The Role of Financial Crisis in the Economic Recession - Essay Example

? Financial Crisis Economic crisis, also referred to as economic crunch, is a phase that a country experiences which is comprised of an economic downturn due to financial instability. A country that encounters economic crisis will most likely face a number of consequences such as a fall in Gross Domestic Product (GDP), scarce liquidity and inflationary trends. This phase of an economy is also referred to as slumping economy which further results in an economic recession. This is an unwanted situation by all the countries in the world as it can have dampening impacts upon the country. Economic crisis has resulted due to a number of reasons. It is a result of improper policies implemented in the financial system which gives birth to numerous micro and macro economic problems. These reasons have varying severity and have affected the global economies of the world. The recent recession has webbed the entire global economies into its victimization and caused severe distress among both, developed and under-developed countries of the world. Recent economic crisis has paved way for inequality across many nations and has had a dampening impact upon their financial position. This crisis has led to other severe crises and it is matter of global concern. Economists believe that the deregulations of 1980s are the major root causes for the recent financial crisis which is likely to bring an end to free market economics. Reagan administration initiated liberalization, which brought about breakdowns in series due to which the government intervened and ultimately the structure destroyed the whole financial system. The Financial Crisis In 2008, the global market collapsed, The Bush administration figured out that only government intervention could save the companies whose failure could fetch destructive reactions. American Insurance Group (AIG) and Fannie Mae and Freddie Macare are those two giants which suffered from this crisis. The companies had come to this point of crisis because free market had allowed them to make investments due to which the institutions were posed to risks. Millions of people in America lost their jobs and had their savings bushed. A number of factors have been blamed for this crisis but economists believe that free market is the very basic factor amongst all. Nobel laureate Joseph Stiglitz wrote in his book Freefall that market fundamentalists and deregulators are responsible for the mess. The situation showed that free-market economists failed and market fundamentalists were responsible for the economic crunch (Sorman 2010). The economy of United States of America witnessed only a few minor recessions each for a short period of time. Those recessions did not stir the economy enough to cause economists to develop a well descriptive recession model. With no major recessions over a long time, the economists tend to believe that the crisis may not happen. The model derived by free market economists was running a healthy economy from 80s to 2008 making economists believe that the model may not turn the situation upside down (Sorman 2010). The free market economists argue that it is the recession that prompted the financial crisis and not the other way around. Economists believe that recession began in 2007 when consumer spending decreased, overdue borrowing increased and lack of interest of homeowners in their mortgaged houses increased. They claim that the failure of financial derivatives were not the cause of financial turmoil as they were helping in the stabilization of the economy. Economists assume that due to a sudden economic downfall government faced pressure from political and non political forces to take immediate steps. This led to government spending and its intervention in the scenario which seemed quite logical at that time. The situation worsened with new public debts and regulations which stumbled upon the recovery of the economy (Sorman 2010; Bordo et al 2010). The economy could be recoiled in a quicker way if government had allowed enterprises to survive on their own by dealing with the crisis with an astute strategic approach. It is also believed that the financial turmoil was brought about by the recession but the initial slump was the result of energy cost as well. The US expenditure of energy as expressed in percentage of total spending had droppedfrom 8 to 5 percent between 1979 and 2004. The price of gasoline had hit $4 per gallon by June 2008, representing a sharp shift in energy share of total spending back to 7 per cent. The shift was due to the increased demand from evolving economies like China and India which soared up the prices. The price grabbed attention as the spending pattern showing a considerable upward movement was an indication of disruption. The unit sales of light truck curtailed by 23 per cent in the second quarter of 2008 in comparison to the preceding year’s 2nd quarter.The auto manufacturing industry cut over 125,000 jobs during the same period. The energy prices affected transportation and hence the housing sector as the houses in the suburban region lost their value and attraction. Failure of the mortgage market came up as another blow in 2007, prior to the financial crisis of 2008 (Sorman 2010; Kalim 2008). Economists believe that massive credit bubble expanded due to the easy money which allowed rampant creation of risky subprime mortgages .Fannie Mae and Freddie Mac, and the relaxed laws of mortgage lending were the main causes of this proliferation. If U.S. and Canadian financial crisis are compared, it can be seen that Canadian banks tackled the financial crunch much more effectively than the American banks. The reason behind this was that Canadian mortgages required strong guarantees with a higher down payment. This policy prevented homeowners from walking away from their mortgage payments when the economy turned down. Economic experts believe that the market remained under fretfulness and credit became immobilized for a year from 2008 which was mainly due to the intervention of the government after bubble burst. Even the free market economists believe that the intensity of financial crisis calls for the need of thoughtful new regulations. Chiappori argues that regulations in finance have been recognized by the free market theory because the economic players are human beings who look for their personal interest. Bankers have complete interest in setting sights at higher risks through which higher rewards can be extracted. The new financial rules and regulations must not be dependent on the acute intuitive insight of regulators but should rather focus on simple and easily assessable procedures such as higher capital and margin requirements. It cannot be said that these regulations would halt the formation of destructive bubbles as they are an inevitable part of the capitalist economy. Capitalism is based on the innovation; people with money to capitalize would collect for innovation; at times the innovation is so much favorable that it turns out to be a mania (Sorman 2010; Bordo et al 2010). It does not mean that government is helpless in preventing bubble formation and management. Manias turn into disasters only when the money supply becomes limitless as was witnessed in the 2008 slump. Government can limit the size of the bubble through stringent monetary policies along with leverage requirements. This way the government can prevent the possible destruction of the financial market. All free market economists are proponents of the idea that financial markets need to be transparent unlike they used to be in the past. Free market economists are also coming at a point to make contingency plans for the potential crisis in the years to come. Free market economists also believe that the lessons of economics must be revised. The crunch indicates that enhanced intellectual insight is needed to understand how various things in market interact with each other from simple to the most complex manner. The recent crisis has made it clear that it is very important for all the constituents of the modern economies to function properly. Any impaired functioning can disturb the whole system (Bordo et al 2010; Kalim 2008). Recent economic crisis has given birth to high levels of frustration into the minds of different people related to different age groups and standards. Related to such sources of frustrations was a report that was issued in August 2010 namely “International Labor Organization (ILO) Global Employment Trends for Youth 2010”. The purpose of this report was to exhibit what the youth of today suffers because of the shallow employment levels. The youth of the world is experiencing a rocky and unstable time due to the economic crisis “An enormous increase was noticed in the un-employment rate of youth. 81 million young people aged, between 15 to 24, were unemployed at the end of 2009 which is a record marking an increase from 11.9% in 2007 to 13% in 2009” (International Labour Office). The report also suggested that the youth faced a higher level of unemployment as compared to the adult level. This report portrays the amount of frustration and agony the youth of today is going through. They are expected to be the future bread earners of their families and high expectations are tied with them. The youth of today spends the colorful part of their lives just indulged into studies and academics, their parents invest huge amounts of money in them so that their children can make their own future bright. But the youth of today is the placed on the last preference for a job and pinned with the first preference to be kicked out of a job. This results in piling amounts of mental stress and mounting frustrations for them. It is not only the developing nations that are subject to this problem, developed nations are in a much more critical stage of youth unemployment “At 49.9 percent, Spain has the highest youth unemployment in the EU. And latest data from Euro-stat suggests that the problem is only getting worse. Youth unemployment in the EU rose to 22.4 percent, or 5.507 million in January 2012, up from 22.2 percent, or 5.495 million in December 2011” (Badkar). This affects the youth adversely as they feel unrewarded for the years they have invested to attain education and yet they stand nowhere. This results in a rise of crime rate just to fulfill small wishes, aspirations and activities which requires financial need. This economic crisis may be the root cause of every other crisis. Globally, unemployment levels are rising which are giving birth to illegal and unwanted activities to take place. People need to survive and they try to do it by any means possible just to feed their families or satisfy certain wants. There is intense existence of demerit goods which may be harmful for every country in the long run (Krugman). The economic crisis has jolted the diverse sectors of economies. Much of which is affected is the global culture which has become subject to noticeable alterations. Global culture has been deteriorating in several ways due to this crisis. Economic crisis has resulted in negatively affecting the field of performing arts which includes theatres, dance groups and shows along with symphony orchestras which exist in a few numbers of places in Europe. America is heavily affected by the crunch because the majority of funds that were accumulated to finance shows through donations and other funding sources lessened by a significant amount. The situation is so severe that there are daily speculations being made regarding the closure of some or the other arts institutions which has indirectly hampered income earning for the people related to such fields. These speculations hold strength to some extent as such institutions are worried about their nearing extinction; the Connecticut Opera – the sixth-oldest continuously operating opera company in the US – is going out of business, after 67 seasons (Inkei). Financial crisis have created havoc previously too but the recent recession was on of the major financial crisis over many years. Following 1930, the negative impact of the New Deal could be curbed by the war production only. After 1970, the West recovered from the downturn through the bold leadership of Ronald Regal and Margaret Thatcher. The governments need to be insightful and must develop the capabilities to react to the crisis appropriately unlike the past. Most importantly the market forces prove to be no more helpful in solving the financial problems as the other mechanisms. References Sorman, Guy., 2010.Guy Sorman: The financial crisis seen through free-market eyes.The Dallas Morning News.[Online] 23 August 2010. Available at: http://www.dallasnews.com/opinion/sunday-commentary/20100820-Guy-Sorman-The-financial-crisis-6024.ece [Accessed 14 August 2011] Siddiqui, Kalim., 2008.Free-Market Illusion and Global Financial Crisis.Mainstream.XLVI(49). Print. Top of Form Bordo, M. D., Landon-Lane, J. S., & National Bureau of Economic Research. (2010). The lessons from the banking panics in the United States in the 1930s for the financial crisis of 2007-2008. Cambridge, Mass: National Bureau of Economic Research. Bottom of Form Center for Responsible Lending. 2011 Badkar, Mamta. "A Quick Guide To Europe's Deteriorating Youth Unemployment Nightmare." Business Insider 1 Mar. 2012: Print. Global Employment Trends for Youth : August 2010: Special Issue on the Impact of the Global Economic Crisis on Youth. Geneva: ILO, 2010. Print. Inkei, Peter. " The effects of the economic crisis on culture."http://www.coe.int/t/dg4/cultureheritage/cwe/conference10_en.asp. 2010. Web. 3 April Krugman, Paul R. The Return of Depression Economics and the Crisis of 2008. New York: W.W. Norton, 2009. Print. Read More