The Impact of GFC on the Global Financial System - Coursework Example

Global Financial Crisis Name Institution Introduction The global economy started to suffer in July 2007 and lasted for about five years, was as a result of the credit crunch in the United States (Forrest & Yip, 2011). Investors lost confidence in the value of sub-prime mortgage, and this in turn, caused a liquidity crisis. Thus, the United States Federal Bank was forced to inject a considerable amount of capital into financial markets. The financial crisis got worse in mid 2008 when stock markets in major economies, including Australia, Greece and Ireland collapsed and became highly unpredictable. In addition, consumers throughout the globe lacked confidence on the markets, and in turn, refrained from investing due to the uncertainties that lay ahead (Gibson, Hall & Tavlas, 2012). Analysts argue that the 2007-2009 global economic meltdown had severe consequences just like the Great Depression of 1930s because it brought an era of great prosperity to an unexpected halt (Emerson et.al, n.d). In Australia, the effects of GFC were less devastating compared to many countries. Compared to other developed nations, the Australian economy has recorded a considerable growth despite the deteriorated financial conditions. The Australian banks have continued to record huge profits against the economic slump (Forrest & Yip, 2011). This essay discuses the imрасts of thе Global Finаnсiаl Crisis (GFС) on thе global finаnсiаl system and how Australian policy makers deal with the problems presented by the GFC. The Impact of GFC on the Global Financial System The 2007-2009 GFC heightened market volatility in the global financial markets. According to Cheng (2007), volatility determines whether financial assets have been trading with wide swings or quietly. When the GFC hit, investors throughout the world resulted to impulsive buying behaviour, and this in turn, caused extreme volatility. The Global Financial Crisis, coupled with the United States housing bubble, had devastating consequences on the real economy. Developed countries including the US, Ireland, Portugal, Greece and Spain responded to this GFC by manufacturing numerous economic bailout packages, in order to cushion financial institutions such as banks and insurance companies from a steep decline. The US and other Western nations recognized the fact that the Global Financial Crisis had devastating effects on both the financial systems and federal government’s balance sheets (Cetorelli & Goldberg, 2012). Thus, numerous economic bailout packages were manufactured with the view of bolstering domestic demand, strengthening the broader Euro-zone economies and preventing additional increases in bond yields (Hubbard, Garnett & Lewis, 2012). The 2007-2009 GFC caused a write down of subprime mortgage assets. In the US, the uncomplicated credit conditions caused a decrease in interest rates. This, in addition to an influx of foreign funds, caused a housing bubble. Therefore, subprime mortgages were used to finance it, hence the subprime mortgage crisis (Hubbard, Garnett & Lewis, 2012). Consumers who had poor credit ratings were given easy access to mortgages, and thus, the default rates were high. The 2007-2009 international financial crisis caused the collapse of major banks. In a span of one month after the Lehman’s bankruptcy, the global banking system almost came down. In the US and western countries, for instance, banking institutions were partly nationalized (Hubbard, Garnett & Lewis, 2012). In addition, the GFC saw the disappearance of investment banks in the US. According to economists, more than 27trillion US dollars were wiped from the international stock markets following the Global Financial Crisis. During this time, the Dow Jones Index hit a record market low of 7,773 (Sheng, 2009). Governments throughout the world resulted in huge taxpayer-financed bail outs to cushion the banks against collapsing. Also, numerous monetary, as well as fiscal stimulus played the critical role of preventing further collapse of major banks. The 2007-2009 GFC had adverse effects on global capital markets. The Global Financial Crisis caused a decline in equity prices. In Australia, for instance, the GFC reduced the wealth of many people by about ten per cent. This is because it weakened investor’s confidence, as many citizens were concerned about their disposable income and forced to reduce their shareholder equity. How Australian policy makers dealt with the problems presented by the GFC Australian policy makers dealt with the problems presented by the GFC by using the stimulus package. Most nations throughout the globe introduced fiscal stimulus packages in order to cushion themselves against the devastating effects of the international financial crisis. The amount of fiscal stimulus packages that nations initiate determines whether or not they will effectively mitigate possible effects of the Global Financial Crisis. Stimulus package plays the following key roles; they effectively cushions against economic recession, enables the economy to grow in the short term and can be withdrawn as the national economy improves and enables the economic activity to return to pre-downturn state (Cottarelli, Gerson & Senhadji, 2014). Australia spent 2.6 percent of Global Domestic product (GDP) on stimulus packages between 2008 and 2010. Following the global recession, Australian government initiated actions aimed at tightening its credit markets. Among the significant actions initiated by the Australian government was the ban on short selling of shares (Gospel, Pendleton & Vitols, 2014). According to Gup (2010), the Reserve Bank of Australia (RBA) was forced to drop the standard interest rate by 1 % point (the biggest in seventeen years). Further, in 2008, the Australian government introduced various measures to enhance the financial system and the economy at large. Among the measures that were announced include raising the amount of security for bank deposits and guaranteeing all deposits, as well as offshore borrowings of the banks operating in Australia. Still in 2008, the Prime Minister, Kevin Rudd, announced a 10.4 billion Australian dollar economic security strategy in order to enhance Australian’s economic growth, and also support households (Gup, 2010). According to Gup (2010), most multinationals operating in Australia such as General Motors Acceptance Corporation (GMAC) and GE Finance were hardly hit by the global crisis. International organizations, including the GE Finance warned their customers that they were not offering funding arrangements, and demanded all loans to be paid back within 6 months. This warning left many Australian car dealers without funding arrangements (Gup, 2010). The government intervened and established the Special Purpose Vehicle (SPV) to support car dealers with funding following the departure by GMAC and GE Finance. In 2009, the IMF predicted that the Australian economy would feel the pinch of the financial crisis. The Australian government was under pressure to put in place measures that will keep the Australian economy afloat in the face of a receding global economy. With this regard, the prime minister announced a forty two billion USD nation building and jobs plan to support the Australian economy and jobs. The Reserve Bank of Australia, like many other central banks throughout the globe, reduced the interest rates following the uncertainty that gripped the global economy. The policy makers instruct the RBA to make sure that commercial banks throughout Australia do not impose high interest rates that may become difficult for borrowers to repay. Thus, the RBA can investigate the conduct of commercial banks suspected to be carrying out illegal activities that can destabilize the economy. Further, the RBA administers external reserves in order to ensure that the Australian dollar remains at the recommended levels. The GFC caused major currencies including the Australian dollar to depreciate rapidly (Goodhart, 2014). As the GFC deteriorated, the Australian dollar depreciated by more than thirty per cent. Australian banks operate in an oligopoly market. This is a type of market structure where there are few sellers selling products that are almost identical and cooperating in placing barriers to entry. Australia banking sector is dominated by four major banks, namely, Commonwealth Bank, Westpac ANZ and NAB (Henry, 2010). These banks have expanded collectively across a variety of loan and deposit products and operate in a manner that makes it difficult for other banks to expand in this market. The recent global financial crisis led to increased consolidation among Australian banks to hedge against the impact of such crises in the future. Conclusion The 2007/2008 global recession has remained a scare to many countries due to its destructive grip (Cetorelli & Goldberg, 2011). The global recession started in the US, before going global. Analysts argue that the 2007/2008 was worse than any since the Great Depression of 1930s. Policy makers, as well as citizens in most countries are still hit by the recent global recession. The Australian economy has played a major role of enhancing the living standards of the Australians. Recent studies indicate that the living standards of most Australians today are much better than they were a decade ago. Australia policy makers dealt with the problems presented by the GFC by introducing stimulus packages, and also encouraging consolidation among Australian banks to hedge against the impact of such crises in the future. The increased regulation by the RBA also played a critical role of providing solutions to the crisis. However, the recent GFC which took a toll on both developed and developing nations still poses a major threat to Australian households and firms. Analysts argue that, although Australia was successful in managing the GFC, most Australian youths are still unemployed. Most youths, especially school leavers and those who have no working experience continue to experience labour market disadvantage like their peers in the United Kingdom and Republic of Ireland. References Cetorelli, N., & Goldberg, L. S. (2011). Global banks and international shock transmission: Evidence from the crisis. IMF Economic Review, 59(1), 41-76. Cetorelli, N., & Goldberg, L. S. (2012). Liquidity management of US global banks: Internal capital markets in the great recession. Journal of International Economics, 88(2), 299-311. Cheng, G. (2007). 7 Winning Strategies For Trading Forex: Real and actionable techniques for profiting from the currency markets. Massachusetts: Harriman House Limited. Cottarelli, C., Gerson, P. & Senhadji, A. (2014). Post-crisis Fiscal Policy. Cambridge: MIT Press. Emerson, M et.al. (n.d). The Strategic Consequences of the Global Financial and Economic Crisis. Brussels: CEPS. Henry, K. 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From Asian to Global Financial Crisis: An Asian Regulator's View of Unfettered Finance in the 1990s and 2000s. Cambridge: Cambridge University Press. Read More