Nature of the Current Global Financial Crisis - Essay Example

Running heading: Nature of the Current global financial crisis Nature of the Current global financial crisis Name 11th May, 2010 GFC is any alteration in the money markets and banking sectors of an economy that lead to a fall in value of prices of assets that financials institutions hold as collaterals, when major banking institutions failing and uncertainties being experienced in the global monetary exchange markets. The present day crisis is just a combination of situations and events in which some assets or financial institutions quickly lost a significant part of their value. In 2007, the United States’ banking system was confronted with liquidity crisis. This resulted in large financial institutions collapsing and worldwide downturns in stock markets. The housing market in many places suffered, leading to numerous evictions, prolonged vacancies and foreclosures (Correia & Flynn, 2007). Most financial analysts as well as scholars in economics have likened it to the economic depression witnessed in 1930 to 1940. It led to key businesses’ failure, decrease in consumer wealth, forcing many governments to make substantial financial commitments, and a significant slow down of economic activity. Many causes have been pointed out. One outstanding cause was when global housing bubble collapsed causing the actual amount estimated of collaterals used to secure mortgages to fall. This led to worldwide damage to the financial markets. Between 1997 and 2006, the prices of houses increased by 124%, resulting in some homeowners refinancing their homes at lower interest rates, or by taking out second mortgages secured by the price appreciation in order to finance consumer spending. Banks collected and used monies from those willing to invest to give financial support sub prime and other lending. This accelerated the growth of housing investments and banks made more money from the commissions charged for their services. But by September 2008, there was decline of over 20% in the average U.S. housing prices from their mid-2006 peak. As prices dipped, borrowers whose adjustable-rate mortgages were not able to refinance to escape the higher payments related with the increasing interest rates and consequently began to default. So the eventual destiny of the housing bubble was triggered by a dramatic rise in interest rates and falling house prices (Horne & Wachowicz, 2008). Lenders then began foreclosure proceedings. The incorrect pricing of risk, predatory lending, shadow banking system and the commodity bubble were the other notable causes. The crisis then rapidly evolved and led to a global economic shock, with a number of European bank failures experienced, reduction in many stock indexes, and market value of equities and commodities were greatly reduced. The final consequence of the GFC on the banks in the larger United States spreading to banks all over the world shows the strong interrelationship of the financial systems in the world (Brigham & Ehrhardt, 2008). To make sure that there is a steady supply of funds to banks to enable them to extend credit to those who needed to buy homes, the US government established and funded businesses like Freddie Mac and Fannie Mae and to acquire and reorder mortgages which are supported by collaterals. Such reordered packages contained pools of mortgage loans being bought from lenders then sold to investors in secondary markets. On the other hand many people were and are still concerned that those responsible for the financial crisis are the ones being bailed out, while on the other hand, a global financial crisis has affected the livelihoods of almost everyone in an increasingly inter-connected world. It appears that the dilemma was easy to avoid, if ideas subscribing to current economics models were that overbearing, infectious and disregardful of the issues raised by others (Krugman &Wells, 2009). Whereas the enormity of the problems has been so severe, some of the world’s largest financial institutions have collapsed. Some were swallowed by their competitors at prices below their market value. Some financial firms were bailed out and rescued by the governments of the well off countries. MNEs are a shortened form for Multinational Enterprises which basically refers to businesses whose core activities include adding value to products and services in more than one country. John Dunning has been the most important intellectual force in international business research during the past half century. His eclectic paradigm is good example of the core international business modern theory and gives the intellectual launching pad for much of this research (Brigham & Daves, 2010). This paradigm stems from three compounded components: Ownership (or firm-specific) advantages, strategically positioned sites which borrow from major parameters in global economics, international politics and contemporary theory on institutions and finally internalization benefits to explore existence together with governance of MNEs. It focuses on firm-level resources, location characteristics (including macro-level institutions) and internalization or de-internalization challenges that provide the scholarly basis for contemporary introspection to international business (Lasher, 2007). From early 2008GFC has since affected the international economic systems and made urgent attention to the thoughts on economics and the productiveness of small and large capitalist businesses at the middle of this financial mishap. It is approximated that there are 65,000 multinational enterprises (MNEs), which have 850,000 subsidiaries globally make up 65 to 70 per cent of international business and world trade. Most of the largest multinationals, by revenue criteria, are American or Japanese. In 1996, 162 out of 500 largest companies in the world were from the United States and 126 from Japan. A few of the largest companies are from the developing countries. In terms internationally located assets the distribution of multinationals is similar: Many top 100 multinationals owning the biggest offshore assets are located in the US, the UK, Germany, France and Japan. Apart from business, mergers and acquisitions, joint ventures and strategic alliances between the multinationals may be termed the global factory. The core function of a multinational performance involves managing the dynamic resource relationships and very complex subsidiary assets, in order to achieve the set goals. Multinationals require effective controls to integrate albeit efficiently the diverse actions of components into a coherent behavior. They use protocols and data management systems, information acquisition, and co-ordination of managerial processes. The importance of communication, command and co-ordination as the integrating tools lies in these controls, significantly reducing uncertainty and making sure that organizational behaviors are in sync with and support the strategy Krugman, P. (2009). Majority of economic players involved in transnational commerce are faced with a wide range of problems associated with capitalist economic systems with most of them having independent guidelines for them. Every global economic crisis ignites a societal debate on the effectiveness, efficiency and distributive equity effects of these macro-level institutions. In fact it may trigger wide governance rethinking and a fresh shield for small international business transactions (Mankiw, 2008). Of our particular interest is how the GFC affects transnational business via its effects on multinational enterprises which covers the whole range of globally operating firms and beginning with humble entrepreneurial ventures to the largest multinational businesses. Also of interest are the new types of business-government involvement in the view of international policy coordination as well as the fresh protectionism. Furthermore we will analyze the new developments in large capitalist institutions that touch on multinational enterprises. It started in the US and it has created a ripple effect culminating in a devastating effect on other economies. It began with the bursting of the housing bubble in the US due to a lax in regulation, deregulation of government policies and the incremental involvement in high-risk lending in the Wall Street. GFC has greatly contributed to economic recession felt by many countries worldwide. Multinational Enterprises have been forced by circumstances to look for avenues to cut spending including laying off workers, selling their assets, closing down on some of the operations, borrowing loans from the government(s) merging as well as negating on their corporate social responsibilities. Downsizing attributed to the crisis. Downsizing has been accepted by many multinational enterprises as a corporate strategy of remaining in business in these hard times (Moyer & McGuigan, 2009). Under this climate there is a reluctance of many multinational enterprises in pursuing their corporate social responsibilities. For example many multinational companies in Kenya have social projects that are designed to benefit the community. Multinational Enterprises have initiated, funded and implemented significant community development projects. It is by these projects that multinational enterprises shun the self interests and profit seeking goals to give back to the community. They always tend to invest in human resource and by enabling their immediate community with the know how to realize their own financial freedom. Therefore GFC has slowed down the key aspect of multinationals giving back to the community. The results are categorized into two parts as optimistic information and pessimistic information. The figure below depicts a study into information provided by employees of several multinational enterprises. It was categorized according to two: pessimistic and optimistic. The figure shows that Coca Cola Company ranks first with optimistic information provided. Other enterprises like Barclays, Unilever, Pfizer and GlaxoSmithKline provided optimistic information. On the contrary enterprises like Samsung Electronics, Sears, Nike, Norvatis, and Mitsubishi Corporation gave pessimistic information (Tracy & John, 2007). Global Financial Crisis has also affected the labor standards. Most multinational enterprises seek less costly labor, raw materials and cheap energy from third world and developing nations in order to make use of economies of scale in these parts of the world. The laws governing labor in such countries are not strict, the major reason why multinational enterprises usually take full advantage. More critically, the current global economic crisis and in order to gain or maintain an economic advantage some multinational companies will exploit these loopholes in the labor policies of the host country. Many misdeeds that have been reported in Kenya include but not limited to unfair employment recruitment, bad workplace environment and absence of compensation to injured employees and mistreatment of those who raise these concerns. Such malpractices occur due to slow legislative process and corruption by the authorities (Mackenzie, 2005). A number of financial governance and economic regulations, including the US capital market, often described as best practice, established location advantages, to be used by other countries. Here, aspects like the strict disclosure rules, complex financial accounting controls, comparable lack of excessive government regulation which impedes innovation and on a general level the resilience and adaptability of the governance regulations in place, have been seen to aid a macro-level platform for firm-level success. It is evident that the major advantages realized by these enterprises as a result of strategic position in various locations are not understood and that the players got the wrong message during the assessment of the advantages and disadvantages of taking their businesses to these good locations (O'Sullivan & Sheffrin, 2005). In a study into some multinationals in Kenya it was observed that many enterprises whose staff took part in the interview showed that trimming the workforce will be the most felt aspect of the GFC. Many people are loosing their jobs because of GFC. Secondly, social projects undertaken by the enterprises would be drastically disturbed or even reduced. Various companies have to participate on the community developments programs as a way of showing concern of the demands of the society. This is a corporate responsibility. It is observed that funds allocated to social projects would be decreased or cut off altogether (Baumol & Blinder, 2008). Thirdly, an overall decrease in the work output which normally comes with cut in costs associated with labor supply. This is because the multinationals seek to reduce the costs that it incurs in its business. One of the costs is associated to labor, the organization is re-structured to fit a well calculated size. This means that the unwanted employees will be laid off and for those retained their job description would bulge. This might lead to job dissatisfaction and change-of-work related stress hence affecting the overall productivity of the enterprise. Fourthly loss of jobs in this period leads an escalation in poverty levels, HIV/AIDS prevalence and of most importance to multinational is security to both businesses and staff. In conclusion, the purpose of this study was to examine how the global financial crisis is affecting the functions and to a significant extent the effectiveness of multinational enterprises in Kenya. It was clear that the Global Financial Crisis contributed to downsizing by multinational companies in Kenya, the commitment of multinational companies to social projects in Kenya declined and the adherence of multinational companies to labor standards in Kenya was adversely affected. During the GFC, the distributions of financial support multinational enterprises cannot extend any kind of remedy to its offshore branches thus validating their operations that will reduce the operating expenses (Blanchard, 2008). The innovations within the firms and between the firms together with knowledge flows have been negatively affected because of uncertainties currently being experienced and expected. Global financial crisis encourage mergers, acquisitions and international strategic alliances to enable the firms to survive. This has an effect on the structure and the management of the firms affected. The global supply chains, as a result are being redesigned as a result of these crisis. The global financial crisis has also affected MNEs decisions such as the combination of R&D and innovation (for a single or multiple locations), human resources management (like revisiting the use of expatriates, trade-offs on global retrenchment decisions) and international marketing (for instance reviewing standards or customizing and reducing or changing the long-term efforts in brand management decisions. It has also encouraged tentative, quick shifting or immediate exiting (Tsikata & Moreira, 2009). References Atrill, P. (2008). Financial Management for Decision Makers. New Jersey: Financial Times/Prentice Hall Baumol, W. & Blinder, A. (2008). Macroeconomics: Principles and Policy. New York: Cengage Learning Blanchard, O. (2008). Macroeconomics. 5th ed. London: Pearson Prentice Hall Brigham, E. & Ehrhardt, M. (2008). Financial management: theory and practice. New York: Cengage Learning Brigham, E. & Daves, P. (2010). Intermediate Financial Management. New York: Cengage Learning Correia, C. & Flynn, D. (2007). Financial Management. Pretoria: Juta and Company Ltd. Horne, J. & Wachowicz, J. (2008). Fundamentals of Financial Management. New Jersey: Prentice Hall Krugman, P. &Wells, R. (2009). Macroeconomics. New York: Worth Publishers Krugman, P. (2009). The Great Depression Economics and the Crisis of 1930. New York: W. W. Norton & Company Lasher, W. (2007). Practical Financial Management. New York: Cengage Learning Mankiw, G. (2008). Principles of Macroeconomics. New York: Cengage Learning Mackenzie, M. (2005). State policies to enhance the new economy: a comparative analysis. Ottawa: Centre Policy Alternatives Moyer, C. & McGuigan, J. (2009). Contemporary Financial Management. New York: Cengage Learning O'Sullivan, A. & Sheffrin, S. (2005). Macroeconomics: principles and tools. 4th ed. London: Pearson Prentice Hall Tracy, T. & John, A. (2007). Small Business Financial Management Kit for Dummies. New Jersey: For Dummies Tsikata, Y. & Moreira, P. (2009). Accelerating trade and integration in the Caribbean: policy options for sustained growth, job creation, and poverty reduction. Washington, DC: World Bank Publications Read More