standards and the reduction in the wealth of households during the period of falling asset prices, savings significantly increased as the demand for consumer goods and investments in residential properties declined. According to Allen and Douglas (2007), the real Gross Domestic Product (GDP) depreciated by 4% in both the European nations and the Euro zone. Economic recovery in the Euro zone has been sluggish apart from Germany. Housing prices in the UK, according to Cohen (2009), fell drastically in 2008. According to a nationwide research, the average price of a house in UK fell by about 14.8% in 2008. This downturn in both the residential and commercial markets, related with the limited credit availability and tightened lending have played a large part in the fall of both the transactions and development activity. The UK banks a large weighting of property exposure existing in their loan books, and have tried to contain and manage its lending while improving the position of their liquidity, and because of this, they are not in the market for new businesses. The responses from the Central Bank in the United Kingdom have been to drop the interest rates to historical lows to maintain and sustain funding costs of the banks. The Banks also provided increased liquidity against collateral to ensure that the banking institutions do not resort to fire sales. Even though, according to Crockett (2008) the measures have resulted into enormous expansion of the balance sheets of the central banks, they have been beneficial as three month interbank spreads drop from their high. The percentage of the trade in Euro zone, notably in the UK declined in the last quarter of 2009 as demand for consumer goods and business investment, which depend largely on credit, declined. Brunnemeir (2009) suggests that these trade squeeze became large than it could have become expected on the foundations of historical relations. In Elliot’s (2011) view, at the end of the last quarter of 2011, the debt of the Euro zone reached a high of 87.3% of all GDP of Euro zone. In Greece, for example, the percentage of the government debt increased to 152%. This was not a good indication for other countries in Euro zone. With the continued financial crisis, countries in Europe separated themselves from the problems they faced, and decided to focus on their own economic problems. The UK decided to stick on its government for bailouts. Nevertheless, as the crisis continued to worsen, it became clear that it would spill over to the rest of Europe. The European Nations, according to Elliot (2011), decided to reach an agreement on the importance of a collective response to the existing debt crisis in the Euro zone as well as its impending spill to the member countries. In 2010, the finance ministers of the European nations decided to implement a $110 billion rescue package to prevent the likely Greece default and the potential spread of the financial crisis to the UK and other economies. The government has also set up place financial measures to ensure that the capital losses of the financial institution would be counteracted. Initially, the governments provided new guarantees or capital on toxic assets. However, it has shifted to asset relief, while toxic assets get exchanged for assets such as government bonds. Adrian and Huan (2008) states that, all these deigned measures were aiming at putting financial institutions afloat and to provide them with the space they need to prevent a disorderly deleveraging. Just like in all other countries, the impact of the global financial crisis on the economy of China was severe. In the first half of 2008, Chinese economy had maintained a growth rate of 10%, according to Schmidt (2009), the central government had to implement monetary and fiscal policies to stop the overheated growth and pressure on inflation. Nevertheless, Schmidt (2009) also states that the economy took a drastic turn and went into recession in the last half of 2008. This had significant effects on the Chinese economy, as its growth rate began to decline. The growth rates of several Chinese economic indicators, like the enterprises profit, value added of industry, and export and fiscal profits dropped drastically. The labor market became highly affected. The newly graduates, low educated youth in the urban area and the rural migrants got affected significantly by the crisis. Another highly affected industry was the export based light industry in the Southern region of China. In the economist (2008), a number of companies became shut down, and a huge number of workers lost their jobs. The stock market fall that started in 2007 affected the financial sector enormously. The Chinese banks witnessed a significant pull out of a number of their Western Nations counterparts that had to sell their stakes in order to retrieve their capital. The global financial crisis seriously affected the China Investment Corporation, CIC. Schmidt (2009) points that the public has become critical towards the firm’s investment strategy with Western companies following the losses incurred. Exports fell in 2008 by 2.2 % for the first time since 2001. Imports fell by 21%. The Chinese government, according to Gaspar (2009) responded to the crisis in different ways. In a speech by Premier Wen Jibao, he said that all they can do is hold the steady and fast rise of the national economy, and to ensure that there will be no fluctuations. This, according to him, will be the greatest effort they can provide to the economy. According to an article by Eurofinance (2008), the Central Bank of China decided to cut the interest rates and the reserve requirement ratio to help stimulate the ailing economy. China’s State Council also announced in October 2008 that it was planning to implement a new economic stimulus package that would not only accelerate the new tax rebates on exports, increased subsidies in the agricultural sector, small businesses lending, and a decrease in the taxes of housing transaction but also on the construction projects. According to Schmidt (2009), the government planned to implement $586 billion two year stimulus package, which will become focused on infrastructure projects. This package would facilitate the financing of the programs in 10 vital areas. These are; rural infrastructure, electricity, water, affordable housing, the environment, transport, rebuilding regions hit by disasters and technological innovations. China, according to Schmidt (2009), reportedly gave aid amounting to $500 million to Pakistan in November 2008. China’s president Hu Jintao was present in the G-20 forum, where he called for serious reforms of the World financial system. He also commented the growing China’s economy as the most significant step a government can take to wisely respond to the ongoing financial crises. In both UK and China, there are a number of similarities in both the causes, consequences and the government responses. Crockett (2008) states that, thousands of people lost their jobs in both nations. The countries, also, went into serious financial crisis because of the ties their leading banks had with a number of banks globally. When one bank became affected, it dragged down the others with it. The government of both nations came up with huge bail out plans for their financial institutions. In conclusion, globalization of the financial system was dangerous. An example is when a large financial institution gets in a total mess, for example, Lehman, which is the third largest investment bank in the world to get into trouble. Since it does its business globally with everyone, leading banking institutions that are, and with their financial muscle they had managed to amaze. According to Anderson and Timmons (2007), when this company took a hit of the financial crisis the confidence it had built in people fell. There was no other national financial system since the United States did not have one neither did the British. China’s banking institutions had connections with Western Banks, and when the crisis occurred, they suffered. Financial institutions should run independently and only receive help from the Central Bank. Bibliography Adrian, T. and Shin, H. S., 2008, The Liquidity and financial contagion. Financial Stability Review (11), 1-7. Allen, F. and Douglas, G., 2007, Understanding Financial Crises, October,. Oxford: Oxford University Press. Anderson, J. and Timmons, H., 2007, Why a US sub prime Crisis is felt arouynd the world, New York Times, 10-12. Brunnermeier, M., 2009, 'Deciphering the Liquidity and Credit Crunch 2007-2008'. Journal of Economic Perspective (11) , 77-100. Cogman, D. and Dobbs, R., 2010, Financial crises, past and present. Retrieved July 10, 2012, from http://www.mckinseyquaterly.com Cohen, M., 2009, Economy in sharpest fall for 30 years. Financial Times, 14-15. Crockett, A., 2008, Market liquidity and financial stability, Financial Stability Review 11, 13-17. Elliot, L., 2011, Global Financial Crisis: Five key stages 2007-2011. The Guardian, 12. Eurofinance., 2008, 'International Asia 08' Conference. EuroFinance 30(2), 10-12. Gaspar, V., 2009, Europe's policies for restoring global financial stability. Journal of Economic Perspective, 15-16. Schmidt, D., 2009, The Financial Crisis and its impact on China. China Analysis, 1-5. TheEconomist., 2008, International Banking Paradise Lost. The Economist 10(3), 15- 17. Read More