The Global Economic Situation - Case Study Example

The Reasons for Market Failure Due to Failure In Banking System and Steps Taken to Overcome It Contents Contents 0 Introduction 2.Financial System: United States crunched capital flows via exercising deregulation of securities since 1980’s 1 3.Banking System Failure: Huge investments by banks in housing sector lead to liquidity crunch 2 4.Causes of Financial Crisis: The failure of financial sector was result of incapability of authorities and banks over participation in sway of acquiring large market portions 2 5.Solutions: To recover from the financial slump United States has to implement stringent solutions 3 6.Conclusion 4 7.Bibliography 5 1. Introduction The global financial crisis appeared to the forefront of the US trade world in Sept, 2008 with the collapse and assimilation of several American fiscal organizations followed with the conversion of two banks, “Goldman Sachs and Morgan Stanley” into bank holding organizations to facilitate the easy exposure towards market liquidity. (SHILLER, Robert J, 2008, PP. 82-83) In the beginning, several plans were exercised to resolve the crisis but eventually former president George W. Bush along with the Secretary of the Treasury were enforced to declare a $700 billion aid package to confine the breakage caused by the failures of banking systems. (SOROS, George, 2009, PP. 227) As per the economists, it is must for every banking institution to maintain ample “cash in hand” also known as “Equity” for a smooth functioning. (SHILLER, Robert J, 2008, PP. 23) This paper emphasizes on causes of market failures and contribution of banking system failure in it along with recommendations to facilitate preventive measures. 2. Financial System: United States crunched capital flows via exercising deregulation of securities since 1980’s Changes in the international capital markets and deregulation of 80s in USA opened new possibilities for raising capital, investing and hedging risk. Historically, America was viewed as a commodity-based economy but has become a services-based economy during the past decade. The US financial market comprises banks, investment bankers, insurance industry, capital markets, foreign exchange market, equities market, debt securities market and the derivatives market. (HAMMOND, Jeremy R, 2008) America is a key center in the world economic region for capital market activity. US markets have deep liquidity in foreign exchange, equities, debts and derivatives markets. US markets have benefited from the timely deregulation and high quality of institutional and operational infrastructure, supported by a highly skilled workforce. (HAMMOND, Jeremy R, 2008) 3. Banking System Failure: Huge investments by banks in housing sector lead to liquidity crunch It is now well known that in array to boost their profits, banks issued huge loans to investors engaged in US housing markets, but owing to sudden price decrease in housing sector, the quantity of loan defaulters increased causing liquidity crunch for banking institutions creating an environment of money crunch for the markets based on investor and end-user relations and eventually resulted in worldwide total market failure. (SANCHEZ, Adrian R, 2009, PP. 22) 4. Causes of Financial Crisis: The failure of financial sector was result of incapability of authorities and banks over participation in sway of acquiring large market portions America, have undergone and started a financial crisis which is conceivably heading towards a recession that will leave its trails over centuries. The causes of crisis have been accredited to exploitation of resources by a group known as “Wall Street, Washington and Main Street.” At core of these “causes” are profound settled aspects, some of these causes are discussed in the following sections. Stern competitions in an over-banked system have led US banks since 70s to provide high-risk credits, charge based, non-loan services and policies to endure. In array to prop up the realization of most wanted earnings coping with balance sheet limitations and consumer demands, banks urbanized multifaceted fiscal instruments that were disseminated nationally and internationally to imperative organizations. (KRUGMAN, Paul, 2009, PP. 13) The enactment of “Gramm-Leach-Bliley” in year 1999 revoked the “Glass-Steagle” limitations on banks link with securities companies. (BRUNNERMEIER, Markus K, 2008, PP. 15-16) It permitted a new-fangled “financial holding company”, in section 4 of the “Bank Holding Company Act” to slot in a statutorily provided listing of “monetary activities, insurance & securities underwriting and agency actions, merchant banking and insurance company portfolio investment activities.” (ZHANG, Mingyuan, 2009, PP. 301) These removed limitations alleviated the road to bring investment and viable banking collectively facilitating low down risk-taking banks merger with soaring risk-taking institutions requiring more money and improved circulation. Several governmental policies also contributed towards the current crisis for instance, “Ginnie Mae, Fannie Mae and Freddie Mac” provided Governmental guarantees on the expense of principal and interest on mortgage loans and mortgage supported securities to investors. (TAYLOR, John B, 2009, PP. 1) Fannie and Freddie also supported mortgage creators by procuring mortgages from deriving banks and kept them in portfolios supported by the loans i.e. a fraction of which they at periods maintained enhancing the accessibility of funds to the creators making space in their balance for more loans. (HOFFINGER, Bachelor David, 2009, PP. 85) The Fed commenced a phase of easy currency to subordinate interest rates in housing finance to low an extraordinary increase in house purchase and escalate prices, which unexpectedly results in failure of real estate market as well as dependent markets all over the world. 5. Solutions: To recover from the financial slump United States has to implement stringent solutions The economy of the US is the most pivotal in determining how exactly the other major economies will be affected. President “Barack H. Obama” is in the white house now and a lot is expected from him. The stimulus package has already been planned by the president of the US and one can only hope and pray that the package works and rejuvenates all the major economies of the world. So everything depends on the stimulus package in place to deal with the various problems posed by recession. In last G20 meet, the members have pledged to execute the planning’s that mainly comprises of reinstate assurance, development and jobs, fix the financial system to reinstate lending, build up financial bylaws to recreate trust, fund and improve worldwide fiscal organizations to beat this crisis & avert upcoming ones, endorse universal trade & investment and refuse protectionism, to strengthen prosperity and last but not the least construct a complete, green and sustainable recuperation. There have been proposals to initiate a $1.1 trillion supportive program to renovate credit, development and employment in the global economy. (THE GLOBAL PLAN FOR RECOVERY AND REFORM, 2009) It is also anticipated by the top economists that this globalized financial crisis will continue to leave its effects on world capital markets till late 2010 as most of the economists who had earlier claimed that the most terrible phase of the worldwide financial crisis had yet to be witnessed did not perceive it passed until the succeeding half of the year and has continued to be suspicious with reference to expectations for a rapid pickup that was observed building over in current weeks. (ROBINSON, Jerry, 2009, PP. 148) 6. Conclusion Subprime mortgage crisis that were primarily started in America had affected economies of all developing and developed countries in terms of banking systems failure. The mortgage crisis that led to failure of significant banking institutions in America might be avoided if Fed had exercised their duties in effectual way and had tried to distinguish early symptoms of crisis. Now, US government has announced huge bailout packages for banks to recover from dilemma. However, in last G20 meet, all members have pledged to implement noteworthy steps to overcome this financial crisis ASAP. Now, it depends on future exercises of nations to implement the lessons learned from past to avert relapse of the dilemma that made millions of lives difficult to survive. 7. Bibliography BRUNNERMEIER, Markus K. 2008. Deciphering the 2007-08 Liquidity and Credit Crunch. Journal of Economic Perspectives., pp.321-413. HAMMOND, Jeremy R. http://www.foreignpolicyjournal.com/2008/10/06/effects-of-us-financial-system-felt-around-the-globe/. [online]. HOFFINGER, Bachelor David. 2009. U.S. Bank Stocks and the Subprime Crisis. GRIN Verlag. KRUGMAN, Paul. 2009. Macroeconomics. Worth Publishers Incorporated. ROBINSON, Jerry. 2009. Bankruptcy of Our Nation: 12 Key Strategies for Protecting Your Finances in These Uncertain Times. New Leaf Publishing Group. SANCHEZ, Adrian R. 2009. The 2009 Economic Landscape:How the Recession is Unfolding across Four U.S. Regions. FDIC Quarterly. 3(1), pp.1-38. SHILLER, Robert J. 2008. The subprime solution: how todays global financial crisis happened, and what to do about it. Princeton University Press. SOROS, George. 2009. The Crash of 2008 and What it Means: The New Paradigm for Financial Markets. Perseus Books Group. TAYLOR, John B. 2009. How Governement Created the Financial Crisis. The Wall Street Journal. THE GLOBAL PLAN FOR RECOVERY AND REFORM. 2009. http://www.g20.org/Documents/final-communique.pdf. [online]. ZHANG, Mingyuan. 2009. Credit Risk Assessment: The New Lending System for Borrowers, Lenders, and Investors. John Wiley and Sons. Read More