The Recent Global Financial Crisis - Essay Example

?Discussion and Analysis of the Recent Global Financial Crisis and the Consequent Credit Crunch Events Leading To the Global Financial Crisis There has been a considerable debate on the events that led to the global financial crisis. However, the genesis of the global financial-turned-down crisis can be linked to the combination of absence of proper regulations and worldwide financial excesses. This combination has been a growing problem in the past few decades. The origin of the global financial crisis can also be linked to the bursting of the oil price and housing bubbles, and excessive low interest rates among the key nations in the global economy. Massive trade excesses in some nations, and deficit in trade in other nations and lastly, savings rates that were too high in some areas of the world and too low in others were also other events that led to the global financial crisis (Kirton, Oldani, and Savona 2011, p90). The recent global financial crisis events began on 9 August 2007. On that date, there was a seizure in the banking system, which was instigated by the BNP Paribas’ move, to cease its activities in three hedge funds that focused on US mortgage debt (Elliott 2011, p1). In 2008, credit markets in the Wall Street froze, and this indicated that credit crunch crisis was eminent. This affected everything in the financial markets (Szilagyi 2011, p18). Sustained low interest rates that began in 1999 up to 2004 made the adjustable-rate mortgages (ARMs) look very attractive to the potential buyers. The low interest rates were largely driven by the huge current deficit in the United States and other nations such as China who purchased the US Treasury bonds (Marshall 2009, p10). There is strong evidence that suggests that, in most parts of the United States, it had become very easy and cheap to get a subprime mortgage (Marshall 2009, p11). The upward rise in the house prices was as a result of the property speculations. These mentioned factors led to the huge housing bubble. However, a number of factors led to the collapse of the housing bubble. These factors include; (a) stagnation and decline of the average hourly wages in the United States since 2002 until 2009, (b) the growth in housing supply that tracked price rises, and (c) as the interest rates increased, the ARMs became less attractive, and this led to the elimination from the market of most non-prime prospective buyers (Marshall 2009, p13). The macroeconomic imbalances (that is, deficits in the current accounts and low bond yields) stimulated low interest rates, which ultimately affected the housing market (Marshall 2009, p15). The events that led to the recent global financial crisis can be summarised into three main shocks that captured the crisis. Firstly, bursting of the housing bubble caused the reallocation of capital and the consequential loss of household wealth and a drop in the consumption rates. Secondly, a sharp increase in equity risk premium caused a rise in the cost of capital, fall in private investment, and the collapse of the demand for durable goods. Thirdly and lastly, a reappraisal of risk by the households caused them to increase savings, decrease consumption, and discount their future labour income (McKibbin and Stoeckel 2009, p6). Economic and Financial Consequences The global financial crisis has had a significant effect on the public finances of most nations in the world. Fiscal revenues are decreasing because of lower commodity and asset prices, and operation of the automatic stabilizers (International Monetary Fund 2009, p3). The global financial crisis affected both the developing and developed nations of the world. However, the effects were far felt in developing nations where there was further segmentation. In the advanced economies, the global financial crisis led to the drying up of credit, as susceptible financial institutions became highly risk unfavorable and very cautious in evaluating the creditworthiness of other companies (Kirton, Oldani, and Savona 2011, p91). Even with the massive bailouts to the largest lending institutions in the United Kingdom and in the United States, it was impossible for households and companies to obtain credit. The absence of credit supply led to some companies curtailing their sales and production activities, households forced to increase their savings, and even some companies shutting down their activities. The cumulative impact of the global financial crisis on the developed or advanced nations was the fall in consumption (Kirton, Oldani, and Savona 2011, p91). The impact on the real economy developments in CESEE (Central, Eastern, and South-Eastern Europe) nations was significant. Real economic developments in these nations were severely affected by financial markets disruption and real channel of transmission such as the trade channels (Gardo and Martin 2010, p33) On the other hand, credit availability among the developing nations was affected by the crisis. This was the case for the nations that were vulnerable and had a low income rate. Demand for exports from the advanced nations to the developing nations was also affected by the crisis. The effect did not start immediately in the transition and developing economies because the crisis did not begin in their financial systems. However, “as global liquidity began to dry up, and as demand fell in the mature markets, trade volumes and the price of exports from the developing nations also declined” (Kirton, Oldani, and Savona 2011, p91). It was widely speculated that the financial crisis would have little impact on the African nations because they were not integrated much into the global economy. However, recent developments indicate that the negative effects of the crisis are already evident in the continent of Africa. For instance, available evidence shows that the crisis will reduce economic growth in the Africa region (United Nations Economic and Social Council Economic Commission for Africa/African Union Commission 2009p1). Government Responses Short-term response or reaction to the global financial crisis by most governments both in the developing and developed world was to shore up their big financial institutions and the financial systems. In response to the economic decline, the governments adopted expansionary monetary policy “with sharp falls in the interest rates of central banks (often very close to zero), supplemented by expansionary fiscal policy. The result was ballooning deficits, most notably in the advanced economies that traditionally provided international liquidity” (Kirton, Oldani, and Savona 2011, p97). In the developing and BRIC (Brazil, Russia, India, and China) nations, each country fiscal and position of the balance-of-payments determined policy response to the present global crisis. In all the BRIC nations, the governments countered the effects by adjusting the interest rates, exchange rates, employment policy, industrial policy, and monetary policy. The BRIC countries created public financial cushions to weather the external financial storms; this phenomenon was not evident in the less developed nations located in the global South. In most of the developing nations, reserves are inadequate, and the balance-of-payments are considered to be precarious. However, during this crisis, the BRIC nations did not have to depend on the World Bank or the International Monetary Fund to finance the expansionary fiscal policy. The BRICs entered the crisis with much stronger macro fundamentals than the majority of the conventional G7 members. However, Russia was an exception since it relies on the energy exports (Kirton, Oldani, and Savona 2011, p97). The Great Britain government immediate response to the global financial crisis targeted three key areas. These areas included addressing issues in individual institutions, making sure that credit flows through the economy just like before, and tackling system-wide instability. The interventions have a common purpose of safeguarding ordinary customers of the financial institutions (that is, businesses and people) from the effects of restricted access to credit and financial instability (Great Britain: H. M. Treasury 2009, p29). The United States response to the global financial crisis can be regarded as interventionist. The United States monetary authorities reacted to the crisis with a swift and a large decrease in the official interest rates. The Federal Reserve attempts to stimulate the economy by lowering the interest rates came with two differing but related developments that indicated the abandonment of the central bank’s conventional monetary policy practices (these practices included federal funds rate targeting) (Rude 2010, p3). Firstly, the Federal Reserve response to the crisis involved restructuring itself as a financial institution. In other words, changing the manner in which it offered credit to the financial system, that is, on what terms and to whom. The Federal Reserve knowing very well the problems could not be solved by simple reduction in the interest rates; it decided to become a direct lender to the majority of the financial institutions thus taking the active control of the United States’ global liquidity and credit risks. Secondly, the Federal Reserve used its ability to lend to thrust the federal funds rates to zero thus; the United States absorbed it as excess reserves. The move made by the Federal Reserve was to contain the contradictory shock the global financial crisis was sending through the global economy (Rude 2010, p3) Lessons to Be Learnt The most significant lesson to appear from the recent global financial crisis is that free markets are not supposed to be unregulated. The current crisis is thought to have been enhanced by the creation of sophisticated financial securities from the sub-prime mortgages offered to borrowers with poor credit histories. However, it is important to note that the problems of regulation could have been the root of the crisis. The Glass-Steagall Act of the Great Depression period is one of the most significant financial regulations. The Act prevented banks from underwriting and speculating new stock issues as they had done in the 1920s. However, in 1999, the Act was successfully repealed after extensive lobbying by the banks (Lodewijks 2012, p1). Commercial banks like the Citibank merged with insurers and investment banks in order to develop massive financial businesses. Knowing very well that the government could bail them out, they offered their investment banking the freedom to participate in significant speculation. When the financial crash hit, the United States Treasury had no option but to bailout Citibank with US$50 million and the other banks with US$700. The bailout was to assist them to buy distressed assets. The Great Depression gave us an important lesson that the banks could not fail, however, the financial deregulation resulted in the removal of the legislation that was designed to stop the banks from failing. Thus, the most important lesson from the current global financial crisis is that policymakers should not consider financial regulations as economic burdens on the market. They should see it as an investment meant to reduce the obligation of governments to bailout financial institutions in the future (Lodewijks 2012, p1). References Elliott, L. (2011) Global financial crisis: Five key stages 2007-2011, The Guardian [online], 7 August. Available from: [Accessed 29 March 2012]. Gardo, S. & Martin, R. (2010) The impact of the global economic and financial crisis on Central, Eastern and South-Eastern Europe: A stock-taking exercise. Occasional Paper Series, 114, pp1-67. Great Britain: H.M. Treasury. (2009) Reforming financial markets, London, UK: The Stationery Office. International Monetary Fund (2009) Fiscal implications of the global economic and financial crisis, Washington, DC: International Monetary Fund. Kirton, J. J., Oldani, C. & Savona, P. (2011) Global financial crisis: Global impact and solutions, Surrey, England: Ashgate Publishing. Lodewijks, B. (2012) The global financial crisis: Challenges, lessons, and opportunities, The Sydney Globalist [online]. Available from: [Accessed 29 March 2012]. Marshall, J. (2009) The financial crisis in the US: Key events, causes and responses, London, UK: House of Commons Library. McKibbin, W. J. & Stoeckel, A. (2009) The global financial crisis: Causes and consequences. Working Papers in International Economics, 2(9), pp1-39. Rude, C. (2010) The world economic crisis and the Federal Reserve’s response to it: August 2007 – December 2008. Studies in Political Economy, 85, pp1-20. Szilagyi, P. G. (2011) The impact of the global financial crisis on emerging financial markets, Bingley, UK: Emerald Group Publishing. United Nations Economic and Social Council Economic Commission for Africa/African Union Commission. (2009) The global financial crisis: Impact, responses and way forward, In: Meeting of the Committee of Experts of the 2nd Joint Annual Meetings of the AU Conference of Ministers of Economy and Finance and ECA Conference of Ministers of Finance, Planning and Economic Development, Cairo, Egypt, 2 – 5 June 2009. pp1-14. Read More