Global Financial Crisis - Lehman Brothers - Case Study Example

Global Financial Crisis ID & number of words Abstract The topic emphasizes on Global financial crisis which affected the economy adversely. The Global financial crisis emerged during the period of 2008 and 2009. The main reason behind the global financial crisis is the subprime loan crisis and the collapse of Lehman brothers. The economic crisis affected all the sectors of the economy. The crisis was experienced by all countries across the world. The debt burden increased resulting in the decline of the Gross domestic product. The government and the monetary authority initiated various steps and measures for curbing the recession in an economy. Contents Introduction 4 Analysis 4 Recommendations 11 Conclusion 12 References 14 Introduction Global Financial Crisis is commonly known as the Global economic crisis. The Global Financial Crisis emerged in the year 2008. This crisis led to the situation of credit crunch in the economy. The economy was severely affected due to the crisis. It resulted in the situation of increase in unemployment and bankruptcy. The Gross Domestic Product of the economy decreased with the increase in the debt burden. Different sectors of the economy were negatively affected by the financial crisis. The main objective of this paper is to analyze the causes and consequences of the global economic crisis on the economy and how the financial system of the country is expected to be reformed. When the US investors lost confidence in the value of the subprime mortgages it led to the liquidity crisis in the economy. The crash in the stock market worsened the situation and the market became highly volatile. The housing market of United States was affected severely as many of the house owners who have taken loan were unable to pay back the money. The failure of repayment by the home owners severely affected the banking sector of the economy. The global financial crisis expanded with the failure of the Lehman Brothers in the year 2008. The liquidity position of the economy was affected due to the credit crunch. The economic crisis affected the Asian countries. The lower rate of interest provided an incentive for the banks to hedge funds for its riskier assets which offered higher rate of return during the period of crisis. Analysis Causes of Global financial crisis The main cause or the reason behind the global financial crisis was the failure of the banking sectors in recovering the amount of loan lend to its customers. The banking sectors were held responsible for the crisis, since they were engaged in creating more money by increasing the price of the houses and speculating the financial market. When the bank provides loan to its customers, it makes money out of it. During the time of financial crisis prevailing in the economy, the banks were making huge sum of money by offering loans to the public. This activity of the banks resulted in increase of debt burden in the economy. The money accumulated by the banks in the process of offering loan was utilized for increasing the prices of house. This led to the speculation in the financial markets of the economy (Davies, 2014). The liquidity situation worsened the economy with the failure of the Lehman Brothers. There was mismatch between the amount lend to the public and amount borrowed. The financial institutions severely faced the liquidity issues. Figure 1: UK banks utilized the money they have created (The Economist, 2013) The above figure represents the sectoral funding adopted by the Bank of England for creating money. 30% of the money created was utilized for the residential property, 33% were allocated to the financial sector, 20% in the real estates and the remaining 8% were used for providing personal loans and credit cards. The banks invested this money in the property market which increased the price of houses. As a result of the increase in personal debt, the rate of interest on loans offered by the banks also increased simultaneously. The home owners were unable to repay the amount borrowed from the banks. The inability of repayment of the loan amount by the public resulted in a situation of bankruptcy for the banks (Horen, 2014). The other major cause of the global financial crisis was the subprime loans availability. The subprime loan affected the credit growth of the economy to a large extent. The subprime loan concept can be explained as the loan that was offered to the individuals without verifying their credit history. The first and foremost step in offering loan to an individual is evaluation of past history of the borrowers. As a result the loan was offered to the individuals with poor credit history. The people were unable to repay the borrowed amount to the banks due to their inadequate income. The borrowers are not required to make down payment for availing loans which encourages more borrowers to apply for loan without considering their credit capacity. The interest rate charged by the banks decreased with the increase in liquidity. Therefore the demand of subprime loans among the public increased which urged the banks in US to provide more loans to individuals. With the increase in loan disbursement, the rate of default in repayment of loans also increased which resulted in Global financial crisis in the economy (Grovum, 2013). The failure of Lehman Brothers in 2008 shattered the economy. This failure resulted in credit crunch in the economy. The Gross Domestic Product decreased significantly. The Lehman brother collapse emerged due to increase in disbursement of loan. The liquidity problem in the economy forced the central banks to offer liquidity in various forms. Figure 2:TED Spreads (Allen, 20090029 The falling interest rate can be considered as another reason for global financial crisis Figure 3: Decline in interest rates Low rate of interest encouraged the borrowers to purchase house. This resulted in the increase in indebtedness in the long run. The failure of the credit rating agencies to predict the economic crisis is considered as one of the reasons for the global economic crisis in the economy (Regnier, 2014). Impact of the financial crisis The financial or the economic crisis affected the economy. The impact of the financial crisis on different sectors of the economy can be analyzed as the housing sector which is considered as the epicenter or the root cause of the economic crisis affected the government due to the inability in generating adequate revenue. The price of the real estate virtually affected different sectors of the economy. The bank acquired homes from those borrowers who were unable to pay the loan amount. But the price of houses fell down resulting in the situation of economic recession due to decline in the real estate sector. The financial crisis led to the decline in the manufacturing industry. The government of US decided to foreclose various factories. The global financial crisis adversely affected the economy all over the world. The exports of China decreased by 24% and decreased by 25% in US. The industrial production declined by 12% in US, 11% in Europe and 43% in Taiwan (Ibel, 2014). The banks refused to offer loans to the individuals after the crisis. The banks adopted strict measures in offering loans to only those individuals about whom the bank is confident that the individuals will repay the borrowed amount. The collapse of the Lehman Brothers worsened the crisis situation prevailing in the economy. The governments adopted several initiatives for rescuing the financial institutions since the collapse of the stock market and housing negatively affected the economy. The decrease in the interest rate and increase in demand among the individuals for purchasing residential apartment led to the increase in leverage for maintaining a high rate of nominal return on the capital employed. The venture capitalist and the hedge funds are the examples of the increase in leverage. The banking sector also increased their leverages. The rise in leverages by many companies created a problem for them since they were dependent on the functioning of repo market and also short funding. The banks and the other companies took the liquid market for granted. The problem arose when the investors were uncertain about their assets involved in the asset backed securities and in the repo market. This resulted in weak liquidity condition in the economy. The financial sectors, banks and the other companies faced financial stress and pressure, thus leading to the situation of global economic crisis in the economy. The debt burden increased with the emergence of the crisis. The bank faced problems in selling its mortgage based securities (Williams, 2013). The banks were unable to sell the assets at any price or utilize them for short term funding. The financial system of the economy dissolved with the worsening of the financial crisis. Due to the excessive lending by the banks to its borrowers, the increase in demand for debt did not match with rise in deposits of the banks. The financial institutions encountered liquidity risk to a large extent. The Global financial crisis affected the trade that is carried out by the countries across the world. The rate of exports decreased due to the situation of credit crunch prevailing in the economy. The economic downturn led to the social disequilibrium. The rate of increase in unemployment affected the economy adversely and the rate of unemployment increased by more than 7%. The decrease in demand resulted in the termination of the employees resulting in a situation of increase in unemployment. The fiscal position of various countries was adversely affected. The jobs created were restricted to part time jobs and low pay works (Davies, 2014). The combination of increase in expenditure and decrease in revenue reduced the capacity of the government to control or prevent the decline in an economic activity with the implementation of expansionary fiscal policy. In a severe economic recession, there is a requirement for expansionary fiscal policy in the economy. But the lack of sustainability of the economy in the boom years led to the situation of crisis. Therefore the smaller companies were exposed to difficulties or problems in convincing the international investors for purchasing the government securities (Horen, 2014). Reforms The failure to prevent the debt crisis led to the situation of global financial or economic crisis which affected the nations all over the world. The banking institution should not be considered as the only sector responsible for the crisis. The mistake committed by the regulators before the bankruptcy of Lehman Brothers was accepting the imbalances in the global current account and the increase in housing bubbles which inflated severely. The recession forced the government to cut the rate of spending. The states decreased the spending by 3.8% in the fiscal year 2009 and by 5.7% in 2010. The governments were adopting strict rules and regulations, restrictions were imposed on the financial institutions. A fixed and specific rate is required to be fixed by the government for lending by the banks or the financial institutions to the public or to the individuals. The credit which expanded was contracted. The housing sectors were considered as the backbone and main sector for economic growth and development. But the financial crisis destroyed the real estate market resulting in the closure of various industries etc (Allen, 2009). The banks for International settlement located in Switzerland were engaged in establishment of rules and regulations for harmonizing the banking sector of the economy. The central bank adopted various measures for maintaining stability in its prices. A strict monetary policy was implemented by the Government. The Global financial crisis increased the debt burden of the government, thus the government initiated adequate measures for generating revenue, increasing the Gross domestic Product and decreasing its liabilities or debt. Regulatory frameworks were designed by the government for monitoring the activities of the financial institutions in order to prevent the occurrence of financial or economic crisis in the future. The global financial crisis affected all the nations across the world. Therefore adequate measures and regulatory frameworks were designed by the respective government of each country. The banks should appear less attractive to its stockholders, restricting their ability of taking advantage of the debt from the banks when it is attractive. Therefore this restriction will reduce the eagerness of the banks to lend more money to the individuals thus increasing the rate of interest on the loan disbursed by the banks (Ibel, 2014). Recommendations The global financial crisis led to the situation of credit crunch in the economy. The subprime loan crisis shattered the economy. The subprime crisis not only affected US but it also affected the other countries of the world. The subprime loan crisis emerged due to the default of the borrowers in repayment of the loan taken from the banks for purchasing houses. The fault of the banking sector is that it offered loan to the public without verifying their credit history. The income capacity of the individuals was not taken into consideration. The default in repayment of loan by the individuals increased debt burden of banks (Williams, 2013). Therefore a fixed limit is to be specified for the banks for disbursement of loans. The interest rate should not be reduced. Since the decrease in the interest rate will result in more income in the hands of the individuals and decrease in prices which will result in inflation in the economy. The government is required to appoint regulatory authority for monitoring of the activities. The government is expected to protect the income basis of the states which includes safeguarding the private and the corporate taxes from evasion. Monetary stimulus should be used by the US Federal Reserve for purchasing the long term Treasury bond and decreasing the rate of interest. In United States money were allocated by the governments to the financial institutions and banks in order to prevent their collapse and promote economic growth and development. In India RBI provided fund for preventing financial crisis. Conclusion The Global financial crisis prevailed in the economy during the period of 2008-2009 disturbed the functioning and the activities of the economy. The Global financial crisis was not restricted to a single place. It affected all the countries across the world. Different sectors were affected by the Global financial crisis. But the sector most severely affected was the banking sector. The financial crisis decreased the global or the international trade which led to foreclosure of various industries and companies. The injection of revenue in the economy also decreased significantly. The Basel committee implemented various measures and initiatives for regulating the banking sector. The central bank imposed restrictions on the fluctuations in the interest rate. The global financial crisis created risk of operation for various businesses. The Global financial crisis worsened with the collapse of Lehman Brothers. The crisis not only resulted in the fall of prices of residential property but it also led to the fall of commercial property. The commercial property may also result in the emergence of similar kind of problem in the economy due to commercial backed securitization as in case of subprime crisis it was due to subprime securitization. The problem originated when the house bubbles burst out, damaged the financial system of the economy. The price allocated was wrong and modifying and identifying the right price is very time consuming particularly in case if the bubbles would have generated from real estate. Therefore during the process of adjustment the economy was adversely affected. The government initiated various steps and precautionary measures for preventing the occurrence of financial crisis in future. References Allen, F. (2009). The Global Financial Crisis: causes and consequences, Retrieved from: < http://www.bm.ust.hk/gmifc/Prof.%20Allen%20%26%20Carletti_The%20Global%20Financial%20Crisis.pdf >. Davies, J. (2014). Global Financial Crisis – What caused it and how the world responded? Retrieved from :< http://www.canstar.com.au/home-loans/global-financial-crisis/ >. Grovum, J. (2013). 2008 financial crisis impact still hurting states, Retrieved from: < http://www.usatoday.com/story/money/business/2013/09/14/impact-on-states-of-2008-financial-crisis/2812691/ >. Horen, N. V. (2014). The impact of the global financial crisis on banking globalization, Retrieved from: < http://www.imf.org/external/pubs/cat/longres.aspx?sk=42418.0 >. Ibel, J. (2014). Steps that the g20 should take to avoid future financial crises, Retrieved from: < http://www.atlantic-community.org/-/steps-that-the-g20-should-take-to-avoid-future-financial-crises >. Regnier, P. (2014). A simple plan to stop the next financial crisis, Retrieved from: < http://time.com/money/3136686/lehman-anniversary-how-to-prevent-financial-crisis/>. The Economist. (2013). The origins of the financial crisis, Retrieved from: < http://www.economist.com/news/schoolsbrief/21584534-effects-financial-crisis-are-still-being-felt-five-years-article >. Williams, M.T. (2013). How to prevent the next global financial crisis, Retrieved from: < http://cognoscenti.wbur.org/2013/09/13/too-big-to-fail-mark-williams >. Read More