Global Financial Crisis - Coursework Example

?Global Financial Crisis Table of Contents Introduction 3 3 Evolution of the Financial Crisis 4 Causes of the Financial Crisis in Western Industrialised Countries 5 Regulatory Failure in the Western Industrialised Countries 8 Immediate Tasks To Overcome The Financial Crisis Due To Regulatory Failure 10 Conclusion 12 References 13 Introduction A financial crisis can be regarded as a situation where economic markets are interrupted because of controlled credit to businesses and households and the real markets of services and goods are unfavourably affected (Jickling, 2008). There are immense causes or roots available for a financial crisis irrespective of any nation. Basically, the structural factors like confusion arising between the free and the continuous deregulation of markets, a remarkable rise in the role of investment markets prevailing in both banking and non-banking economic organisations, rapid use of new global monetary mechanisms, declining transparency of the free markets, increasingly spreading out high business risks, inequality in a particular businesses origination and distribution factors among others are a few of the major causes or roots of a financial crisis (Alliance of Liberals and Democrats for Europe, 2008). Also the general factors like regular conflicts regarding the market interests among the free and capital market contributors, deviation between individual bank interest rates with central bank’s policy rates, extremely minimum risk-free interest rates in major economies like the US and Japan among others, growing gap between maximum capital profits and low cost of capital, spreading out unfavourable low credit difficulty across all mechanisms also constitute a few of the crucial roots of a financial crisis that are prevailing in a particular organisation or in a particular nation (Alliance of Liberals and Democrats for Europe, 2008). In the paper, the regulatory failures that especially the western industrialised countries faced and which led to the universal economic crisis in the year 2008-09, is examined along with the findings about the causes or roots of the arising financial crisis along with certain immediate tasks that should be followed in order to cope up with the financial crisis has also been discussed. Evolution of the Financial Crisis The international financial crisis was originated with the ‘sub-prime mortgage’ crisis and was eventually faced especially by the western industrialised countries during 2008-09. With the result of increase in rate of interests along with decline in home prices, there was a sharp jump in non-payment and foreclosures. In that particular period, there arose certain doubts regarding the liquidity of those assets and eventually became tough to fetch adequate price (Rangarajan, 2009). As a result of raising this crucial doubt, it gradually started to affect the prevailing institutions for their enormous investments made in their respective products. Thus, the entire financial system of the western industrialised countries was recognised to be in an acute crisis. There was a mutual distrust among the financial institutions in the western countries which led to freezing up of several markets including the inter-bank market. This crisis in a financial system had moved to affect the real sectors in various significant methodologies (Rangarajan, 2009). Due to the evolution of financial crisis during 2008-2009 in the western industrialised countries, the emerging market risks, the bank lending flows, the foreign direct investment (FDI) flows and the export volumes among others had turned negative. The economic activities were contracted rapidly and particularly the western industrialised countries experienced large decline in their respective industrial production which weakened their credit growth (Berglof, 2010). Causes of the Financial Crisis in Western Industrialised Countries The financial crisis has been brought about by a combination of unsuitable monetary policies, extreme risk taking of certain financial organisations and inefficient remuneration practices especially of the bank executives and dealers. During the year 2008-09, a major ‘savings-investment’ inequality was recognised. This is partly the result of export based growth strategies particularly in the western industrialised countries along with insufficient savings in other financial practices. Lack of exchange rate adjustments can also be considered as an additional part of this significant issue (International Labour Organization, 2009). The other significant cause of financial crisis that the western industrialised countries faced was due to the eventual growth of income disparities within the countries. Minimum wages and incomes for the workers in certain countries encouraged demand for credit in order to maintain expenditure potentiality along with housing expenditure decisions. A rise in the share of over-indebted households has also been recognised in all western countries where income disparities have increased (International Labour Organization, 2009). The income disparities were made possible by regulating the monetary performances that allowed enormous liability accumulation and focused on short-term proceedings rather than long-term investments made in the real economy. The crisis then spread to the real economy through various channels. Initially, the crisis spread through the financial system process of securitisation of ‘toxic assets’. Direct exposure to ‘toxic assets’ led to some localised bank failures and thus the inter bank credit was affected. As a result, the volume of new credit available to the real economy eventually declined (International Labour Organization, 2009). Also the crisis scattered globally through international association with trade practices and as a result, the developed countries of the West with relatively healthy financial systems were being affected through world trade. The global trade movement was also affected by the scarcity of trade financing. Certain trade values especially for oil and other commodities among others in western countries along with sudden reduction in export revenues as a result of the recession were affected which was due to world trade prices (International Labour Organization, 2009). Moreover, foreign direct investment (FDI) and other private capital flows are also affected as well due to these trade prices. In particular, private capital flows in western industrialised countries were expected to fall to a significant amount in 2009. This issue had implications for development, as some portion of growth in western countries comes from investment. The reduced flow of capital had a dramatic effect on western countries with massive current account shortages with a limited borrowing ability from others (International Labour Organization, 2009). The large influx of money into the western financial system enlarged the supply of funds which are available for loans and investments also led to the financial crisis to a significant extent. This consequence combined with inadequate government economical guideline and supervision, resulted in investors and banks making riskier loans such as for subprime home and refinancing mortgages. These deliberately arising riskier loans led to financial crisis in the western industrialised countries (Shane & Et. Al., 2009) Regulatory Failure in the Western Industrialised Countries Regulatory failure by the western industrialised countries contributed significantly to the global financial crisis of 2008-09. In this connection, the regulatory failure was based on various dimensions. One of the dimensions is that certain parts of the financial system were either insecurely synchronized or were not synchronized at all by the western industrialised countries which eventually led to ‘regulatory arbitrage’ with funds moving more towards the unregulated segments (Rangarajan, 2009). The other dimension of regulatory failure lies in the imperfect and inadequate understanding of the implications of various ‘derivative’ products. In general, ‘derivative’ products are natural consequences of financial development. However, if the ‘derivative’ products become too much complex or complicated where the risk lies, they eventually become a major cause of worry. The rating agencies were negligent in creating a flourishing market in suspect of ‘derivative’ products. As a result, there was a disparity between economic modernisation and the ability of the regulators in order to scrutinise them (Rangarajan, 2009). The regulatory failure also constitutes the unsteadiness of financial markets to a number of unusual factors, ranging from ‘asymmetric information’ to human psychology. The western industrialised countries should realise in the belief that the financial markets must be regulated to certain extent if crises are to be minimised (Helleiner, 2009). Moreover, the international regulatory function seeks to reform and to update the existing international regulations. From this perspective, the financial crisis was caused not only by the failure of market regulators to keep aware with market innovations but also by modifying their existing regulations. The essential key features of those market regulations need to be changed in order to avoid the financial crisis (Helleiner, 2009). The other significant regulatory failure that led to the financial crisis was due to push for the re-regulation of financial markets made by the government. From this perspective, the government regulators did not bear sufficient knowledge in order to prevent the financial crisis. The financial crisis was caused largely by the government policy rather than market failure. The government regulators instead of improving the quality of monetary policies remained more focused on re-regulating the existing monetary policies (Helleiner, 2009). In this connection, the western industrialised countries also faced a global economic crisis due to this regulatory feature by performing excessive capital mobility. The enormous uncontrollable capital inflows of the western countries generated the financial crisis among themselves (Helleiner, 2009). The other regulatory failure that led to the financial crisis was the factor of regulatory decentralisation of international financial regulation. Certain financial officials laid emphasis upon the implementation of a wide range of international best practice standards and codes particularly in the western industrialised countries. But the government of the respective western industrialised countries were recognised to be less interested or focused on this initiative and such disinterests eventually paved the way for the financial crisis (Helleiner, 2009). Therefore, it can be aid without much doubt that there are certain regulatory failures that led to the global economic crisis of 2008-09 that were severely faced by the western industrialised countries. Immediate Tasks To Overcome The Financial Crisis Due To Regulatory Failure Due to certain regulatory failures, the western industrialised countries faced the financial crisis, thus some immediate tasks might be followed or taken into action in order to overcome the financial crisis. The financial system has to remain fixed in order to maintain the aggregate demand at a high level to a certain extent in order to stimulate the real sector economy. Since the real economy is one of the major components of the financial system, the first priority is to take utmost care of the financial system in order to cope up with the financial crisis (Rangarajan, 2009). The other significant task in order to cope up with the financial crisis that had been prevailing in the western industrialised countries lies in the issue of leverage. It has been recognised that many of the weaknesses of the financial system developed in an atmosphere of very minimum interest rates. As a result of leverage, the net savings rate of particularly the household sectors stands negative. It has also been recognised that in a globalised system, a particular country’s investment rate is not solely determined by its savings rate. Nevertheless, the extent of leverage factor is a crucial issue in which the regulators and the policy makers should attain special attention, if financial stability is to be achieved or in order to cope up with the financial crisis (Rangarajan, 2009). Moreover, the central banks around the world have initiated actions in order to address the various challenges that are faced by the global financial market by means of providing liquidity and easing monetary conditions. In this context, monetary policies have been used as the first line of defence in an attempt to sustain and to strengthen the aggregate demand and economic activity. This particular shift in focus of monetary policy has been highly supported by a rapid decline in the process of inflation. This feature of the central banks can be one of the serious weapons in order to cope up with the financial crisis due to regulatory failure (International Labour Organization, 2009). Thus, these are certain recommended immediate tasks or procedures that can be implemented in order to cope up with the financial crisis due to certain regulatory failures faced especially by the western industrialised countries. Conclusion A few of the major disruptions in the financial markets and various other government policies are certainly the chief reasons that led to the global monetary crisis during 2008-09. Apart from the viewpoint of financial markets and government policies, there are also certain valid reasons or causes that generates financial crisis. The financial crisis that was faced by the western industrialised countries was particularly due to certain regulatory particularly in those countries during 2008-09. In lieu of the financial crisis, a few immediate tasks or procedures are also recommended or suggested particularly for the western industrialised countries in order to cope up and recover from crisis. If the western industrialised countries follow the prescribed tasks or procedures then it might solve the serious issue of financial crisis to a certain extent or can prevent such a disastrous outcome in future. References Alliance of Liberals and Democrats for Europe, 2008. Roots of the Current Crisis. The International Financial Crisis: its causes and what to do about it? [Online] Available at: http://www.alde.eu/fileadmin/webdocs/key_docs/Finance-book_EN.pdf [Accessed December 14, 2011]. Berglof, E. & Et. Al., 2010. The Crisis: A Synopsis. Understanding the Crisis in Emerging Europe. [Online] Available at: http://www.mof.go.jp/english/pri/publication/pp_review/ppr012/ppr012d.pdf [Accessed December 14, 2011]. Helliener, E., 2009. Five Regulatory Agendas in Search of an Outcome. Crisis & Response. [Online] Available at: http://library.fes.de/pdf-files/ipg/ipg-2009-1/03_a_helleiner_us.pdf [Accessed December 14, 2011]. International Labour Organization, 2009. The Crisis: causes and transmission mechanisms. The Financial and Economic Crisis: A Decent Work Response. [Online] Available at: http://www.ilo.org/public/english/bureau/inst/download/tackling.pdf [Accessed December 14, 2011]. Jickling, M., 2008. Summary. Adverting Financial Crisis. [Online] Available at: http://fpc.state.gov/documents/organization/103688.pdf [Accessed December 14, 2011]. Rangarajan, C., 2009. Evolution of the Crisis. The International Financial Crisis And Its Impact On India. [Online] Available at: http://164.100.24.207/inputprogram/lecturefiles/Dr.C_Rangarajan.pdf [Accessed December 14, 2011]. Shane, M. & Et. Al., 2009. Causes of the Economic Crisis. The 2008/2009 World Economic Crisis. [Online] Available at: http://www.ers.usda.gov/publications/WRS0902/wrs0902.pdf [Accessed December 14, 2011]. Read More