The Global Recession - Essay Example

The Global Recession The Global Recession Global recession occurs when the global growthfalls below 3%. Similarly, it happens in an economy when the GDP of that country falls for two consecutive periods. In the last few decades there have been significant changes in the global economy faced by regional, national and shared conflicts resulting in one of the most damage inflicting recession period that we are witnessing. It has influenced all sectors of the economy and requires a new collective approach to combat these calamities currently persisting in the global economy. This recent slump in the global economy seems to be cyclical in nature after studying the past trends, as it struck the world in 1998 as well. It has been repeated once again after almost 10 years, causing businesses to shut down in particular those that were unable to generate enough cash flow to supplement their operations in difficult times. This analysis paper examines the factors leading to the present global recession and its impact on the global economy. The financial crisis has overwhelmed the global economy and is being addressed not only on country level but also on a global forum. The capital markets are falling, industrial growth is at decline and economy trends are against the market. However, this situation did not happen all at once and many factors could be identified over the last decade or so that lead up to such catastrophic economic conditions. Just knowing about the current situation, we cannot come to know the actual root of the reason. For this, we have to explore issues and the basic flaws in the major economies of the world to understand from where the global recession was started. It basically started in the US as its housing sector collapsed and failure of subprime mortgage market lead to a meltdown in the financial sector. Prior to the collapse heavy inflows of foreign investment in the housing sector motivated financial institutions to go on a lending spree allowing home buyers to acquire mortgages at very low interest rates and at easy credit conditions. The demand for homes and mortgages continued to increase over the years as buyers became more confident of their buying decisions and the return on their investments thus creating a form of bubble that resulted in a continuing rise of home prices. To further induce the borrowing by home buyers loan terms were further relaxed as plenty of funds were available with the lenders and agencies causing a wide dispersion of credit facility without properly checks and balances (Jaffee 2008). Property agents were assigned the task of bringing potential home buyers to the agency in return of the additional benefits and incentives. At that time, the only aim of the financial institutions was to give loan to as many people as possible to earn more and benefit from the soaring prices of properties. But what they ignored in their greed was to check the repaying competency of their potential customers in order to avoid the future debacle. The financial prudence was ignored and people with low income or bad credit history were facilitated by the lenders. Favorable loan conditions were offered as a way to attract borrowers by lending companies that in fact led to solvency issues for them. Loans offered at variable low rates were expected to increase in the future and many borrowers took mortgages in their anticipation that the high prices will help them to refinance swiftly at more encouraging provisos (Jaffee 2008). However, this did not happen and conditions really worsened over a period of time. High leverage, defaulting credit swaps and collateralized debt burdens are the causes of the crisis in general. Another important factor which intensified the magnitude of the crisis was the wrong calculations of the banking sector and lenders regarding the risk level for such unregulated debt burden. In particular they neglected the reality that every boom has a burst and every success has an end. So this bubble burst at last. The surplus inventory of homes in the US resulted in decline of the home prices in the summer of 2006 and as a result of it, refinancing became difficult for buyers. The home owners began to default on their repayments as a result of increasing bank’s lending rate and subsequent payment amounts. By March 2008, the situation became extremely unmanageable as a major proportion of borrowers walked away from their homes and commitments as they became increasingly unable to repay. Foreclosures started in US when the lenders repossessed the default property. About 1.3 million US housing properties foreclosed in 2007. Homes sales volume declined by 26.4% in 2007 and 4 millions houses were put on for sale (Le Vine and Magaldi 2009). The lenders were of the opinion that they would still be able to get returns from the property repossessed even as borrowers default as they could exercise the option to sell these properties. However, it was not as simple as it seems and the market eventually collapsed. Such weakening situation in the housing industry forced house prices to decline and made many homeowners to default. According to Salmon (2009): "Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Lis formula hadnt expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial systems foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril...Lis Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees" (Salmon 2009). During the housing boom in the US and favorable conditions in the capital markets many fund investors took their loan portfolios from the original lenders. As an outcome of this move involving institutionalized investment, lenders had more funds to lend and thus the housing market received further boost to grow. To benefit from the higher returns from risky investment many American and European banks and other financial institutions bought mortgage backed securities that actually led to a greater international problem. The issue which was to stay within America was propagated in the world’s financial markets. Huge investments by US and Europe in securities began to shed their values that caused the depletion of the capital of banks. No one at that time was sure about the immensity of the loss and its effects on the continuity of businesses (Jaffee 2008). The loss was so huge that led the global banks and brokerage houses to write-off an enormous amount of $512 billion. The US banks were struck by the biggest loss of $260 billion where Citibank and Merrill Lynch were the major losers. Across the Atlantic, Europeans were the next to lose $227 billion and similarly Asian banks lost $24 billion as a result of this pandemic situation arising from the housing industry in the US (Pandyan 2008). Though the US Federal Reserve Bank tried to assist financially to the ailing sectors this couldn’t prevent the world’s largest investment bank from collapsing as a result of the recessionary conditions in the worldwide economies. Not just this Lehman Brothers which stood against major upheaval for past 158 years went bankrupt. Some large organizations like Freddie Mac and Fannie Mae were nationalized to save them from the setback (Bawden 2008). As the financial sector is considered as the backbone of any economy as it provides businesses and individuals with loans and investment capital. A major loss in the overall capital position of financial industry undermined the ability of financial institutions to provide loans to businesses and the industry. Many companies ran out of cash as they failed to secure financing from banks and thus needed cash for performing business activities was not available. This situation also affected the money markets all together. The liquidity crunch resulted in tighter policies and even major corporations failed to get running finance to support their weakening operations and poor consumer demand. Interbank markets were frozen worldwide and rendered the stock markets to decline significantly. Despite of all the steps taken by the US government to stabilize the economy, nothing really worked out well. However, tougher regulation led to a view that continuous and appropriate scrutinizing and controlling of money will in due course control the crises. No country remained isolated from the present economic fluctuations fueled by globalization of businesses. All countries were affected as major financial institutions that incurred heavy losses as an outcome of the collapse of finance sector in major economies have investments in global markets. Tremors that were experienced by these institutions in certain markets had their aftershocks in other economies and similar conditions led to shortage of liquidity, falling share markets and weakening of money value. Bob Davis in his writing reported that in the recent times, the stock market of many countries broke records and made new heights because of heavy investment from foreign investors. But, as the parents companies were stuck by severe credit crunch, they withdrew their money from the capital markets in other countries. Their egress from these markets obviously inflicted chaos in amongst local investors as well that further forced the markets to their lowest levels in recent times. The demand for US dollar increased and pushed the value of US dollar down again setting back the US economic situation. The recession mostly affected the industries that were finding it really difficult to generate demand for their products and services. Prior to the recessionary period, businesses were able to access cheaper funding from the capital markets however it is not the case anymore as investors’ view of IPOs became highly negative. The global recession has caused the external demand to decline as lenders are becoming extremely risk-averse (Davis 2009). The recession has caused the demand for all consumer goods to fall affecting the growth rate of the countries. Exports are also affected poorly in many countries including India, Pakistan, Bangladesh, Sri Lanka etc. The unfavorable conditions, declining demand and growth potential, market fluctuations and increasing anxiety are visible signs of global economic recession. What seemed to be a small subprime loan default in US has become the global recession taking back the progress made in the last decade. This is clear from IMF report that the economic crisis which affected every nation in the world, led the per capita income fall below 2.5%. According to its report, the unemployment level is increasing more rapidly, whereas the capital flows and oil consumption are falling along with trade and production of industry (Davis 2009). Year Per Capita Output (PPP Weighted) Industrial Production Total Trade Capital Flows* Oil Use Jobless Rate** Per Capita Consumption Per Capita Investment 1975 -0.13 -1.6 -1.87 0.56 -0.9 1.19 0.41 -2.04 1982 -0.89 -1.08 -0.69 -0.76 -2.87 1.61 -0.18 -4.72 1991 -0.18 -0.09 4.01 -2.07 0.01 0.72 0.62 -0.15 2009, projected -2.5 -6.23 -11.75 -6.18 -1.5 2.56 -1.11 -8.74 Average (’75, ‘82, ‘91) -0.4 -2.01 0.48 -0.76 -1.25 1.18 0.28 -2.3 Source: IMF (Cited in Davis (2009)) Thinking about the present situation will surely bring up the thought that this huge global recession was the result of the carelessness of those who overlooked the penalty of their proceedings. So it is true to say that the greed of some resulted in the woes of billions. No one was saved from this crisis. Free markets and capitalism concept have played key role in letting the danger spared everywhere and affected the lives of all of us. There should be a stronger regulatory framework for every decision made by financial institutions. Many developing nations are bouncing back swiftly. China has showed a quick recovery and growth. US and Europe are also progressing but at slow speed (Kurtenbach 2010). This is depicted in the following figure higlighting the recovery process in major economies across the globe. Source: (IMF 2009) Economists are of view that two-speed recovery will gain power in 2010 but it would take a longer time to recover the prerecession conditions. Some are of the view that recession is already over. Dominique Strauss-Kahn, the managing director of the International Monetary Fund (IMF) states that "2010 is going to be a crucial year – the first year after the crisis when countries can lift their eyes to the longer-term horizon". He further added that this will be "a year of transformation for the world" (Strauss-Kahn 2010). For an economist’s point of view, the global economy is again escalating. Countries are progressing, for example, China has an increased GDP of 10.7%, India’s 7.9%, US 5.7% and Britain economy rose to 0.1% (Yahoo! 2010). However, Professor Johnson says that this recovery is driven by those markets whose financial systems are less affected by the crisis and they were not overly indebted prior to crises. China, Australia and India did not really go through the recession however, their economies slowed down because of the global recession. But this recovery signs may not suggest full recovery of the global economy and it is some time before full recovery can be achieved (Johnson 2010). According to Ruth Stroppiana, Asia would be the first one to get back to its prerecession phase, then Latin America and with a lag other developed countries will follow. However, those that would be slow to recover include US, Britain and continental Europe. This delay is because of the structural and policies flaws and low saving ratios of these countries (Stroppiana 2010). The high unemployment along with increasing household debt and ongoing foreclosures are showing that consumers are not in such state to impel recovery. The reason for unemployment is that firms facing extreme recessionary conditions are still not in a position to have a large number of people working for them as they are generating less revenues and profits to run their operations at full levels, Businesses are undergoing restructuring process to reduce the cost as much as they can, and downsizing is part of their cost reduction plans. Though as the world largest economy, US should have played major role in the global recession recovery but its sluggish return is showing that its role will not be as prominent as it was before in such critical situations (Davis 2009). The rising commodity prices is a warning to economic recovery as it is viewed that if prices continue to rise as a result of imports from cheaper sources, the purchasing power of individuals will decline and it will surely result in higher inflation rate which in turn will pose threat to the economic recovery. Thus, high inflation in the country can hinder the recovery process and can cause further implications for economies that are trying to stir up local demand for products and services. In order to overcome the conditions prevailing in the current recessionary period it is essential to develop and maintain basics for persistent international progress and learn from mistakes made in the history. Through collective efforts between major economies including the US, UK, Germany etc. and tougher international regulations overseeing the activities of global financial institutions such catastrophic situations can surely be avoided or minimized in the future. It is necessary to enforce countercyclical strategies to avoid such calamities. Industries need to be fostered and lending needs to be made easier for them to bring them back on their previous levels. Domestic savings and corporate earnings should be encouraged. It should however be considered that the stimulus measures taken to recover from crisis should not be withdrawn as the governments would require to address their increasing debt levels and raising interest rates is one action that could push back the recovery process worldwide. List of References Bawden, T., 2008. Fannie Mae and Freddie Mac bailed out by US Government. [Online] Available at: [Accessed 17 April 2010]. Davis, B., 2009. What’s a Global Recession? [Online] Available at: [Accessed 17 April 2010]. IMF, 2009. World Economic Outlook: Update. [Online] Available at: [Accessed 18 April 2010]. Jaffee, D. M., 2008. The U.S. Subprime Mortgage Crisis: Issues Raised and Lessons Lear. Working No. 28. Washington, DC: Commission on Growth and Development The International Bank for Reconstruction and Development / The World Bank. Johnson, S., 2010. Global recession ends, economists predict recovery in 2010. [Online] Available at: [Accessed 16 April 2010]. Kurtenbach, E., 2010. Chinas robust growth fuels debate over policy. [Online] Available at: [Accessed 18 April 2010]. Le Vine, S. S. and Magaldi, A. M., 2009. Mortgage Crisis, Derivatives and Economic Chaos. New York, NY : Pace University. Pandyan, S., 2008. What is a sub-prime loan? [Online] Available at: [Accessed 17 April 2010]. Salmon, F., 2009. Recipe for Disaster: The Formula that Killed Wall Street. [Online] Available at: [Accessed 16 April 2010]. Strauss-Kahn, D., 2010. Global recession ends, economists predict recovery in 2010. [Online] Available at: [Accessed 16 April 2010]. Stroppiana, R., 2010. Global recession ends, economists predict recovery in 2010. [Online] Available at: [Accessed 16 April 2010]. Yahoo!, 2010. Global recession ends, economists predict recovery in 2010. [Online] Available at: [Accessed 16 April 2010]. www.oppapers.com/subjects/global-recession-page1.html Read More