International Trade and Finance Law: Global Economic Crisis - Essay Example

? Global Economic Crisis Module Module Number: Academic Year: Seminar Essay Question: The global financial crisis (2007-2009) is an evidence of the weaknesses of the existing international and national regulatory frameworks aimed at preventing systemic risk and excessive risk-taking by financial institutions Student Number: Introduction The global economic meltdown of 2007–2009 is widely perceived by economists as most serious crisis in seven decades. Since the Great Depression of the 1930s that almost brought the global economy to its knees, the global economy has registered positive growth. The crisis made the likelihood of a total economic collapse look real for big financial institutions, prompting government bailouts of banks to control the slump in stock markets, which was already affecting all sectors of the economy. In a number of ways, the mortgage industry also suffered, culminating in evictions, cancellations of mortgage programs in the pipeline and led to prolonged joblessness. The meltdown contributed immensely towards the closure of important corporations, decreases in buying power, and massive business losses. The ensuing chaos led to a significant slump in economy leading to recession, with lasting ramifications still being felt in Europe as evident in Euro Debt crisis. This paper critically analyses whether or not weak regulations resulted in the crisis. Many factors have been linked to the financial crisis, with differing priorities being attributed to the possible causes. There is consensus, though, that the crisis was the consequence of excessive investment in too risky, intricate financial programs1. Conflicts of interest being kept secret, the ineptitude of credit regulators, and the inability of the market to control the stock market are also other contributing factors linked to the crisis. It is notable that the 1999 amendment of the Glass-Steagall Act by the US Congress, successfully removed the thin line which separated investment and depository financial institutions in the country. As a result, it can be argued that credit regulatory bodies and investors did not provide accurate valuation of the risks that mortgage-related pecuniary products could precipitate on the global economy. Equally, governments failed to modify their regulatory regimes to handle the current neo-modern financial economy. Studies on the origin of the meltdown have also been based on the impact of interest rate. Nonetheless, immediately after the crisis erupted, governments responded by enacting palliative pecuniary policies to control the ripple-effect on different economic sectors. These elaborate self-preservation measures such as the US Dodd-Frank regulatory reforms (2010) point to the laxity of laws as the main cause of the crisis. Poor regulations Out-dated regulatory mechanisms arguably left the financial sector to virtually regulate itself, despite the main aim of business organizations being making profit. It was difficult to verify the intentions of the many citizens who had applied for excess credit in an effort to build their families a decent home. This presumed innocence of the investors has turned the heat on bankers who approved the indiscriminate borrowings2. Banking industry has been an operating under strict laws for a very long time now; but over time and due to the growth of the global economy, the financial services industry may have been operating under lax regulatory regimes that could not handle rapid economic growth and globalization of the economy. This paper will prove that weak regulations and poor policy decisions played an important role in in events that led to the crisis. Institutional policies left oversight authorities with little to do in terms of making effective responses to crises of this magnitude. Regulations are said to have aggravated the negative impacts of the bubble in the value of homes. The laws and policy decisions that arguably contributed toward the crisis will also be considered. If not, new regulatory mechanisms intended to avert a perceived economic crisis of self-indulgence might be repeated in future, by establishing new existential problems that may hinder smooth operations within the banking sector3. Identifying the organizational regulations, rules and policy decisions that can be linked to the crisis reveals that the crisis was not caused by the banking sector or big mortgage companies alone, but also by poor policy decisions from political quarters with weaknesses tracing to the 1980s. The situation before the crisis The economic situation before the crisis was fairly pretty. For a number of reasons including a decline in the prices of industrial commodities due to the presence of competitive goods from emerging global economies like China, there was no clear pointer to the impending crisis. The situation, coupled with an altered pattern of measuring commodity prices, which was reformed from the earlier indicators based on indirect asset value, major world economies such as the US really forgot about an impending crisis4. Low interest rates served the role of motivation for more lending, most of which were riskier in the then economic regime. But the assumption that major Western economies had achieved consistent economic growth for more than five centuries added various stakeholders in the industry an impetus to go on the on borrowing spree. Governments equally established an inaccurate show of pride and financial security to potential investors. These developments conspired to mislead credit institutions to underrate the potential risks and set off a boom in asset value. Government regulations in the United States, for instance, triggered the slackening of rules on mortgage plans. Consistent crusades in the early 2000s, which were aimed at pressuring financial institutions to lower the thresholds for accessing credit, yielded appropriate outcomes, though in the short-run. At the same time, the Fannie Mae and Freddie Mac, out of political pressure agreed to purchase 44 per cent of the entire share of subprime securities, in a move that was construed to mean a tacit assurance to lenders to engage in more risky lending with the hope that they would extend an eventuality of long-term risks to the federal authorities to deal with5. In the United Kingdom, local planning laws and policies that were aimed at encouraging home ownership really contributed to the uncertainty in home value. Owing to the inelastic status of supply of homes, fluctuations in demand are generally reflected in the value, and this is what brought the unpredictability of the economic trends. The fluctuations in the value of homes arguably had a direct impact on the 2007-2009 global economic melt-down. Although, past governments have attempted to solve the problem through government-granted incentives envisaged in the Basel treaties, which tend to regulate lending from spiralling out of control, weaknesses still persist such international regulations. Nonetheless, the International Monetary Fund has indicated that attractive incentives have resulted in companies moving low-risk properties off the equilibrium sheet. In light of this, UK authorities have tested the effectiveness of the Basels by allowing substantial borrowings and sparing the balance sheet of the impact6. In 2008, with respect to the prospective public finance initiative funds, nuclear power generation closure, government pension plans and the money that Network Rail owed its suppliers, government liabilities amounted to 29% in excess of gross domestic product (GDP), even prior to the recent enactment of Basel III agreements. Despite the discrepancy, the government put on a brave face, insisting that it was not badly off the Sustainable Investment Rule7. As a result, the government decided to maintain the debt at well under 40% of GDP. Such bold faces even in the wake of massive risks had a role in the crisis. Failure of the regulators In the wake of the global crisis, it was evident that indistinct and restraining orders by European Union practically curtailed the ability of the Bank of England to initiate effective responses to the crunch. In particular, the duty upon the UK to implement the Takeover Code and the Market Abuses Directive basically tied the institution’s hand in initiating a disaster control mechanism within the banking sector, including covert moves that could have stemmed the situation from spiralling out of control8. The two regulations resulted in pedestrian support for the financial institution, with guarantee to protect customer deposits being the only tool left at the bank’s disposal to nurture confidence among the public9. In particular, the long duration it was taking the Financial Services Compensation Scheme (FSCS) to disburse funds and delayed public payments may have convinced depositors to believe that they would not be allowed to make any withdrawals for a long time in case of a crisis. The regulations translated into the Bank of England’s incapacity and lack of knowledge on how to effectively evaluate the situation and implement appropriate emergency lending options as a response to the crisis10. Despite the inability of supervisory bodies to act right and swiftly, the takeover of the supervisory role by the Financial Services Authority (FSA) soared compliance fees for financial institutions. Before the FSA assumed the new role, sufficient concerns had been raised over the incompetence of the organization in playing oversight roles at such a delicate time. Prominent voices condemned the organization’s incompetent staff and lack of insight into the general risks that would affect its work, but adequate reforms were ignored leading to the rise in operational costs upon banks. Impacts of weak regulations on the crunch The primary aim of enacting Basel I Capital Accord was to evaluate capital with respect to lending risks, or the likely risks that would result in a loss in the event that a party failed to fulfil their duties11. Basel I heralded significant research toward enhancing risk modelling; but its slacken rules, and narrow mandate eventually led to the creation of the Basel II Capital Accord to complement its impact. Regardless of the improvement, Basel I was the first inter-state regulatory mechanism, whose implementation brought sanity in the otherwise risky risk-capital equilibrium market. The financial regulation remains an important move towards ensuring control of lending by financial institutions12. Capital adequacy regulations incorporated in Basel II essentially control borrower default risk. The regulations envisage the likelihood that business organizations and mortgage firms will cave in under the weight of a crisis13. This implies that capital will grow as an economy slumps and vice versa. An analysis of the activities of the United States Federal Reserve System has however illustrated that for a decade now, the rules are indirectly proportional and may not be the best remedy for financial crises. Despite its mitigating intent in the wake of a crisis, Basel II has been attributed to the likelihood of aggravating a financial crunch. This is especially factual considering that common capital adequacy regulations trigger companies to own identical assets and implement similar responses to a crisis. Such a strategy ferments herd behaviour which is a recipe for chaos especially when a case of financial crisis demands different approaches to mitigate. Similarly, common inter-state rules imply that economic booms and declines will be expected to happen uniformly across the states, thus amplify the risk of credit cycles across the world14. Moreover, mark to market rules look up to a market to set an asset value and cannot operate when there is disconnect in the market’s operations as it happened at the beginning of the recent global economic meltdown. Notably, had the regulation been operational in the late 20th century more than 10% of America’s biggest financial institutions would have collapsed15. This is because regulations, especially those limiting short-selling have been attributed to the collapse of hedge funds in the United States in the past. The ensuing impact not only eliminated the credit services from the market, but made troubled financial institutions suffer more due to the closure of other avenues to funds such as convertible bonds. The Basel III is a worldwide regulatory system for the assessment of capital adequacy, stress level and market liquidity risk among willing countries in order to avert and or control economic crises. The Basel Committee on Banking Supervision has reached a consensus on the new regulations coming into effect from 2013 throughout 2018. Basel III was created as a response to the shortfalls of the financial regulation which arguably resulted in the recent global economic crunch. The main intention of Basel III is to support capital requirements by banks through an expansion of the level of liquidity of the financial institutions and limiting bank leverage16. It is notable that unlike the previous Basel agreements, mainly concerned with the control of the level of bank capital reserves that the institutions must hold for different categories of borrowings and other moneys and properties that are in their possession, Basel III is mainly seeking to mitigate the risks that might face banks by imposing a multi-layered approach to the control of different categories of reserves for different kinds of bank deposits and other lending practices. In light of these whole new approaches to managing future financial crises, Basel III regulations basically compliment Basel I and Basel II in establishing a tighter, more effective regulatory regime that guards against indiscriminate lending and borrowings that might result in a serious international economic crisis. Conclusion The recent global economic crisis was touched off by weak regulatory mechanisms, which could not control lending and borrowings. For business expediency, most bankers approved massive amounts of credits under a relaxed legal regime influenced by constant calls for free market under intra-sectoral regulations in the United States and the United Kingdom. The liberal market convinced the people to pursue their desire to improve their individual status by engaging in massive mortgage investments, which resulted in the crisis. Had the financial industry been properly regulated in response to the massive economic opportunities and challenges of the 21st century, the crisis would have been averted. Controls and reasonable incentives for bankers and individual investors could have kept cases of borrowings and risky lending manageable and averted or controlled the crisis. 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