The Impact of the Financial Crisis - Essay Example

The period between 1994 and 2006 was characterised by development in the banking sector. The important industry was in a stiff competition. Banks, in the United Stated and the United Kingdom, were in the surge of seeking control over the growing economy. At the end of it all, the ability of a bank to perform was solely placed in the responsibility of the CEOs. To encourage the financial performance of banks, CEOs were provided with remuneration incentives. Many studies stage claim that such form of compensation in the banking system led to the financial crisis. On the other hand, there are scholars who argue that pay incentive for bank CEO was overshadowed by the forms of mismanagement and poor policing exhibited in housing, and financial innovation (Robert 2010, Pg. 15). These claims bring out a new dimension that focuses on the two forms that CEOs incentives took and how each of the two forms might have contributed to the crisis. The first way that CEO that incentives made was monetary compensation. Financial incentives are characterised as short-term and so are the benefits that arise from using them. Most important feature for the short term financial incentives is that they led to more risky ventures. Bank CEO had to engage their workforce in activities that would reflect performance as fast as possible. Adverse effects of such engagements would be felt later when some of the remunerated and compensated CEOs no longer held positions in the banks.

The other form of remuneration includes was the use of equity incentives like 30% shareholdings within the institutions and other investments. Many researchers and investigators strongly feel that this type of incentives led to performance due to leverage. The management team was compelled to partake in activities that benefited their institutions at the long-term. That cannot be ruled out, though. Some CEOs employed crafty methods that bailed them out earlier before the real problems surfaced. One of the exit plans is the transfer of equity while they were still admirable and profitable to potential customers.

Moral hazard in both banking and housing institutions contributed to the creation of the crisis. On one hand, housing agency acted out of greed and to some level due to government policing. To be successful in their endeavours, housing institution had to compel participation of the banks, especially with providing loans. In returns, housing institutions provided backing for the loans issued as illustrated from the discussion above. On the other side of the banks, CEOs worked hard for their incentives. Banks and mortgage brokerage firms strained their portfolios with the release of troubled loans. As the volume of loans is increasing, the default for the sub-primed loans also increased. It is at this point that the nightmare of the financial crisis came to reality. Despite the mitigation plans in place to control the bubble, governments and the responsible financial institutions could not help.

Government Contribution.

The blame game on who initiated and perpetuated the financial crisis could not get any interesting without the mention of the contribution of government. There are several reasons to blame the government, in any case, there is always a good cause to do so. As it is the role of government to oversee economic activities in the country, the government must have terribly failed in that responsibility. The question is what the government was doing instead. Some may not view the following discussion as government incentives. Then it is hard to describe some of these government actions that directly contributed to the financial crisis.

Fannie Mae and Friend Mac, through their mortgage enterprise, are always pinpointed with the destruction of the housing sector, consequently leading to the financial crisis. Taylor (2007), strongly argues that the government-supported Fannie and Mac. To some level, it can be argued out that government had the interest of the citizens, at the expense of the economy. From one government to another, deregulation on mortgage worsened, allowing Fannie and Mac to expand a potential risk tremendously, created decades earlier. Through the Housing Urban Department, the government responded to the needs of Americans. Studies that carried out within that period, before the financial crisis indicated that Americans valued owning a home more than other things, even marriage. To what came to be known as the National Homeownership Strategy, surveys reported that homeownership would positively lead to civic responsibility, wealth and peaceful neighbourhoods as illustrated by Kaufman, (2013, Pg. 7). To fulfil such findings, the government had to make it easy for individuals to obtain loans. Freddie and Mac had to invent some creative lending practices that led to the situations discussed above.

Several arguments have been stages that challenge the transparency of such financial coalitions between government and the private sector. There lies a possibility that Mac and Fannie companies financially exploited the special relationship with government. Before the dawn of the financial crisis, the housing management programme had already aided individuals that were legible for the loans. House ownership rate had grown from 64% to 70% rate. It is questionable why the government failed to pre-identify the risk associated with sub primed loans. Norbert (2015) concludes that government created and worsened the financial crisis through perverse policing.

Existing reforms to mitigate perverse financial incentives.

The compensation packages that led to the financial crisis did not take into account the risk attached. After the financial crisis, there was the need to establish sound compensation methods to avoid overlooking possible risks that would arise. Banks have adopted the practice that encounters procyclicality of financial markets (Ruthoff 2010, Pg. 13). One of the practices is to ensure that compensation is calculated from risk-adjusted profit. Its profit determined after removal of all forms of risk ascertained using risk model. Risk models may not be accurate, but to a large degree, they aid to lower effects of actualized risks. Another practice that is used to kerb additional compensation is by the retained payments. Delayed payments are meant to ensure that if risks arise, payment is lowered. Additionally, several accounting practices have been adopted to ensure provision for future loans.

Kerbing shadow banking is one of the primary focus on how to reduce the risk of financial crisis. Regulatory bodies have established rules and regulations that do not acknowledge shadow banking. If the banks are to adopt the best practice, they should act independently from non-banking institutions. Shadow banking to a given point encourages the use of economic growth. For that matter, indirect methods are employed carefully to monitor the kind of relationship in shadow banking

As a policy in the banking system, every bank is required to maintain a given amount of deposits that will help solve problems of insolvency if they arise. This system has been existing for a long time, even before the financial crisis. After the financial crisis, higher liquidity buffers and capital requirements have been set to rule out weak points in the banking sector (World Bank 2013, Pg. 4). To strengthen the banking sector especially with multinational banks, incentives such as teamwork and bail out are provided in case the situation gets out of hand. However, there is more to be done to avoid political interference of different regions as it is observed with 2007/8 financial crisis.

Events that led to the financial crisis serve as a lesson to authorities Coalitions between regulators and perpetrators fuelled the occurrence of the several events that summed up to a financial crisis. There is minimal overlook on the delivery of the regulators in the finance market. Government and public regulation are a dire need, as a step towards minimising the likelihood of perverse practices in substantial financial sectors Good international coordination through joint funding and regulation will aid in preventing potential risks.

The financial crisis of 2007/8 revealed many issues. The role of government and institutions in the economic regimes is yet to be fulfilled. One thing for sure is that financial problems require the international contribution to ensure double regulations measures. Through proper policing and use of economic tools potential financial risks can be predicted and mitigated.

In depth, the paper analyses the cause of financial crisis, and the extent to which house financing and the financing sector contributed to the financial crisis. From the essay and other available literature, the economic problem is a result of poor policing both in the private and the public sectors. Possible coalition between the two escalated the situation