Five Years after Lehmans Collapse - Essay Example

? ‘Five Years after Lehman’s Collapse: Have the problems of the financial system been solved?’ Introduction On 15th September 2008, when Lehman Brothers collapsed and got bankrupt, the whole financial sector worldwide was left in trauma. It was at this point of time that the financial market in the global economy became highly fragile. The impact of this collapse of Lehamn Brother’s was deadly in the economy of U.S. In the modern era of globalization and liberalization, the negativities of the collapse of the giant investment banking company, tickled down to the other economies in the world, especially in the Euro Area. The essay will throw light on three such measures undertaken by the public regulatory authorities in these nations to recover the economies from the state of crisis. In brief, the essay will implicitly analyze the impact of these measures in the economy of U.S., U.K. and Continental Europe, five years from the implementation of the plans (Ragan, 2011). The Causes behind Financial Crisis Faulty Monetary Policies: It was analyzed by many economists and analysts that the loose monetary policies adopted by the financial institutions were a factor responsible for the financial crunch at 2007-2008. The rate of interest at which the banks offered the short term loans in the market along with the lessoned cost of lending money to the whole sale intermediaries were responsible to augment the gross risk exposure of the commercial banks. This resulted in an increment in the number of defaulters in the market. Global Imbalances in General: It was also found that the rising global imbalances in the current account balances and the unequal transfers of capital had generated financial crisis in the global economy. A high capital inflows in the developed economies as the rationale of development had helped to reduce the gross cost of the financial institutions for lending domestic loans (Agatha, 2011). The credibility of the creditors in the market went unscrutinized in many situations. Thus, the high amounts of capital inflows in these economies were largely responsible for the excess of loans sanctioned in the domestic markets in these nations. A lot many loans were offered to unworthy borrowers, who turned out to be defaulters in the later stage. Regulatory and Supervisory Factors: In the regime of the free market principles in nations, the fiscal authorities undertaken in the economy should be largely different from the monetary authorities. However, the success of the regulatory and supervisory bodies of these authorities must always be effective and efficient. It is stated by the analysts that the poor regulatory and supervisory systems of these organizations were largely responsible in these developed for the financial crash in the global economy. Reforms Undertaken for Recovery The Gearing Ratios of the Commercial Banks Analysis by the commercial banks in this crisis and volatile market conditions shows that the most crucial tasks of the banks should be the verification of credibility of the borrowers (Thomas and Mastropieri, 2006). Before the crisis, the commercial banks in the U.S. and Euro Zone economies engaged in high credit lending operations to hike their revenue. However, after the collapse, the banks started to adopt the policy of optimizing the revenue instead of maximizing it. This is because the banks adopted several credit appraisal tools to prevent the probability of losses in the market (Joshua, Jurek and Stafford, 2009). One such important step undertaken by the banks was gearing up of the ratios. It was believed that the low leverage of the commercial banks was a primary factor leading to the financial crisis in 2008 associated with the collapse of Lehman Brothers. The international community had retaliated to the crisis by introducing credit appraisal techniques and increasing the leverage ratios of the commercial banks. The leverage ratio indicates that the commercial banks gets to avail the risk based capital. Figure 1: The banks Performances over time. The above diagram shoes the performances of the banks at the time of the financial crisis. (Source: Hulster, 2009) The commercial banks have taken active steps to recover the economies from the financial crisis. The steps taken by the central banks primarily comprised of two principles. Firstly, it supported a higher extent of market liquidity and implementation. Secondly, they altered several macroeconomic factors though those were implemented in the economy through new types of monetary policies. In order to control the recessionary trails in the market, the Federal Reserve eased the supply of money in the economy by lowering the rate of interest at which the loans were offered to the borrowers. The banks also started to offer implicit bail outs to recover the failed projects in the economy. Indeed such measures undertaken by the banks helped to improve the state of the U.S. economy by the middle of 2009. The rise in the liquidity in the economy helped to increase the velocity of money circulation, which in turn helped in augmenting the level purchasing powers of the individuals. Therefore, there was an increase in the aggregate demand in the economy and facilitated the lulling of the impact of recession in the economy. The gross market credit conditions of the economy improved at this stage. Though the banks adopted various credit appraisal tools, it only checked the powers of defaulters in the market. Moreover, in order to stimulate the gross amount of money supply in the economy, the central banks started adopting the policy of quantitative easing. This policy involved a process through which the central banks offered loans to other commercial banks at almost same rate of interest. In return, the central banks demanded worthy government bonds from the commercial banks. This process helped the commercial banks to get access to larger economic resources. These resources were used to by the banks to lend worthy and productive investments in the market. It was also studied by the analysts of the central banks that the rise in demand for the government bonds would help to augment bond prices in the market. At the same time it would lower the interest rates in the economy (William and Shepherd, 2003). On the other hand, a hike in the bond prices in the market would help to increase the profit of the government through the open market operations. It was seen that five years down the line after the collapse of the Lehman brothers, it was then that the financial institutions took the policy of reducing the risk expose and decided to increase its income through maintenance of higher leverage ratios (Acharya and Richardson, 2009). Risk Management As stated on the previous section of the essay, the primary cause for the collapse of Lehman brothers and the global financial crisis was the extensive numbers of bad debts in the economy of U.S. and U.K. After the global financial crisis, it has been found that both the commercial banks and the central banks have actively upgraded its risk management programs. The banks have adopted several credit appraisal tools to check bad debts. The banks adopted the Basel rules by abiding by the founded lending and depositing operations. With the implementation of the Basel rules in October 2010, the Basel Committee facilitated and generated the process of corporate governance (Admati and Hellwig, 2013). These rules were not only applicable for the banking and financial institution but were also used to check the powers of the corporate organizations. For instance, scrutinizing the works and qualifications of the board of directors and advocating the importance of risk management among the organizations (Brian and Vane, 2002). All these steps were undertaken to minimize the failure of projects the corporate organizations. The Dodd-Frank Act was introduced, that facilitated the establishment of a special risk management committee. This committee included the officials of the publicly traded bank holding companies, as the board of directors. These regulations helped the economies to recover from the recessionary situations. The new credit rating approach replaced the ancient formulaic approach to analyze the risk based capitals in the markets. In the segment of regulatory capital management, greater volatility was found. The derivative counterparty risks were also reduced by the introduction of such rules. The risk weight calculations were also introduced among the commercial banks. The U.S. SEC rule was also introduced to check the board’s role in risk oversights in regular intervals. The level of appraisal tools in the investment and retail banks were also increased in the economy of U.S. after the collapse of the Lehman Brothers. The loans pay pack capability of the borrowers was checked in details by these banking authorities before it sanctions were actually made. All these measures helped to lower the risk of the financial institutions in U.S. at this point of time. Figure 2: Steps to be followed for Risk Management (Source: Deloitte, 2011) The above diagram shows the various tasks that the corporate business organizations had to execute for the purpose of risk management. Indeed, the Basel rules were effective in reducing the extent of failed projects in the economies. However, it should be considered that the global financial crisis took place due to various reasons. Thus, only manipulating the leverage ratios and the initiation of risk management programs were not enough to recover the economy from the recessionary trails of Lehman Brothers’ crash even after five years. It was also analyzed that the U.S risk management committee made to make more changes in programs than other risk management committees in other economies (Desai, 2011). Pay and bonuses, Greed and Competition This financial crisis was a turning point in the history of global capitalism. It was found that the rate of unemployment increased in terms of almost millions immediately after the financial crisis (Tabb, 2013). The oil prices soaring after the wars among the gulf countries augmented the prices of the basic requirements like food and shelter (Gorton, 2012). All such problems were further responsible to increase the negativities of crisis in the economies. It was necessary for the government to stimulate the aggregate demand in the market. The governments of the economies of both the American and European continent started to increase the implementation of several programs to stimulate the slowed down economies. This was done by providing good remunerations and bonuses to the individuals and encouraging competition in the markets. Almost 200 billion Euros was subsidized by the European government through the European Stimulus Plan in 2008. The American Recovery and Reinvestment Act were also introduced in 2009 to create immediate jobs in the economy. The Act also aimed to improve the poor health, literacy and energy sector of the country. Many social welfare and unemployment benefit programs were also incorporated in the market through this Act in U.S. Apart from these projects, Trouble Asset Relief Program, Housing and Economic Recovery Act etc were also other types of projects taken up by the government for recovering the economy from the critical situations (Dewatripont, Rochet and Tirole, 2010). Figure 3: Improvement in Investment after the global Financial Crisis (Source: Brender and Pisani, 2010) The above graph shows the improvement in the investment rate in the U.S. economy after the global financial crisis. Rather the regulations in the derivative markets also changed at this point of time. The new rule based on swap trading in U.S. helped to tackle the conditions in the derivative market. The cross border transactions in derivatives were assessed more intuitively as per the new regulatory systems. An improvement in the quality of derivative trading helped the economy to trigger potential investments. The long established tool of credit default swap in the economy was also limited at this point of time. This practice allowed the sellers to compensate the buyers on an event of a default in loan. The process of short selling was also practiced less in the economy, that involved in repurchase of derivates of an organization at lower prices. The limiting of such practices helped to reduce the extent of bad debts in the economy. Conclusion The context of the essay only encompasses three issues that were considered by the fiscal and monetary authorities of the economies of U.S. and Euro Zone. In reality, there are many other factors that were considered to improve the poor economic status of these nations. Though improved to a large extent, there are still some hurdles to be surmounted in these economies. In the European continent, economies of Spain, Portugal, Italy and Greece require the maximum attention (Addisson and McQuinn, 2009). The U.S. government should facilitate more employment opportunities throughout the nation. The governments of these economies have consecutively tailored several policies and regulation to recover their crisis economic system. It is expected that in future with the help of such measures, the economies would prosper once again (Sinn, 2010). Reference List Acharya, V and Richardson, M., 2009. Restoring financial stability: how to repair a failed system. New York City: John Wiley & Sons. Addisson, S.and McQuinn, K., 2009. Modelling credit in the Irish mortgage market. Economic and Social Review, 40(4), p .371-392. Admati, A. and Hellwig, M., 2013. The bankers’ new clothes: What’s wrong with banking and what to do about it. Princeton: Princeton University Press. Agatha, E. J., 2011. How Lehman Brothers Used Repo 105 to Manipulate Their Financial Statements. Journal of Leadership, Accountability and Ethics 8(5), p. 44 – 55. Brender, A. and Pisani, F., 2010. Global Imbalances and the Collapse of Globalised Finance. [pdf] (CEPS) Available at < http://www.ceps.eu/ceps/dld/2923/pdf> [Assessed 21 October 2013]. Brian, S. and Vane, H. R., 2002. An encyclopaedia of macroeconomics. Massachusetts: Edward Elgar Publishing. Deloitte, 2011. Global Risk Management Survey. [pdf] (Deloitte Global Services Limited) Available at [Assessed 21 October 2013]. Desai, P., 2011. From financial crisis to global recovery. Columbia: Columbia University Press. Dewatripont, M., Rochet, J. C. and Tirole, J., 2010. Balancing the banks: Global lessons from the financial crisis. Princeton: Princeton University Press. Gorton, G., 2012. Misunderstanding financial crises: Why we don’t see them coming. Oxford: Oxford University Press. Hulster, K. D., 2009. The Leverage Ratio. [pdf] (World Bank) Available at < http://www.worldbank.org/financialcrisis/pdf/levrage-ratio-web.pdf> [Assessed 21 October 2013]. Joshua, C., Jurek, J. and Stafford, E., 2009. The Economics of Structured Finance. Journal of Economic Perspectives, 23(1), p. 3-25. Ragan, R. G., 2011. Fault lines: How hidden fractures still threaten the world economy. Princeton : Princeton University Press. Sinn, H. W., 2010. Casino capitalism: How the financial crisis came about and what needs to be done now. Oxford: Oxford University Press. Tabb, W. K., 2013. The restructuring of capitalism in our time. Columbia: Columbia University Press. Thomas, S. and Mastropieri, M., 2006. Applications of research methodology. West Yorkshire: Emerald Group Publishing. William, S. and Shepherd, J., 2003. The economics of industrial organization: Fifth edition. Canada: Waveland Press. Read More