Financial Crises of 2007-2010 - Essay Example

Running Header: Financial crises of 2007 – 2010 Student’s Name: Instructor’s Name: Course Code: Date of Submission: Table of Contents Table of Contents 2 Introduction 3 Causes of Financial crisis in Dubai 3 Effect on Dubai 4 Strategies by the government and central banks 5 Causes of crisis in World and Dubai 6 Future of global financial market 7 Conclusion 8 References 9 Financial crises of 2007 – 2010 Introduction As a result of the great depression that began in 1929 in USA, there was a collapse in the global financial markets which brought about significant economic downturn and severe social consequences related to a higher number of unemployed people. This study gives a systematic review of the financial crisis of 2007-20110. First, the causes of the crisis are analysed which include the growth of the housing bubble and provision of easy credit conditions. The study also examines the global financial crisis in 2007-2010 in Dubai in UAE. The study also shows the real estate sector in USA as a world example. Dubai is one of the 7 emirates of the United Arab Emirates (UAE) and is located south of Persian Gulf. Dubai is estimated to have the largest population among the emirates and is also the second largest territory after Abu Dhabi (Cochrane and Harif, 2009).  Causes of Financial crisis in Dubai The events experienced before the crisis included the overvaluation of the house market in 2006 in United States. The price of housing was increased because of easy credit and over assumption on the belief that housing prices always increase. The other cause of the financial crisis was the low initial rates put on adjustable rate mortgages as well as the experienced low down payment requirements. These encouraged short term speculation where seller hoped for favourable terms in future. The interest rates also rose therefore building a poor refinancing environment. The major financial institutions suffered losses due to drop on house prices and at the same time, the housing bubble grew (Hall, 2009).  Effect on Dubai Dubai is an investment emirate that deals with management and supervision of business portfolio therefore promoting the country as a hub for commerce and trade. Among other emirates it bears the flag of global investments which is included in its major functions. Hall (2009) shows some of the assets owed by Dubai include DP world and Nakheel. The 2007-2010 financial crisis was the most severe since the Great depression of 1930s. The causes of the global financial crisis are still being debated through many factors are now clear for example due to failure of major corporations and decline of assets values. Effort has been made to combat the effects of the crisis which include taking up both regulatory and market based measures. The Dubai was launched as a holding company in 2006 where it employed about 50,000 employees located in more than 100 cities. Mantel (2010) describes that Dubai has invested in extensive real estate in the US, UK and South Africa. In 2009, Dubai World decided to delay the payment of its debt and this resulted to increased risk in government default. The delay was for about six months and the debt amounted to 26 billion dollars. As a result of this debt, many markets were affected causing a drop in indices including those of oil prices. The US traded stocks also fell through they were later rebounded. Oil prices rose by about 7 percent as well as other stock averages. With the effect of the 2007-2010 financial crises, Dubai market for real estate has declined after it had been a boom business for six years. In 2009, the Dubai government announced its intention of asking financial institutions not to lend any money to the public and this was to be extended up to May 2010. About 10,000 employees were laid off world wide due to the standing debt of about 59 billion dollars. The financial crisis experienced in Dubai resulted to more than half of the construction projects being put on hold as the amount totaled to about 582 billion dollars. These projects have include the Nakheel Harbour & Tower of 38 billion dollars, the other projects put on hold include Al Salam City, Asia Hotel, Dolphin City, Falcon City of Wonders, Plaza Major among others. The major cause of Dubai’s trouble is by being over ambitious development plan which included world famous infrastructures and the construction of tallest buildings on earth. Strategies by the government and central banks In November 2009, the Dubai government announced asking its creditors to corporate and freeze debt repayment and if the proposal was to be rejected, Dubai would sell its real estate assets. However, in December 2009, Abu Dhabi which is the wealthiest among other emirates extended a loan of 10 billion dollars to cover for some of the debt and in order to help Dubai avert some of its problems. Watts (2009) puts it that in May 2010, Dubai had come to an agreement with most of its bank lenders in restructuring a debt worth 23.5 billion dollars and the remaining was 14.4 billion dollars. The terms involved in restructuring included the conversion of about 8.9 billion dollars of government debt to equity. The UAE has pledged to support the economy of Dubai that for example the Central Bank has offered 10 billion dollars to ease the mounting debt default. The Central Bank also announced new liquidity measures which are expected to strengthen consumers and market confidence in the economy. In February 2010, CNN announced that Dubai was considering selling QE 2 which is one of the most famous ships in the world in an effort to restructure their debt financing though the sale has not yet been completed. Emaar Company that built Burj Khalifa is also considering selling some of its assets and Dubai Holdings plans to sell about 40 percent of its shares (Raja, 2009). Causes of crisis in World and Dubai According to Jeff (2010) the World and Dubai crisis was majorly caused by market instability for example a change in creating new lines of credit. This reduced the flow of money therefore slowing new economic growth and the buying and selling of assets. This affected individuals, businesses and financial institutions, which were left holding mortgage, backed assets that had dropped in prices and could not amount to the expected money for payment of loans. The effect of this was drying up reserve cash at the same time restricting credit. The other cause of World crisis was as a result of cheap credit making it easy for people to purchase houses making their investment base on speculation. This created more money therefore increased consumer spending. This increased demand for houses leading to inflation. The other causes included speculation on oil prices and higher unemployment rates. Credit promotes growth of an economy and employment opportunity but when poorly used it turns to be a catastrophic which is what happened in the 2008-2010 financial crisis. The bail out involves changes in lending regulations and having an oversight of the industry. Since the 10 billion rescue package from the UAE Central Bank will not be enough, Dubai will continue to struggle with its debts and from massive construction projects. The main issue is lack of transparency as the government is not clear of the causes of debts. The real estate investment market underwent a dramatic fall in 2009 after the annual returns in 2007 (Jeff, 2010). The outsized annual returns were especially fueled by availability of inexpensive debt linked to the unrealistic assumptions of future income growth. The United States economic recovery will depend on the stabilization of housing and financial markets. Fiscal policy will also be a major boost to the economy which will involve a large stimulus package and measures of stabilizing the financial markets. NAI global which is a major real estate and financing firm discovered an increase in the number of empty stores with vacancy rates rising by 14 percent in 2008. Watts (2009) shows the national average rental rate also rose to 7 percent. The firm hopes that the plan for President Barack Obama in reviving the economy and consumer confidence will work. Due to the slowed construction in the housing and commercial real estate sector, the construction firms now rely on schools and other public amenities as they wait for states to balance their budgets affected by the declining tax revenue. Future of global financial market The recent political shifts have however resulted to mismatch between the global financial market and state policies. This gap is therefore left for managers to formulate strategies for managing the structural and managerial issues. Some of the issues faced by firms that market their products globally include; cultural issues. For multinational firms for example the Mc Donald’s to succeed in the global market the cultural dominance is necessary. International finance involves various risks since assets traded in the financial markets are claims to flow of return that is used for many years. Pylas (2009) explains that one example of dangers caused by the volatile financial market is the mismanagement of mortgage lending experienced in 2008 in US. This also led to banking failures and shortages in credit. Such sudden flows of capita lead to financial crises in most developing countries. Financial crises have a great impact on the economy and for this reason governments have imposes strict policies over which banks operate. The policies control activities and conducts of various financial institutions to achieve efficiency gains. The other reason for imposing great restrictions is to create a flexible international financial system. Cochrane and Harif (2009) describes that a complex interactive system is usually difficult to analyse and it may result to financial crises for example the Asian financial crisis of 1997, which collapsed the long-term capital management hedge fund. The consequence of this is decrease of asset prices, increase in risk premium and reduced liquidity. Globalisation increase has posed several benefits for example recessions have been shared among different countries since market failure in one country leads to a reduction in activities in another country. However there are some setbacks where it is argued that benefits of globalizations are not equally spread among countries and this therefore leads to income inequalities. The result of this is that the parent countries lose social capital and the receiving countries lose on social strain caused by immigration. Conclusion In coming to a consensus with the recent global financial crisis, some of the reforms needed include strengthening risk management of financial firms, reforming regulation and improving supervision. In the near future it seems that financial crisis may be reduced since globalisation is increasing. To mitigate the crises, governments should introduce effective fiscal policies which ensure that financial institutions have enough reserves to control borrowing. The IMF should also initiate other methods of stabilizing international currencies in order to reduce loss of value against the US dollar. This will reduce inflation and therefore mitigate the spread of financial crisis. References Cochrane, L. & Harif, Barak. (2009). Dubai debt delay rattles confidence in gulf borrowers. Hall, C. (2009). Dubai government statements on Nakheel, $5 Billion, viewed 17 May 2011, < http://www.bloomberg.com/apps/news> Jeff, J. (2010). The Dubai financial crisis: An oasis of debt, the Palm Islands, Dubai World and the Burj Khalifa | Suite101.com, viewed 17 May 2011, Mantell, R. (2010). Home prices off record 18% in past year, Princeton University Press. Pylas, P. (2009). Dubai woes hit world stocks again; Asia down most, Associated Press, viewed 17 May 2011, Raja, S. (2009). Asia stocks drop for second week on Dubai, share sale concerns. Bloomberg News.  Ryan, R. (2008). The 2008-2009 financial crises: Causes and effects, viewed 17 May 2011, Watts, W. (2009). Dubai woes roil financial markets: Stocks fall and government bonds rise on flight to quality. Market Watch, viewed 17 May 2011, Read More