Fall of Financial Systems and Governments Interventions - Literature review Example

Name: Tutor: Title: Report on the fall of Financial Systems and Governments interventions Institution: Date due: Executive Summary…………………………..…………………………………….3 Introduction…………………………………………………………….…………..4 The global financial crisis…………………………………………………….….....4 Funding conditions and government Guarantee Arrangements …………………...5 Market infrastructure …………………………………………………………...….7 Public Unit trusts and other managed funds………………………………………..7 The Context of Global Financial Turmoil in UK………………………..…….……8 The reported casualty of this crisis in Iceland……………………….….…….……9 Reasons for Iceland failure…………………………………………….…….….…..10 Resolution and way forward on financial insurance ………………………………..11 Conclusion…………………………………………………………………………...12 Bibliography…………………………………………………………………….……13 Executive Summary This report reveals financial crisis that was witnessed late in 2008 and also discuss governments intervention in recovery of this financial institutions. In the report we look at the financial institution unfolding as they happened, introduce the three main phases that culminated into this financial turmoil, this include first phase involvement of market stakeholder under estimating the risk associated with structured loans. The second phase indicates financial system announcement of the losses made on the structure loans and the impaired assets, among other related issues. The third phase, involves the crisis and failure of US Investment bank, Lehman Brothers and the intensification of this crisis in Australia, UK, and the Iceland. In this, we report on government guarantee arrangements and funding conditions, public unit trust and the Insurance market in Australia. The report also unravels the contention behind the experience financial difficulties in Iceland, the inflationary issues and the failure of its biggest financial institutions, and the impact witnessed on the Iceland economy. The final stage involves resolution and the break-through over the financial insurance. Introduction The financial systems have continued to perform relatively stronger after the first global financial crisis of the 21st Century witnessed in 2008. Bisignano et al (2000), asserts that it was during this financial global crisis, that the industrial world witness the largest bank failures in history, this triggered many governments intervention in healing the deepening crisis among most financial systems. This was unexpected contribution in reviving the reduced performance of the industry in most countries’ economy, government involved played crucial role, in a manner that would have for years remained unthinkable. Many financial firms are reportedly failed or merged away, while others where left with significant ownership positions of the national governments. The economy of Iceland, Australia, and United Kingdom suffered a collapse just as any of other countries for instance, Latin America or East Asia during the crisis. The Global Financial Crisis The banking crisis report bases on the series of events, which culminated to be one of the worst international banking turmoil at the time. The crisis is identified into three phases. The initial phase, financial systems figured out that they had underestimated the risks associated with a number of structured loans. Unexpectedly, the demands for these products fell sharply, consequently driving down their prices. The crisis triggered fear in lending services as no financial lenders knew which bank was more exposed to these assets (Bisignano et al, 2000). The second phase, witnessed larger number of major banking system announce losses incurred on structured loans and other impaired assets in early period of 2007. The situation triggered top leadership resignation Alexander (2009). The losses incurred are associated with increased uncertainty that involves complexity of this form of asset opacity and the deteriorating micro-economic situation in the sophisticated economies, turned uncertainty about the value of impaired assets into the solvency of a number financing systems. The third phase of this crisis, involved the failure of the United States investment bank, the Lehman brothers, magnified the crisis. During this phase, banks stopped trusting each other and further their customers lost trust in these banks. This led to a reduced confidence in the international banking system Evanoff et al (2007). The move generated the necessity for government plans in rescuing the banking industry from collapse, as a number of governments ware reportedly involved in adopting policies which fostered reinstallation of trust in the financial system. Despite these unprecedented interventions from government, the crisis triggered a global economic downtown, which further, threatened the economic prosperity and necessitated more action. Funding Conditions and Government Guarantee Arrangements The Australian government intervention improved the funding conditions considerably over the years. The market segment has recovered from the extreme risks it experienced in the late 2008. As discussed earlier the Australian banks were not immune from the acute uncertainty, which unfolded in concern to the global banking system that was precipitated through collapse of global financial system. The Australian government reacted through depositing $ 1,000 or less in any eligible ADIs qualified for automatically for the government guarantee, under the government financial claims scheme, which was introduced as a fee- based guarantee scheme for large deposits and wholesale funding Bisignano et al (2000). Claims by Stacey (2010), reveals government initiative was successful in assuring investors unease while improving funding conditions over the course of 2009 as risk aversion is reduced. This move triggered increased issued long-term debts both on domestic and off-shore markets, without backing of government’s guarantee as the deposit growth improved steadily. However, there are reports indicating limited signs in improving securitization market for issues that mostly concerns private investors, but their continuing development for a better solution. According to Evanoff et al (2007) the industry recovery, in concern to the witnessed crisis over the previous period has been evidently portrayed through improved performance in the domestic money market. The financial results indicates an increased spread between yield witness on the bank bills and the index rates having narrowed to an average of about 20 points just a few month after the government intervention measures were put in place, this is compared about 100 points witnessed at the height of the global market uncertainty during the crisis. Since the government guarantee provision for the wholesale funding was put in place on 28th November 2008, the Australian financial system have issued an estimated $ 185 billion on long-term debt, with reports indicating that over $ 142 billions issued under the guarantee scheme. In addition, about 60% of the government bonds were issued offshore and particularly in the US market Bisignano et al (2000). The demand for government guaranteed papers remained strong, financial lenders boosted their issuance of the unguaranteed debts for both customers from US and the domestic markets. For instance, the domestic market accounted for about a half of the total issuance few month after the government initiative was effected, compared to 10% issuance witnessed during the financial helmet. Following this move, several banks have gained offshore markets for tapping in the unguaranteed debt late on, more especially for the long-term loans serving beyond a 5 year limit as indicated in the guarantee scheme (Alexander, 2009). Currently the pattern of wholesale debt issuance has remained consistent with banks willing to lengthen the maturity on the profile of their liabilities. This is contrary to what was seen in the initial stages, as many financial institutions offered a shortened debt repayment maturity in the early stages after the financial setback. This further improved the bank’s share in the unpaid debt, with the original maturity greater than one year increased from 63% to a better rate of 78% within one year. Later on the average tenor of the new bond issue is reported to be about 4.5 years, while the average maturity of outstanding government guarantees remained stable at just above 3 years (World Bank, 2008). Market Infrastructure As the condition in the banking industry stabilized, immediately after the crisis there is increased recovery in activities that concern Australia’s cash equity and the derivative markets. For instance, the central counterparties supporting Australia’s financial markets worked in reversing the increased margin levels as they were established in late 2008. This reduced the strength placed in the participant monitory credit activities. This is responsible for the witnessed improved arrangement of high-value payments and securities trades as it faired on smoothly (Evanoff, 2007). Public Unit Trusts and Other Managed Funds Majority of the Australian assets under the management are invested in the public unit trusts. This form of business ventures have significantly impact on the previous financial tribulation, it is reported that their general consolidated assets dropped by an estimated rate of about 10% over the financial year to June 2009. The asset valued declined across all main types of the public unit trusts, as prices of most asset class dropped immediately the financial crisis started. Many of these trust funds were reported to have experienced outflow of funds towards the end of 2008, an action that triggered deferral redemption in response of the illiquidity of their underlying assets. After all this, ASIC launched provision which allowed investors to withdraw the limit set out for the investors, this further allowed for funds withdrawal basing on the hardship grounds while more faulty claims be pointed on their in ability to meet immediate living or medical expenses. By mid 2009, the freezing mortgage trust is reported to have paid out an estimated $38 million to investors under the provisions. Towards the end of 2009, the ASIC relaxed the hardship provisions through increasing the annual withdrawal limit for investors, allowing more frequent withdrawals by the investors. This is responsible for the increased range of investors accessing funds in these public unit trusts in Australia. The Context of Global Financial Turmoil in UK Globalization developed increased benefits, but it also created challenges to the G20 members. The challenges and benefits include whether, in the global financial markets, we have the financial supervision that are equal to the risks. For instance, entry of China and India among other countries in the global trade system boosted the global supply in concern to labor. The steadily increased the world trade, particularly boosting of low price goods. The changes brought by implementing the world global trade generated a powerful disinflationary effect, which helped in keeping interest rates lower than they would otherwise be (Stacey, 2010). Although the micro-economic level, indicated a declined returns on the traditional assets that is believed to have prompted investor engagement in search better yield. This has been met by increasing complex financial yields and the financial sector influence. This was encouraged lower borrowing costs as the previous periods set out, the realization on certain assets being linked to subprime mortgages as they developed higher risks than previously predicted. This advanced limitation of the liquidity in these markets hence, declined investments as the investors lost confidence in their ability to value assets. As the markets activities were narrowed, the financial systems as a whole come under threat (Cooley et al (2010). The UK government response to the financial crisis by established a recovery framework responding to the economic crisis through a) Government protection of its citizens and their savings through measures that assisted prevention of collapse of the financial system. b) It offered real help to families and businesses in a move targeting to boost recovery of its economy c) Maintaining the financial lending d) Invested in the recovery process, will preparing the country from the new opportunities and challenges that comes with globalization. The Reported Casualty of This Crisis in Iceland According to the reports published in November 2008, the Iceland banking system was ruined. The GDP indicated a decline by an estimated rate of a bout 65% calculated in euro terms. Many firms in this country faced bankruptcy while other firms resulted in moving their operations abroad. The industry too was faced with claims from the Dutch government and the British, which both were demanding for compensation that amounted to over full amount earned as the Iceland’s gross domestic profits during this time of turmoil. This was move to protect their citizens who had higher investments inform of deposits in the domestic branches at Iceland banks (International Monetary Fund, 2009). This was Iceland’s worst experiences as it was the deepest and the most rapid financial crisis witnessed when its three major banks collapsed at same time to wards the end of 2008. This is one developed country that was reported to have made a requested seeking assistance from the IMF for over a period of 30 years Bisignano et al (2000). The crisis was further hit by the UK move, following use of anti-terror laws by the British authorities that ware against the Iceland bank Landsbanki and the Icelandic authorities in the transfer of money between Iceland to oversea countries. This coursed extremely increased difficulties that resulted to a standstill, for their economy that is dependant on the imports and export the situation weakened their economy performance. However the situation has been improved with possible transfer of money with some difficulty but the Icelandic currency now operational in the market is under capital control. The Iceland government is continuity seeking for financial support re-floated to have the Icelandic Krona under supervision of IMF. Reasons for Iceland Failure The Iceland’s banking system crisis is purely blamed on series of policy mistakes dating back in the beginning of the decade. The most identified cause of the crisis was the use of inflation targeting. Through this decade inflation targeting was generally above that target rate, responding to this situation the central bank kept the rates high, as they exceeded 15% at certain points during this period. For a small economy like this of Iceland higher interest rates did encourage the domestic firms and households to engage in borrowing in the foreign currency. Claims by Cooley et al (2010) the increased rates also attracted traders’ speculation against uncovered interest similarity, which resulted to large foreign-currency in-flow. It increased exchange rates appreciations giving the Iceland citizens an illusion of wealth as they resorted to doubly rewards to the transmit traders. The out comes on the currency inflows encouraged economic growth and inflation further forcing the central bank to raise interest rates. Resolution and Way Forward On Financial Insurance Any immediate solutions for this problem that Iceland is facing are dependant on the UK and the Netherlands settling with the Iceland. On the contrary, the ability for Iceland government to fully meet their current demands is highly doubted. Results of the opinion polls in the Iceland, which indicate one third of its population is considering emigration. Increased economic hardships may at a point, due to Ice save obligations to achieve this expression of opinion as a reality. During the financial crisis, many firms were faced with bankruptcy while other contemplated on a switch of their headquarters and operations overseas (Charles & Green, 1997). The general financial insurance industry made recovery after the critical times during the crisis as claimed by Alexander (2009). As the industry recorded solid profits over the recent financial years contrary to the earlier results after the challenging operating environment. The total pre-tax profits is said to have improved, for instance Australian firms recorded pre-tax profit of about $3.6 billion in the period ending June 2009. This was about 4% lower prier to the crisis and the period pre-tax on equity was around 13% as compared to a ten year average of about 17%. Most countries government has taken the issues upon their task to ensure that the crisis does not repeat. Equal measures across the globe have been put in place to safe guard issues of the investors and that of their individual country economy. This is responsible for the government’s action in introducing measure of providing liquidity and increasing the minimum deposit guarantee (Stacey, 2010). This in its self reveals that the governments involvement in regulating the financial institutions activity is never going to be altered as they solidly monitor and ensure banking practices are up to the required measure in preventing the repeat of this financial situation in the future. Conclusion The global economy remains in a very fragile position. Much damage to the financial systems has continued to pose an increased risk to the wider economic activity. The international community needs to break this helmet to a lower cycle with a decisive policy in a move to get credit flowing again and to better enhance the desired demand. Governments and the regulatory authorities around the world have taken unprecedented action in responding to this global crisis and economic fallout. The step taken is to correct where the financial institutions and markets had failed. On a global view an estimated $500 billions has been announced for recapitalization in a move to shore up the financial system. Most of the G20 countries have announced stimulus packages with a booster fund estimated at over $2 billion in the world economy. Bibliography Alexander, C. (2009). Market risk analysis: Value-at-risk models. Market Risk analysis , Vol.4. Charles E, Green, H. J. (1997). Banking soundness and monetary policy: issues and experiences in the global economy : papers presented at the Seventh Seminar on Central Banking. London: International Monetary Fund,. Evanoff et al. (2007). International financial instability: global banking and national regulation. London: World Scientific,. International Monetary Fund. (2009). Global Financial Stability Report: World Economic and Financial Surveys. London: International Monetary Fund. Bisignano et al. (2000). Global financial crises: lessons from recent events. Chicago: Springer. Stacey, R. (2010). Complexity and Organizational Realities: Uncertainty and the Need to Rethink Management After the Collapse of Investment Capitalism. New York: Taylor & Francis. Thomas F. Cooley, V. V. (2010). Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance. New York: John Wiley and Sons. World Bank. (2008). Global Development Finance 2008: The Role of International Banking. London: World Bank Publications Read More