Global Financial Crisis - Impacts on New Zealand - Literature review Example

Finance and Accounting Global Financial Crisis: Impacts on New Zealand (College) Global Financial Crisis: Impacts on New Zealand Introduction The global financial crisis began to show its influx in the middle of 2007 and later spread into the whole 2008. The crisis caused dreadful effects on all segments of people across the globe, especially in western countries. The global financial crisis rapidly resulted in the failure of world stock markets and subsequently the collapse large financial institutions. Countries with economic insecurity were largely affected since they could not effectively initiate various monetary tools. However, even wealthiest governments were forced to declare diverse rescue packages in order to bail out and thereby ensure the safety of their financial systems. The decade witnessed a series of collapses in the American banking sector, which were directly attributed to the crisis. The most challenging issue associated with the global crisis was that the institutions responsible for the financial difficulties were the ones being largely bailed out. This paper intends to explore the major causes that led to the crisis and how it affected New Zealand’s financial system and economy. Facts of the financial crisis Davies (2009) says that the financial crisis widely struck the global financial markets and its first impacts were seen in the United States’ sub-prime mortgage market. As a result of this crisis, the prices of bonds and other financial assets were considerably declined by which the generated losses largely hit the financial system. In the view of Davies (2009), in this period, number of financial institution underwent bankruptcy mainly due to the collapse in credit; this situation adversely affected the economic confidence of business houses/entrepreneurs and thereby the overall economic growth of nations. A gigantic expansion in credit and asset prices just prior to the collapse increased its severity. This adverse credit as well as asset price expansion was more visible in the housing markets of US. Davies (2009) points that the situation of immense global imbalances between corporate giants created huge reserve accumulations. The aftereffects of these accumulations led to the fall of real and nominal interest rates. Naturally, this economic condition produced an environment that offered excess liquidity and very easy credit; hence, borrowers began to take advantages of this favorable situation. Subsequently, companies also increased their leverage with intent to exploit the situation. In the view of Davies (2009), households got the opportunity to borrow more and more under this economic situation; and consequently, the ‘household debt rose to unprecedented levels in relation to GDP’. The banks and other financial institution were willing to approve this increased demand for credit and allowed credit even to vulnerable and very risky borrowers. Obviously, this massive and thoughtless credit creation hurt the financial stability of the credit sector. Causes of the global financial crisis Prior to the emergence of global financial crisis, it seemed that America had struggled with productivity and competitiveness in the Asian markets. The speculative economy has also notably contributed to this financial turbulence since the relationship of the international money supply did not commensurate with the actual production of goods. We know that energy consumption significantly increased by the beginning of 21st century. Since the existed reserve levels could not meet the increasing energy requirements, it caused energy crisis. Scholars opine that this energy crisis has also played a vital role intensifying the crisis. Davies (2009) argues that the irresponsible and passive trade room practices have also contributed to the crisis. Many of the economists are of the opinion that severe feeding problems or food crisis are also factors that fueled the global financial crisis. However, the major cause of the 2007 global economic crisis can be directly attributed to the sub-prime mortgage sector in the USA. During the early part of the last decade, major highly developed economies practiced markedly loose monetary policies for long periods. This exercise of excessively loose monetary policies produced global imbalances which were ascribed to the outburst of the severe global financial crisis. In the opinion of Portes (2009), the crisis was greatly resulted from the global macroeconomic imbalances; the financial intermediation process was largely intervened by these global macroeconomic imbalances and consequent huge cross-border financial flows. The global economic crisis followed by the US housing recession has been influenced by many other factors also. The collapse of Lehman Brothers led the global crisis to the next phase and it gradually reflected the destruction of US housing sector as well. The housing sector was very successful in US since various financial institutions had offered ranges of funds sources in order purchase homes. With the help of this financial assistance, people largely started to buy homes and the demand of this program highly rose. This situation led to the speculative trade of houses in many instances. The extensive credit facilities for the purchase of homes persuaded people to take unfair advantages of this project by making it a business. This situation is called “housing bubble”. In Davies’ opinion (2009), as a result of this phenomenon and other monetary policy issues, US policy rates reached one per cent in June 2003 and it lasted up to June 2004. The housing bubble and related incidents lasted only for a short time and interest rates notably raised in order to keep inflation rates under control. This economic strategy badly affected the easy availability of credit facilities and thus the housing demand fell. As a result, financial institutions faced challenges to get back their mortgages and loans. For instance, Citygroup lost US $9,800 million on the ground of mortgages in the second quarter of 2007. Impacts on New Zealand financial system and economy It is estimated that the cost of the rescue activities associated with the crisis reached around US $9 trillion in the US, Europe, and Japan. Unemployment is the most severe issue that emerged as a result of the crisis and struck the developed world. As Davies (2009) points out, the global financial crisis caused to double the unemployment rate in the New Zealand as compared to the pre-crisis period. The adverse effects on commodity prices also raised difficulties in the New Zealand market. Reserve Bank Deputy Governor Grant Spencer (as cited in Reserve Bank of New Zealand, 2009) claims that New Zealand banking sector has successfully survived the global financial crisis as compared to other affected countries. The banks are the heavily regulated financial institutions which could defend the crisis well (Bank regulation. The role of a modern central bank. The RBNZ). Although, the Reserve Bank could keep the overall asset quality stable, the value of impaired assets went out of control. The crisis affected the NZ corporate bond market since the companies breached or they were close to the breach of covenants on loan agreements (Reserve bank bulletin). New Zealand highly depends on offshore borrowing and hence the country is exposed to external financial shocks as a result of the crisis. By the end of 2008, signs of gradual improvement in the funding markets were seen. The Reserve Bank’s prudential liquidity policy greatly assisted the country to overcome the crisis since it aided the banks to extend the maturity structure of their funding and thereby minimize offshore market disruptions. According to Tumbarello (2010), New Zealand banks could effectively defend the global crisis even though it has faced some vulnerability; the major risks associated with loans to households and corporates become manageable as a result of the successful operations of the reserve Bank. The Fed act as the lender of the last resort and it seems to be the most important function of the bank (Lecture notes, Topic 8). The New Zealand government established deposit and wholesale funding guarantees in 2008 with intent to provide adequate liquidity; this provision and successful central bank activities largely improved confidence in country’s financial sector. It is also found that the country could effectively maintain an increase in mortgage defaults. In addition, new and existing mortgage interest rates considerably fell since mid 2008. This economic condition assisted the country to mitigate the risk elements associated with mortgage lending bank losses. However, the global crisis also increased the unemployment rate of New Zealand even though it was the least affected country. “New Zealand’s unemployment rate jumped 6.5% from the September 2009 quarter to 7.3% in the last 3 months of 2009, its highest level in more than 10 years” (Economy). However, this increased rate fell to 6.8% at the end of 2010. The Westpac banking Corporation’s study on international country debt reveals that New Zealand is the least affected country by the global financial crisis (NZ fares well in global financial crisis survey”, March 12, 2010). Conclusion Obviously, the combination of a series of factors caused the global financial crisis. Issues associated with sub-prime mortgage sector in the USA were the major reasons which intensified the crisis. Similarly, housing bubble phenomenon also contributed to the issue. Evidently, New Zealand could successfully survive the global financial crisis as a result of its banks’ strongest structure. Although, the crisis caused an increase in NZ unemployment rate, the government could successfully bring down the rate by the end of 2010. References “An overview of the money and bond markets in New Zealand”. Reserve Bank Bulletin. 58. Davies, H. (July 30, 2009). The financial crisis: do dunnit? Reserve Bank of New Zealand. Retrieved from http://www.rbnz.govt.nz/research/workshops/75thpubliclecture/3713648.html Economy: New Zealand Oceania. Travel Document Systems (TDS). Retrieved from http://www.traveldocs.com/nz/economy.htm “Global financial crisis still affecting NZ, says RBNZ”. (13 May 2009). Reserve Bank of New Zealand. Retrieved from http://www.rbnz.govt.nz/news/2009/3630161.html “NZ fares well in global financial crisis survey”. (March 12, 2010). TVNZ Best Media Site. Retrieved from http://tvnz.co.nz/business-news/nz-fares-well-in-global-financial-crisis-survey-3412142 Portes, R. (2009). “Global Imbalances” in Mathias Dewatripont”. X. Freixas & R. Portes (Ed.). Macroeconomic stability and financial regulation: Key issues for the G20. London: Centre for Economic Policy research. Tumbarello, P. (Jan 22, 2010). “Global economic crisis: Australian, New Zealand banks remain sound during global crisis”. International Monetary Fund. Retrieved from http://www.imf.org/external/pubs/ft/survey/so/2010/car012210a.htm Lecture Notes/slides. Read More