The Financial and Economic Crisis - Case Study Example

? Financial Crisis A Capitalism Failure In 2007, what was seen as a banking crisis spread to other financial s and in the process developing into a global crisis in 2008. The financial crisis represented a turning point in the history of most countries especially those that followed a capitalist ideology. Even as the economic crisis became the most serious to face the capitalist countries, since 1929, it had far reaching consequences in the social lives of many people who lost employment while many others who were qualified failed to get job opportunities. Following the economic crisis, the International Labour Organization forecasted unemployment grew from approximately 20 million to 50 million people by the end of 2009. The Food and Agriculture Organization also painted a grim picture of the years following the crisis in their report where the incomes of the poor was falling due to the crisis while the international prices of food commodities was also high. The high food prices coupled with a reduced income for the poor means the number of undernourished people in the world rose to more than one billion for the first time in history in 2009 (Bresser-Pereira 2009, p.1). The magnitude of the 2007-8 financial crisis raises many patient questions based on why it happened, why institutions and theories put in place after previous crises failed to forestall this one, was the crisis predictable based on what many see as a lack of stability of capitalism? This essay argues that it was in fact the changing global system especially in financial markets after the 1970s that caused the financial crisis of 2007-8 and should not therefore be taken as a failure in capitalism. Consequently the 2007-8 financial crisis associates are associated with financialization and neoliberalism. Financialization as used in this essay is a distortion of financial systems that is characterized by creation of artificial financial wealth, which is financial wealth that has no relation with the mechanisms of production of goods and services. On the other hand, neoliberalism from this perspective not only a fundamental economic liberalism but should be perceived as an ideology that is unsympathetic to the proletariats, to poor and to the welfare state (Epstein 2005, p.3). As with previous global financial crises, the global crisis of 2007-8 began as financial crises in first world countries which was caused by the deregulation of financial markets in developed countries which was followed by widespread speculation that such deregulation made possible. Accordingly, these deregulation policies was the historical additional fact that allowed the crisis to take place due to the behavior exhibited by the banking and other financial institutions can be blamed on the deregulation policies of the government. The state failed to undertake a supervisory role that would have identified and forestall the situation (Bresser-Pereira 2009, p.3). Gradual deregulation not only in the US but globally in addition to fragmented financial authorities and the absence of international cooperation encouraged and legitimized the thinking that financial sector had to be free in order to flourish. Both “macroprudential” and “microprudential” supervision would have proven effective in regulating the banks given that even if all banks had proper financial practices, unforeseen risks as result of small changes on a broad scale at the macro level could have occurred. Therefore macroprudential supervision would be an innovative type of regulation that is suitable for central banks (Dullien, Kotte, Marquez and Priewe 2010, p.23). Part of the deregulation policies for the period before the crisis was the US Federal Reserve Bank’s monetary policy decision which saw interest rates kept at an all-time low for a long time after the 2001/2 financial period. Such measure resulted in a major increase in the credit supply that was a catalyst for the production of high leverage levels related with the crisis. Financial stability during economic turbulence calls for limiting credit expansion in addition to credit expansion is maintained monetary. Based on the assumptions of neoclassical macroeconomist credit expansion can be a precursor of economic crisis that efficient markets would in normal situations be able to avoid (Dullien, Kotte, Marquez and Priewe 2010, p.23). Prior to the financial crisis, Alan Greenspan, US Federal Reserve chairman undertook an expansionary monetary policy that might have contributed to the crisis. Although, many financial experts argue that credit expansions are a common financial undertaking that does not in most cases result to crisis, it is evident that deregulation that took place in the 1980s can be used to explain the crisis. Although Alan Greenspan did not make a public admission of the monitory policies made during the time as being the reason for the crisis in 2008, he admitted to the fact that the financial industries which were vocal in demand for deregulation, had influential powers in the Fed and of central banks. Buiter (2008, p.106) notes the financial industry do not always aim at compromising the monetary authorities through means of corruption, it is in fact the financial authorities that adopt the perceptions, objectives, and interests of financial industries. This admission by Alan Greenspan points to the failure of government policies and the subsequent parliaments, which consciously advocated financial deregulation in the US due to demands made by financial industries. Due to the influence of those in Wall Street, Posner (2009, p.269) notes the political leadership constantly ignored problems experienced in the financial market especially the housing bubble. Events following the outbreak of the subprime crisis, point to insufficient attempt at of tackling the problems during the initial stages. The imprudent manner with which the authorities handled subprime crisis at its initial stage culminated in the decision to let Lehman Brothers go bankrupt while failing to realize that a liquidity crisis a solvency crisis had emerged. Financial crisis in developing countries are in most cases a result of balance of payment or problems with their currency as opposed to a banking crises. Although the world financial imbalance as a result of the current account deficits of the United States while the Asian countries recorded high current account surpluses weakened the US dollar, the imbalance cannot be blamed for the financial crisis. The connection that the imbalance and the 2007-8 financial crisis have in common starts and ends with the fact that nations which recorded current account deficits were also nations were business organizations and households were more indebted, which means they will have challenges recovering. In contrast, the nations that recorded a surplus had business organizations and households with lesser debts which will not present any challenges in paying. Nations that have a high leverage in both their financial and non-financial organizations and households are at a higher risk of having a financial crisis (Dullien, Kotte, Marquez and Priewe 2010, p.33) The general financial crisis of 2007-8 originated from the mortgages that subprime clients were offered. The mortgages were then shoved into complex securities that made it impossible for the clients to notice any associated risk. Such financial undertakings in a small section of the economy hypothetically speaking should not result in a major financial crisis. The fact that such undertakings in the mortgage industry precipitated into a global financial crisis should not be taken to mean a failure in capitalism but attention should be focused towards exploration of the effects of the integration of international financial system. The integration of international financial system into a scheme of securitized financial operations resulted in a risky financial system that was characterized by financial innovations and speculations (Bresser-Pereira 2009, p.12). Historical analysis of events leading to the global financial of 2007-8 crisis will conclusively determine that it was the outcome of major financial steps backwards, mainly for the US. After independence, the adoption of capitalist ideologies in the US had a lot of success leading to imitation by other countries which used the twentieth century US as a standard for their own development. For example, In France the regulation school calls the period beginning at that time the Fordist regime of accumulation. The economic success experienced at the time led to the emergence of a new professional class that was in between the capitalist class and the working class. Further, the professional executives managing big corporations become independent from the stockholders while the public bureaucracy in charge of the state machinery expanded in both their numbers and influence. As a consequence of this expansion, the US economic system developed and became complex where production shifted from firms owned by families to large and bureaucratic corporations (Bresser-Pereira 2009, p.2). This new form of capitalism experienced the in the 1929 stock-market crash that developed into the Great Depression in the 1930s. The authorities at the time responded with a host of financial regulations which after World War II, enabled the United States, to come out as the undisputed world super power both militarily and economically. The new found success enabled the US triumph in the ideological cold war against the Soviet Union in addition to being an example of technological modernity, high living standards, and democracy. The success experienced by the capitalist US after world war two was halted by the changes in the economic sector that induced growth while changing the country in political sector from a liberal state to the social state where the guarantee of social rights became universal. Although the capitalist class continued to leading in economic sector, the changes introduced compelled them to share privileges and powers with the evolving professional class, the working class and the other lower professional class that had over the years developed into the large middleclass. Therefore, as the United States continued to be a super power politically, it was losing economic ground to Asian countries like Japan due to their expanding per capita income that had developed to the levels existing in the USA. the 1980s United States the takeover of power by those who favored neoliberalism and practiced financialization, as opposed to the capitalism’s top business executives, the middle class and organized labor who were in power during the Fordist era (Bresser-Pereira 2009, p.5). The effect of this change from a liberal to a social with guarantee of social rights was that Keynesian macroeconomics was substituted by the neoclassical macroeconomics substituted while development economics was replaced by growth models as the mainstream teaching in the universities. This new dispensation led to the creation of the neoliberal ideology that borrowed heavily from the ideas old laissez-faire. The capitalist golden age was based on a regulated financial market, financial stability, high economic growth rates and low inequality levels. In contrast, the neoliberal years recorded falling growth rates, increased financial instability and inequality which favored only two percent of the national society who were rich (Bresser-Pereira 2009, p.5). The neoliberal capitalists introduced a new regime of accumulation based on financial capitalism which gave rise to financial globalization which is the liberalization of financial markets that resulted in the increase in the global financial exchange. Financial capitalism has three main characteristics the first being a rapid rise in the overall value financial assets revolving globally. Secondly, the separation of the actual economy from the financial economy through formulation of fabricated financial wealth that benefits capitalist rentiers. The third characteristic of financial capitalism is seen in the financial institutions with high profit rates coupled with their ability to pay large bonuses to financial traders. Consequently, credit stopped being based on loans to business organization from banks in the framework of regular financial market, but was now based on securities traded by financial investors in over-the-counter markets (Bresser-Pereira 2009, p.6). The credit packaging, in addition to the market speculations led to the increase of financial asset prices which artificially sustained fictitious capital that further increased at a considerably higher rate than real wealth. One of the contributions of Adam Smith in economics is his separation of real wealth which according to him is based on production process from fictitious wealth. According to smith fictitious wealth is the increase in credit which makes capital appears to duplicate or even triplicate. The prospect of duplicating or even triplicating capital encouraged banks to engage in a classical trade-off that involved looking for more profit while ignoring or underestimating the higher risk involved (George 2006, p.114). Both neoliberalism and financialization took place in the background of financial and commercial globalization. Yet, while commercial globalization was an essential development of capitalism in relation to the reduction of transportation and communication time and cost which sustain international trade and production; financialization and financial globalization were neither natural nor a necessity but a distortion of capitalist development. Strict adherence to the principles of capitalism could have restricted globalization to commerce concerning liberalization in trade only. It was not a necessity for globalization to comprise financial liberalization that made developing countries fail to control their exchange rates in addition to experiencing a persistent balance of payment crises. Regulation would have limited any financial gap therefore making the capitalist economic system more efficient and stable to resist financial turbulence. The fast growing Asian countries seems to have distinguished the two which made them actively take part in commercial globalization while restraining financial liberalization (Bresser-Pereira 2009, p.19). Globalization was an unavoidable outcome of the rapid global technological development. This however does not mean that capitalism is not a natural type of social and economic system to the extent that it can be systematically altered through human resolve as expressed in culture and institutions. Institutions the world over do not exist in a vacuum but depend on values and political will of the society. Therefore, they are culturally and socially entrenched as well being defined the state. Institutions reflect the dissection of the society into the powerful and the powerless where in the neoliberal years the powerful were seen as the winning coalition of capitalist stockholders, the financial traders, financial executives, and consultants who ascended to power during time capitalism was characterized by financialization (Bresser-Pereira 2009, p.19). From the foregoing it is evident that various government measures in the changing global system is what resulted to the global financial crisis of 2007-8. There were various changes in the economic system that provided the necessary conditions for the global economic crises. Although capitalist allows for a free trade and accumulation of wealth, regulations must be put in place so that financial activities of corporations are streamlined with the national and global demand. Prosperity of the US after the world war two was based on a regulated capitalism but changes over the years made the economy vulnerable to the crisis. Even as some of the principles of capitalism might have presented openings that were used by the financial industries to abuse the system, a number of measures taken over the year has seen capitalist countries record increased economic growth. This resurgence of capitalism highlights its resilience that will enable capitalist countries survives to be economically stronger again. References Bresser-Pereira, L 2009, The global financial crisis and after: a new capitalism? [Online] Available at: http://ideas.repec.org/p/fgv/eesptd/240.html Buiter, Willen H 2008, Central ban ks and financial crises, Kansas City: Symposium of the Federal Reserve Bank Kansas City, August 21-23, [Online] available at www.kansascityfed.org/publicat/sympos/2008/Buiter.09.06.08.pdf. Dullien, S Kotte, D, Marquez, A and Priewe, J (Eds.) 2010, The Financial and economic crisis of 2008 2009 and developing countries, New York: United Nations. Epstein, G (Ed.) 2005, Financialization and the World Economy, Cheltenham: Edward Elgar. George, H 2006, Science of political economy. New York: Cosimo Inc. Posner, R. 2009, A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression. Cambridge, MA, Harvard University Press. Read More