The Global Financial Crisis of 2007-2009 - Essay Example

The global financial crisis (2007-2009) Introduction The financial crisis of 2007-2009 is one of the worst financialcrises since the great depression. The economic crisis resulted in the decline of economic activities with such industries as the housing sector suffering great consequences such as foreclosures and forced evictions resulting from prolonged unemployment. The essay below therefore investigates the courses of the crises and the factors that sustained the escalation of its effect throughout the world. in doing so, the research analyzes the banking policies inkling the Basel 2 and Base 3 all of which sought to cushion the world economies from such crises. An economy is a self-sustaining cycle with the financial activities in one sector rapidly spiraling its effects on many other industries thus crippling the economy1. The same was the scenario with the causes and rapid spread of the consequences of bad financial activities in some of the greatest economies such as the United States and the United Kingdom among others across Europe. Such ripple effects as increased unemployment and reduced government spending affects the purchasing power of the population thus resulting in the rapid collapse of economies as was the case during the financial crises. Major companies reduced their financial activities owing to the increasing cost of doing business. Most companies closed down while others reduced their sizes. Both the actions resulted in increased and prolonged joblessness that accounted for the breadth and depth of the crises both in the developed and developing economies. The Basel 2 accord provided for specific operational features of both investment and commercial banks. These included the amount of money that the banks ought to set aside for emergencies to cushion the economy from such shocks. Additionally, the regulations define the roles of both commercial and investment banks. Disregarding the laws including the repeal of the Glass-Steagall act in 1999 instituted by the Clinton administration was among the key causes of the crisis. The act sought to cushion from financial crises following the lessons learnt from the great depression. According to the provisions of the act, the government clearly distinguished commercial banks from investment banks. An effective regulation of the banking industry cushioned the economy from financial crises since banks could maintain appropriate financial activities2. By repealing the act, the government permitted commercial banks to take part in risky investments with the view of increasing their profitability. The repeal of the acct was an embodiment of the weaknesses of the regulation of the economy thus validating the escalation of the crises3. The liberation of the act, commercial banks began investing their money in the economy. Such big commercial banks as the Wells Fargo and the American Bank became active investors in the economy. Among the industries that appeared lucrative included the housing industry as the commercial banks increased their investments in the sector4. The American government for example, provided the citizens with incentives thus encouraging the citizens to acquire mortgagees and purchase homes. The banks saw that as an opportunity to invest in the industry and benefit from the increased financial activity in the market. Without any clear regulation, the government watched as commercial banks competed with the investment banks for the few investment opportunities. Before long, the economy began experienced declining liquidity as both investment and commercial banks both began lacking adequate money to stay operational. The debt levels thus increased as most of the people who had acquired mortgages lost their jobs owing to the worsening economy and the increase in layoffs5. Commercial banks just as their names suggest make their profits from the financial transactions undertaken by their customers. They sustain the liquidity of the economy by availing the money whenever the customers want. This way, they keep the money in the economy flowing. The unpredictability of the financial activities of their customers prevents such financial institutions from investing their money in order to avail it to their customers. This thus explains the extent of the repeal of the act that sought to prevent commercial banks from taking part in long term and risky investments. The real estates’ industry appeared lucrative at the time as the government encouraged employers and financial institutions to avail loans to the populace in order to improve the living standards of the people6. However, the industry is both risky and requires long-term investment a feature that the commercial banks could not sustain. The action to repeal the act did not only exhibit the weakness in the existing international and national regulations but an abject lack of such. Apparently, the American economist did not consider the ramifications of reverting the act. They therefore thought that such an action would improve the pace of economic growth by increasing activities in the economy. The perpetrators of the repeal of the act must not have learned from the great depression of the 1914 as the Clinton administration had. This implies that the economists who influenced the repeal did not carry out extensive market researches before advising the government to formulate financial policies. The effects of the repeal spread fast as the banks competed for the market that appeared lucrative and large enough to sustain the competition. The repeal resulted in a spontaneous influx of currency in the economy as the government thought that the repeal had resulted in increased financial activities. However, the increased investment in such industries as the real estates resulted in the decline of property value before the economy ground to a halt with companies registering loses that would later reverberate in other sectors of the economy7. The speculation of the size and potential of the real estates industry heightened the effects of financial crisis. This portrays lack of effective regulation of the financial market. In a bid to achieve the political promise of improving the living condition of people in the country, the government encouraged financial institutions to provide mortgages to the population. This resulted in heightened speculation in the industry thus portraying the industry as lucrative thus presented perceived adequate potential to sustain economic growth. However, such speculation resulted in an unregulated influx of investors including commercial banks as discussed above. Provision of mortgages requires appropriate scrutiny of the applicants. However, the financial institutions did not employ appropriate scrutiny of their applicants owing to the incentives promised by the government to such financial institutions8. The banks and financial institutions thus provided mortgages to risky and undeserving customers. The trend heightened the risk to most commercial banks thus instigating a crisis that later became the largest global financial crisis. The provisions of the Depository Institutions Deregulation and Monetary Control Act of 1980 escalated the effects of the crisis. In fact, the act played a role in instigating the crisis. According to the act, investment banks would develop various financial instruments in order to gain control of the financial markets9. The government at the time felt that it was prudent for banks to enjoy larger controls of the financial market since most of them unlike private investors enjoyed a larger capital base. This had paid off, as the economy remained stable with the financial market registering increased financial activities. However, by 2006, the economy began exhibit undesirable features owing to the expansion of the real estate’s market. On the contrary, the investment banks diversified their operations often developing new and more precarious financial instruments10. Among the instruments created by the financial institutions included adjustable-rate mortgages and securitization among many others. Additionally, the securitizers paid the rating agencies to influence their ratings of the new securities in order to portray the market as both lucrative and exhibiting adequate potential. Such actions by players in the financial industry portray a weakness in the financial laws, as the government could not consider the possible effects of such legislations despite the evident risks the financial institutions exhibited. This way, the act played an integral role in the instigation and spread the effects of the financial crisis. The act presented the potential of instigating a global financial crisis as became evident in 2007. After the creation of such regulations, the government does not follow up the implementation of the regulations in order to ensure that the financial institutions maintain fidelity in their operations. After creating numerous financial instruments as provided by the act, the financial institutions influenced their ratings since they paid the rating agencies. The laxity by the regulating authorities thus permitted the instigation of the crisis. Their inability to monitor the enactment of the act by the financial institutions laid favorable infrastructure for the spread of the crisis11. Competition is healthy for the development of an economy; however, in such a case the government must develop appropriate regulatory measures to ensure that the competition rates remain realistic. In this case, the government watched as the financial institutions lowered their interests while giving out loans to more applicants. The trend would eventually boomerang on the economy. To address the issues of crises, world economies developed new financial regulation in the Basel 3 accord. The new regulations provided bans with basic capital requirements12. Banks would henceforth hold 4.5% of the equity of the risk weighted assets. This way, banks would monitor the financial activities in the market thus instituting appropriate financial activities in a market. The percentage is an increase from the previous 2.4% set by the Basel 2 conference. The new regulations included an appropriate liquidity requirements and leverage among other financial policies that sought to stabilize global economies. Conclusion In retrospect, the financial crisis in 2007 to 2009 portrayed the extent of the weakness in the legislations governing operations in the financial markets. Operations in the international financial markets rely on the effectiveness of the national regulations. The fact that the United States and Europe dominate the financial market thus sustained the spread of the financial crisis since the lapses in the respective countries influenced their dominance of the international markets. The negative economic turn out in the greatest economy in the world quickly affected other economies owing to the nature of the market13. The globalization of the financial market and the spread of international marketing had influenced different companies to seek market in different parts of the world. Loses in one country would therefore influence the profits and operations of the companies in other parts of the world14. Works cited Alexander, Barry. International Financial Reporting and Analysis (5th edition). Oxford: Oxford university press, 2010. Print. Bernays, Edward L. Public Relations. Norman: University of Oklahoma Press, 2009. Print. Blackshaw, Pete. 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