Financial Crisis Assignment - Case Study Example

Its effects were far reached and almost everyone on the globe was impacted by it on some level. Those who were closer to financial markets and deeply involved in the investment business faced greater impacts and are still incurring huge losses. This crisis raised questions that pointed fingers on the functioning of the global financial markets. The liquidity crisis was triggered by a bunch of policies that were implemented by the United States banking system to promote massive investment and growth in the economy.

Nevertheless, what started as an attempt to increase consumer spending and encourage investor confidence soon turned out to be the underlying weakness in the financial system. The imbalance in the global economy became too massive for any individual government to control and with the passage of time it only worsened. A critical part was played by the developed economies whose excessively loose monetary policies during the early part of this decade contributed in widening the gap between the West and the East.

It is very interesting to know that the budget deficit of the United States was at an all time high during 2006-2007, while on the other hand huge surpluses were being recorded in Asia, particularly China and other oil exporting countries of Middle East. If we look at figures they reveal a clearer picture, the current account balance as a percent of GDP for US was -4.7%, while for China, Saudi Arabia, Russia and UAE was 10%, 28.9%, 6.1% and 15.8% respectively. Analyzing the figures it clarifies that even after the West was generating billions of dollars in revenue, the global net flow was concentrated towards the Eastern giants as they were becoming powerful by the day.

This can be strongly attributed to the fact that the gap between the saving-investment function was extensive and this gap was only widening with time since developing countries started relying more heavily on developed economies to provide for their development expenditures. There were some direct impacts of these huge cross-border financial flows on the financial intermediation process. (Mohan) One of the major causes of the crisis is attributed to the sub-prime lending in the housing industry in America.

In order to increase the share several banks gave loans to individuals who were doubtful of paying back their installments in the future. Nevertheless, since in the short run it would show an artificial boast in the economy along with a positive growth of the company many bankers and financial institutions to fulfill their personal interest gave top notch credit ratings to doubtful individuals. This resulted in a massive spending in the housing sector even though it was clear this was only short-lived.

Banks gave loans on negligible interest rates at times even below 1%, showing the extent of how eager they were to raise their customer base. The financial sector was involved in a personal struggle to widen its customer base. Derivates were used to inject huge sums of money from the investors in the market, but these derivatives were passed on to other investors and so on. The original derivative holder had no idea who was in possession of his derivative as it was a long chain that no one was aware of.

The derivative market surpassed the whole US GDP number and according to estimates in 2010 the US GDP stood at $14 trillion dollars compared to the $300 trillion derivative market. It is apparent that the market was financially diluted and