Market Reaction to the Crisis - Coursework Example

Running Head: THE FINANCIAL CRISIS OF 2008, RECTIFYING MARKET SHORTCOMINGS Name Course Tutor Date Introduction In 2008, the world experienced one of the worst financial and economic crises since the occurrence of great depression in the 1930s. The crunch had many negative economic and financial impacts on almost all sectors of the world economy. Institutions that had been in existence for long periods of time came crumbling down in a matter of months. The situation was so dire that even banks which usually gave financial assistance in such cases were severely affected. Some governments tried implementing stimulus programs to save their institutions but this was barely enough. A closer scrutiny at the crisis, economist and financial experts gave some reasons that could have led to the crisis. Developed and emerging markets were worst hit by the crisis. Many people were rendered jobless as employers sought to survive with leaner budgets and growing demand (Nanto, 2009, p. 4). As a result, those who had taken mortgages and loans had no choice but to foreclose on their property. The situation affected the stock market and trading of important assets. Major share prices went down and essential commodities become more expensive. The crisis was an accumulation of factors over previous years that climaxed finally in 2008 (Coulibaly, Sapriza, & Zlate, 2013, p. 27). Normally, economies experience cycles of booms and slumps within given periods of time. During periods of boom, they are expected to gather enough resources in terms of wealth, information, and expertise that would help them survive crunches. In 2008, not all organisation and companies went under. Some organisations were able to withstand the shock without any external assistance. Though profitability fell to certain percentages, they were able to meet their costs and survive the volatile markets. Some organisations made even losses but they were still able to survive the crunch. Economists and financial analysts came up with some explanations as to why the crisis in 2008 was o severe compared to others in recent history. There were small underlying factors that persisted and finally exploded in 2007-2008. One of the major reasons for the crisis was corporate governance where corporations engaged in ambitious expansion plans at the expense of shareholders welfare. They were forced to pay debtors using shareholders’’ money. The housing sector in the previous years had been experiencing a boom like never before. This was a result of a developing middle class which was more independent and self sustaining. Many resources were transferred to this market in terms of loans and mortgages. Low interest rates facilitated increased borrowing which would later compromise financial institutions. This came to be known as the bubble burst situation (Savona, Kirton, & Oldani, 2011, p. 48). Despite the effects of the crisis, markets recovered and growth as experienced again. Experts view that the crisis was not evidence of market failure but the ability of markets to react to shocks and rectify the shortcomings that lead to crisis. The fact that a majority of the institutions survived the crises shows that markets have the ability to withstand turbulent times and come up with mechanism tat will ultimately solve the underlying problems. The 2008 crunch was a learning process for many organisations. Many of them had not experienced such challenges in their lifetime of operations. Organisations were left wiser in terms of strategies and financial competences. The lessons leant from the crisis have helped organisations to regroup and become more stabilised. In this research paper, the response to the crisis will be evaluated and how markets were able to deal with their shortcomings to rectify the effects of the crash. Market reaction to the crisis The crisis started in the United States from the housing industries fuelled by mortgages and bank loans. Coupled with other causes, the effects spread throughout the world at an alarmingly fast rate. The immediate consequences were reduced liquidity, falling prices of stocks and assets, increasing costs of doing business and outstanding debts. The situation affected in the most solid financial institutions as confidence in the markets fell drastically. Governments being key players in economic stability and prosperity had to step in to save the situation in most counties. This was facilitated through central banks and partnerships with private investors to rescue the most affected sectors in economies. However, there is always a risk in government involvement in free markets in the long run period. In normal market operations, banks usually lend money to each other upon agreeable terms and conditions. The situation in 2008 was different as even banks became sceptical and reluctant to lend money to each other. This is where governments all over the world stepped in the form of central banks. Central banks engaged in ambitious plans to revive commercial financial institutions through improving their dwindling liquidity portfolios. The strategies applied included short term loans with eased collateral requirements and introduction of liquidity facilities that did not exist before. Long term financial solutions were also offered to financial institutions where loans allotted to them had longer payment periods with friendlier terms than the market was offering. The effect of this strategy was eased financial support from all other lending institutions. It created a form of competition between central banks and other financial institutions. At the same time, the risk involved in lending at the time also came down. The aim of this strategy was to increase revolving currencies in the form of enhanced liquidity. Consequently, other lending institutions eased their lending requirements due to the government intervention and stimulus programs. Another way that the market regulated itself through government intervention, was buying of securities in debt to help individuals and small business access loans and financial support from banks like before. The liquidity problem was further accelerated by panic withdraws by bank account holders. This was driven by the fear of losing savings. To respond to this crisis, central banks increased the insurance periods and guaranteed deposits. Through this strategy, banks were able to have enough operating liquidity to see them through daily activities. Some governments provided a blanket system where all deposits were guaranteed. Due to the crisis, the balance between assets and liabilities in the balance sheets of many banks were heavily compromised. As a result, the intervention was establishments of schemes that guaranteed the loans that banks had. This enabled them to once again extend short term financial solutions. Governments played a huge and crucial role in cushioning financial institutions against eminent collapse. Being a key player in determining the status of economies, their role was fundamental. Central banks all over the word showed that markets could be restored with proper strategising and implementation of quick and working policies. Apart from governments and central banks, international financial institutions lie IMF and the World Bank also played crucial roles in reviving economies from the crisis (Dominguez & Hashimoto, 2012, p. 393). The situation in the world economy facilitated the IMF to ease its lending framework to governments. Through these funds, governments were able to restore financial sanity in their respective countries. In the past, these institutions looked at the performance of previous loans and for what purpose they had been used. Such criteria were abandoned for the sake of the crisis. Governments were also allowed to access higher loan limits than they could in the past. Additionally, international lending institutions also included flexible conditions in their lending strategies. The international institutions ether carried these strategies on their own or jointly with governments or the financial institutions themselves. The external intervention of markets had its potential for destabilising markets even further. First, it offered an uneven playing ground for institutions within the sane industry. This was especially the case between local and foreign markets. Foreign organisations that were still in operation had a hard time coping with competition from institutions that were receiving aid from governments. However, there were policy measures put in place to prevent the crisis from worsening, due to the distortions of intervention measures. Though there were uneven playing fields, the market responded through adequate support systems and price support mechanisms which reduced the advantage of aided institutions. The flow of resources both internally and externally from countries also risked being potentially distorted. This called for harmonised programmes that were meant to control the cash flow trends between trading nations and international financial institutions. Policy measures to cope with these included non discriminatory approaches to both local and international organisations (Savona, Kirton, & Oldani, 2011, p. 48). Both local and international subsidiaries and franchises were given equal opportunities and were treated equally. For markets that were not supported, there was the potential of crowding out. To prevent this, these markets rectified the situation by facilitating the purchase of debts and securities at the specified market prices. The result of extending support to struggling institutions was also uncertain to ensure that investors did not stay away from such markets. Policy makers ensured clarity on support stems and policies. Clarity was also essential in curbing distortions of market access to new entrants and institutional access. Support also elicited concerns from the independence of central banks and their roles in economies. This however was restricted to recovery measures which ensured that institutions could get back on their feet and compete with other players independently (Wu & Ma, 2013, p. 378). The measures taken were temporary boost to the institutions to prevent eminent collapse. The policy measures were associated with appropriate exit strategies that would see support systems withdrawn, once institutions could actively compete again, both locally and internationally. Further corrective measures Governments all over the world came up with corrective measures to rescue the situation caused by the global crisis. Many governments set aside huge amounts of money to return their markets to profitability and growth. The reason why governments were so concerned with the well being of the institutions in their countries because without them many aspects would go wrong. First, many people were already losing their jobs as unemployment levels soared. Further, pressures were increasing on governments to spend on social matters hat were not economically productive. As a result, governments were spending huge amounts with reduced revenue collections. The intervention was long term solution to these problems. The only ways that markets could maintain sustainability is through consistent consumer spending. If consumer spending abilities are diminished, then recession and inflationary pressures strikes. This is why markets have to provide consumers with adequate spending capabilities through provision of jobs and affordable products. The market should also facilitate affordable loans to the public. The crisis of 2008 interfered with this system. Governments introduce stimulus programs and which were i8ntended to facilitate infrastructural developments that would balance the spending patterns. The application of monetary and fiscal policies also aided the situation in 2008.monetary and fiscal policies were meant to place regulatory, preventive and protection measures to cushion struggling institutions. The market necessitated this for maintained growth and survival (Creighton, A, 2013, p.25) Conclusion The financial crunch of 2007-2008 was one of the worst in modern history. Its effects were so severe that the global economy has not yet fully recovered from the shocks. The markets responded to stimulus and support programs that were implemented from different avenues. The sudden effects of the crunch got many institutions unaware. To a large extent, the effects of the crisis have shown the ability of markets to respond to crises and rectifying the underlying circumstances that cause such challenges. One factor that emerged in the global crisis is the role that governments play in the world economy. Governments are not just regulatory bodies but are also part of the business environments. Were it not for government assisted from the enormous resources they have, that global economy would have fallen into further shambles as the crisis worsened. The abilities of governments lay in the institutions and organisations that a country has. Luckily, such support institutions are not in to make profits. Some experts see the rescue programs as appreciation from the years of sustained revenues that governments earned. Furthermore, it was a way of markets to rectify its shortcomings and inadequacies caused by the global crisis References Berkmen, P, Gelos, G., Rennhack, R, & Walsh, J, 2009, 'The Global Financial Crisis: Explaining Cross-Country Differences in the OutputImpact', International Monetary Fund , pp 3-10. Coulibaly, B, Sapriza, H, & Zlate, A ,2013, 'Financial frictions, trade credit, and the 2008–09 global financial crisis', International Review of Economics & Finance ,vol 26, pp. 25-38. Creighton, A, 2013, "The problem with banking on the future", Charter, vol. 84, no. 7, pp. 24-25. Dominguez, K,& Hashimoto, Y,2012, 'International reserves and the global financial crisis', Journal of International Economics , vol 88,no 2, pp.388-406. Erkens, D. H., Hung, M., & Matos, P. 2012Corporate governance in the 2007–2008 financial crisis:Evidence from financial institutions worldwide. Journal of Corporate Finance 18 , vol 18, pp.389–411. Freedman, C., Kumhof, M., Laxton, D., Muir, D., & Mursula, S., 'Global effects of fiscal stimulus during the crisis', Journal of Monetary Economics , vol 57 no.5, pp. 506-526. Freedman, C., Kumhof, M., Laxton, D., Muir, D., & Mursula, S,2010, Global effects of fiscal stimulus during the crisis. Journal of Monetary Economics , vol 57 no 5, pp. 506-526. Nanto, D. K, 2009, 'The Global Financial Crisis: Analysis and Policy Implications', DIANE Publishing,Collingdale. Savona, P., Kirton, J. J., & Oldani, C,2011, 'Global Financial Crisis: Global Impact and Solutions, Ashgate Publishing, London Wu, B. U., & Ma, S,2013. Recovering From the Global Crisis: A Panel Study. Gastroenterology vol. 144, no.5,pp. 378-379 Read More