Analysis of the Financial Crisis of 2008 - Essay Example

Financial Crisis By [Presented to] of PART A A1 The feature documentary “Inside Job”, directed by CharlesFerguson documents the slide of the economy through the acknowledged individuals who speak the economic crisis of 2008, the various reasons that contributed to the ultimate downfall of the economy and its impact on the billions of lives and livelihood of the huge number of people. The economic crisis that affected the entire world economy during 2008 and beyond took shape from an economy which was known as one of the most stabilized economies and peaceful land among the world economies. According to Keynes (1936) the smooth flowing world economy was destabilized during the late 2000s and such a scenario was seen in Iceland for the very first time and even in the world. Krugman (2008) explains economic crisis is one the retarding factors that have pulled down the steep growth of the world economy including the subsequent growth of the smaller economies which have gained a new impetus in the growth of their economies. Kothari (2010) defines economic crisis as a collection of varied circumstances that results in the huge loss of the nominal value of their financial assets. He further explains that an organisation or a company has a number of stakeholders who are directly or indirectly related to the organisation or company through a financial relation. An economic crisis turns a company into a dried well of financial resources and a result the stakeholders of the company even suffers through immense lack of financial resources. According to the observations of Kothari (2010) the economic crisis faced by the entire world has turned a disturbingly huge number of people jobless and thus penniless. People all over the world lost their jobs while others bargained for the job in exchange of one of the most meager sum of money. As more and more people turned jobless the chaos and panic regarding being jobless seemed to engulf them over a long time. He further elucidated the different kinds of economic crisis. Firstly it is the banking crisis where the depositors of the respective banks immediately ask for returning their deposited money. The bank faces a crisis over the availability of the funds within a stipulated time period. The second form of economic crises is the stock market crash which clearly suggests that it refers to the drastic decrease of stock prices over the larger section of the stock market that hugely depreciates the amount or value of the stocks resulting in excessive loss for the investors. The third form of economic crisis comes in the form of currency crisis. Currency crisis takes place when there is a sudden devaluation of the currency of a particular economy which normally maintains a fixed exchange rate of its currency. The final kind of economic crisis identified by Kothari (2010) is the recession. The recession is defined as the negative growth of the Gross Domestic Product (GDP) for a period more than two or more quarters. It is considered as one of the most disastrous of all the types of economic crisis. It not only prevents the economy to grow but it even causes negative growth of the economy. In the late 2000s a series of incidents culminated to cause the economic crisis of 2008 that had a havoc impact over the world economies for a longer period of time. Iceland being a stable country which has a high standard of living, abundant natural resources and a lower population of 320,000 during the making of the documentary “Inside Job”. According to Andri Magnason, Writer and Filmmaker, Iceland had the perfect infrastructure of a modern society, clean energy, cultivation of food and others that made it self-sufficient. Gylfi Zoega, Prof. of Economic, University of Iceland, informed that Iceland had great healthcare and education system, with hardly any crime. Given the number of population, its geographical location, natural resources and the stable condition of the democracy, it is ideal for progression but due to certain factors its economic condition crippled to unwavering lows. The economies of the world are inter-connected with trade and commerce that make them inter-dependent. As a result the toppling of the economic system in Iceland sent rippling effects to every corner of the world. During 2000 the government of Iceland began a huge deregulation which cause havoc damage to the abundance of natural resources that it possessed and it even highly damaged its economy. The government of Iceland allowed companies like Alcoa to build their production units on the lands of Iceland and use its abundant naturals geothermal and hydroelectric energy sources (Sornette, 2003). During the same time the Icelandic government even privatized three of its most important banks like Islandsbanki, Kaupping, and Glitnir. In the March of 2000 the country suffered a huge loss of $ 5 trillion when the Internet Stock Bubble burst for promoting the non-promising internet companies (Charles and Kindleberger, 2005). It was a huge blow to the economy. During the same year, when the Banking Industry was dominated by investments banks like Goldman Sachs, Morgan Stanley, Lehman Brothers, and others; financial conglomerates like J P Morgan, Citigroup; securities insurance companies like AIG, MBIA and others; and rating agencies like Moody’s, Fitch and others. The investment banks combined the mortgages with other debts and loans and sold to investors while the rating agencies arbitrarily rated undeserving groups and approved huge loans which the owners could never pay. This culminated a huge sum of unrecovered money that over burdened the economy. The investment banks bought excessively more than their assets. The arbitrary and unjustified grading of the rating agencies resulted in the rocketing of the number of AAA –rated instruments from a few in the year 2000 to the staggering 4000 in 2006 (Laeven and Fabian, 2008). The Collateralized Debt Obligations (CDOs) market collapsed under severe conditions during the late 2000s which left the investment banks with loans of up to hundreds of billions of dollars. As a result of all of the financial institutions crippling down the Great Recession began in 2007 and by 2008 the Bear Stearns went out of cash. Gradually the stalwarts of the financial institutions like the Lehman Brothers, AIG, and others went on to become bankrupted resulting in the economic crisis that gripped the world (Sornette, 2003). PART A A2 (a) The financial organisations operating in the country carry certain responsibilities which are at the balancing point of fulfilling the responsibilities towards the public. It is indeed an organisation with commercial interests, the profit is very important for the sustenance of the organisation itself. So in order to maintain a striking balance between the self-interest and serve for public good in the tumultuous situation of the financial crisis the financial institutions need comprehensive policies in terms of interest rates and strict terms for the returning the borrowed money from the bank. Keeping in line with the professional standards and even with the moral standards, the financial institutions developed policies that would aim for long-term growth (Brunnermeier, 2001). The economic crisis in Iceland that toppled the entire world economies taught the lending policies has to become more conservation, has to have a balance and a high consideration about the origin of the money. This would ensure that the financial institutions do not lend money exuberantly that could not be traced down. The later policies that were adopted after economic crisis gripped the economy, concentrated more on the practicality of the borrowing and lending scenario. The financial institutions that still managed to survive and the ones which were saved by the intervention of the International Monetary Fund (IMF), formulated lending and borrowing policies made sure that the borrowers are lent the money and made sure that they strictly adhere to the returning policies and return them on time and in the mean time ensured generation of the financial resources to maintain themselves and recover from the recession. In recent times the financial institutions are stronger than before and offer one of the best financial solutions in the market. Being a financial institution it has a greater role to play in the financial system of the nation. When a nation is at the influential point that could influence the world market, its significance and role intensifies (Fried, 2012). Beck (2011) observes that the financial institutions like the banks plays an important role in building up an economy by encouraging people with minimal income for making small savings. The savings would accumulate to form a larger amount that would enable the individual in strengthening his or her economic condition and make him or her more economically stable. The process works more beneficially for people with larger ownership of wealth, it makes them wealthier. This overall system leads to the formation of a strong economy. The financial institutions also plays an important function in the creation of the infrastructure and assisting individuals and groups in making further development by lending them money at reasonable interest rates that serves the purpose of the both the parties – the banks in generating revenue through the levied interest and of the individual to develop with the aid of the loan. In the aftermath of the economic crisis the financial institutions adopted balanced policies that helped it recover from the crisis and register itself as stronger than before. A2 (b) When the de-regulation in the financial institutions resulted in financial crisis that toppled the world economy, it led to the creation of distrust of the public over the financial institutions. The breakdown of the entire financial system and disturbance of the economy all over the world was caused due to the failure of these giant financial institutions (Brunnermeier, 2001). It led to such an economic crisis that made companies curtail their number of employees as a result numerous people lost their jobs, this added to the financial woes because it shattered the base of the economic foundation of the world economic system. Due to globalisation the nations and their economic system are very well connected and inter-dependent on grounds more than one. As a result failure of the economic system of a nation would affect the economic system of other nations as well and in a similar fashion. The high fallout of the economic system and the development of the financial crisis led to the depletion of public trust over these financial institutions which were trusted as the stalwarts of the economic stability (Fried, 2012). The financial crisis developed largely due to the de-regulation of the financial institutions. So, in order to restore the normalcy of the economic system the institutions need to impose self-regulation in a more organised and practical way that would work to secure public faith and apathy in the financial institutions. The financial institutions need to impose self-regulation in terms of lending policy that ensures timely returning of the borrowed money, lending interest rates that enable generation of the needed revenue for the banks and other financial institutions, grading the organisations based on proper justification and not out of arbitrary wishes. In case of the failure of the borrowing individual or group in repaying the loan the financial institutions should employ strict mechanisms to ensure that the amount lent out to the individuals are returned with an additional interest rate as a mark of penalty or punishment. The adoption of such workable policies by the financial institutions helped them to survive. The adoption of stringent policies is useless unless supported by legislation that ensures that they are implemented in the truest terms and sense. The financial institutions that survived the blow of the crisis framed such legislation and ensured that they are strictly followed. Such a procedure also reflects transparency in the system (Kothari, 2010). The prevalence of transparency in a way greatly contributes to the creation public trust in the financial institutions. Thus it collectively works to restore public trust which paves the way for furtherance of the balanced and thus stable economic condition of the world (Laeven and Fabian, 2008). References Brunnermeier, M (2001), Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding, Oxford University Press Cipriani, M and Guarino, A (2008) Herd Behavior and Contagion in Financial Markets. "The B.E. Journal of Theoretical Economics" 8(1) Charles P. Kindleberger, R (2005), Manias, Panics, and Crashes: A History of Financial Crises. Palgrave Macmillan. Fried, J (2012), “Who Really Drove the Economy into the Ditch” New York: Algora Publishing Ferguson, N (2009). The Ascent of Money: A Financial History of the World. Penguin. p. 448 Keynes, J. M. (1936), “The General Theory of Employment, Interest and Money”, Chapter 12. New York: Harcourt Brace and Co. Kothari, V (2010). “Executive Greed: Examining Business Failures that Contributed to the Economic Crisis”. New York: Palgrave Macmillan. Laeven, L and Fabian, V (2008), “Systemic banking crises: a new database. International Monetary Fund Working” Paper 08/224. Obstfeld, M. (1996), ‘Models of currency crises with self-fulfilling features’. European Economic Review 40 (3–5), pp. 1037–47. Sornette, D (2003), Why Stock Markets Crash, Princeton University Press. Read More