Lehmann Brothers - Role of Monetary Policy - Research Paper Example

?Client’s 4 December The Great economic depression triggered off in the year 1930 in the US, it was triggered off by the collapse of the US stock market which is now known as Nasdaq. It was the worst period of the US history, people slept on Hoover blankets and had no money to spend. The economy of the US recovered from this setback only to suffer from a similar setback of a lesser magnitude in the year 2008 which is called recession. This paper will comprehensively throw light upon the roots and causes of the current economic crisis. All the major cause will be expansively presented in this paper. The valuable lessons learnt from the crisis will also be thrown light upon in this paper. Wachovia, Bear Stearns, AIG, Lehmann Brothers, Northern Rock, Goldman Sachs are some elite names that suffered the most because of the economic crisis also known as recession. Wachovia was once the fourth largest bank in America but it could not sustain the wrath of recession and was taken over by Wells Fargo in the year 2008. Lehmann brothers filed for bankruptcy while AIG and a few other elites just hung in there with the skin of their teeth. This economic crisis is still having repercussions on countries like Greece and Spain; the whole of Euro Zone is facing a financial turmoil. There are a few other countries that have been not so severely affected by the same. The crisis triggered off because of unchecked debt, banks kept issuing loans to people who invested heavily in buying assets, several things were taken for granted but when proved otherwise there was hardly a place in the world to hide. Overvaluation in real estate is perhaps the biggest cause of the current economic crisis, it is better known as the subprime crisis in the US. The likes of Lehmann Brothers and other financial services went bust because they kept issuing credit to the people who thought the property price would increase and they would be easily able to pay off the debt that they are borrowing. It did not turn out that way and there was a short of equity, this is exactly why the financial institutions went bankrupt. The overvaluation is the biggest factor that caused the current economic crisis. Factors like bad income tax practices have added insult to injury, bad mortgage lending also contributed heavily to this current economic crisis. “The way to address the root cause is to let house prices drop to where an average house is within the means of an average household.  (Or, alternatively, boost the income of the average household to the point that they can afford an average house.  But that's very hard.  Letting houses prices go on falling, although painful for everyone who owns a house or who has lent money to someone who owns a house, is very easy.)” (Root Cause of the Financial Crisis) The UK housing market was also greatly affected because of recession. The impact of the global economic crisis on UK property companies was dire. Previously well performing firms in terms of turnover and profits experienced drastic falls in profits and even losses. Tightened lending conditions and dips in confidence in the UK housing sector translated to inactivity in business and thus reduced turnovers, hindered growth and difficult operations. In the general pattern as the rest of the economy, property firms found it untenable to maintain workforce numbers as lack of activity and the heavy toll of remuneration on available resources. Reduced spending propensities and the lack of credit in the housing sector left most of these companies’ futures hanging in the balance. There is also the question of how the entire properties sector and the property companies have set out to recover from the economic crisis. Concerns also arise in terms of how well the instituted strategies can buffer such firms against an occurrence of another financial downturn in the future. The content analysis reveals that the property companies went through severe impacts on their management dispositions as well as on their employees. The managers were forced to adopt new strategies, while the employees, whose positions were already under threat from the lay-off patterns in all industries, had to immediately adopted such strategic shifts. The managers of property companies have had to adopt strategies to steer their firms out of the crisis and prepare them for future economic crises, with some firms achieving success and some not finding a way out in the short term. As the study reveals, different companies have followed different strategies to recover, as can be viewed in the management and financial aspects of such companies. One of the strategies adopted by some property companies is expansion of business activities. Expansion allows for engaging in more transactions and thus higher turnovers and more profits. The view that the economic crisis will not plateau forever backs expansion as a way of preparing for economic recovery and placing the company on a strategic position at the return of normalcy. Internationalization is one of the forms of expansion undertaken by some property companies as they seek to safeguard against local downturns. However, expansion requires the availability of capital, which is a constraint especially in light of the tightened credit environment. It is thus not a tenable strategy for smaller companies. Diversification into new markets within the properties sector is another strategy pursued by property companies in their bid to recover from the economic crisis. In this particular case, it was found that companies such as (Miller Group/ Sir Robert McAlpine/Emerson/ Gallagher/ and Bower and Kind) have successfully implement diversification as the tackle against the negative influence from the global crisis. Indeed, here it is observed that property firms have launched business activities across both residential and commercial property markets. Property companies are seeking to diversify into new housing products beyond the description of their main activities as they seek to engage in more business and counter the economic crisis. Diversification can be viewed as a formidable strategy for recovery from the global economic downturn as well as a way to face similar events in the future. In comparison to expansion, it requires significantly less in capital investments as internal restructuring takes center stage. Adoption of sustainable practices in property development and activities is also another strategy undertaken in recovery from the economic crisis. Here, firms seek to sustainable technologies and business models alongside environmental awareness and waste reductions in their day to day activities. This is a good strategy as it enables property firms to save on costs, a crucial factor for survival especially during an economic downturn. It also places the firms in line with changes in consumerism patterns, as the world is increasingly valuing eco-friendliness. The result of this is more business activities alongside lean management. Although investing in sustainable technologies may not pay off in the short term, it is a good long term strategy with the capacity of helping recovery and helping prime for future economic crises. It is also noted that several property companies executed multi-strategic recovery plans involving combinations of expansion, diversification and sustainable development. This study meets the objectives it set out; it establishes the overall effects the financial downturn had on the property markets in the UK; discusses the impacts on consumer decision-making; and lastly addresses the financial and management strategies adopted by UK companies in their efforts to recover from the impacts of the global financial crisis. The effectiveness of these strategies is discussed, as well as their capacity to buffer UK property companies against future economic downturns. Role of Monetary Policy Some of the main plausible reasons that caused the recent financial crisis have been identified in the above sections. According to Brunnermeie (2009), cheap mortgage financing to sub-standard borrowers fuelled the boom in the U.S. housing market. Three factors were primarily responsible for the fall of the housing market in the U.S. (which in essence, constituted a very small segment of the financial market in the country) transforming into a global contagion. First, the “originate and distribute” banking model, together with the high rate of securitization, led to declining lending standards and made it impossible to re-price the complex structured products. This significantly eroded the confidence level of banks, thereby disrupting the inter-bank markets and credit flow. Second, banks relied heavily on short-term funding sources, hence raising the risk of funding. Finally, the ever-growing integration of global financial systems and the increasing interest towards structured financial instruments quickly transmitted the crisis to all the major regions of the world. Gourinchas (2010) focused on the role of monetary policy in the recent financial contagion as well as the role played by exogenous influences, particularly the rising external deficits referred to as ‘Global Imbalances’. According to Gourinchas, both explanations are not satisfactory as the sole reason behind the crisis. This opinion has also been corroborated by Caballero (2009), who suggested that the primary reason for the crisis lied in the “imbalance” between worldwide demand for secured liquid instruments of debt in the U.S. and abroad, and the limited asset supply. Per Gourinchas, the imbalance in safe assets impacted the monetary policy effects and the external deficit patterns of the U.S. (Gourinchas, 2010, p.1). The rosy macro-economic picture that prevailed prior to the year 2005 was blemished by the overheated housing markets and the rising external deficits in the U.S.. During the period between January 1997 and January 2006, the S&P Case Shiller Composite-10 Home Price Index rose by 128% in real terms. The household leverage, i.e. the household debt as a proportion of disposable household income, increased substantially with the rise in the prices of real estate. However, there is a general perception by many economists that the developments on this front were mainly benign for three main reasons. The financial innovations, as evident from the increase in securitization, had a positive impact in the form of low borrowing costs and reduced risk borne by the lenders. Due to the limited supply of houses in the short-run, an increase in housing demand raised the housing prices. According to Greenspan (2005b), though concerns about the boom in the housing market were present, there was a perception that the domestic economy could easily bear the slowdown in the household prices in some highly speculative markets without an impact on aggregate conditions. In addition, central banks stated that they were vigilant and could offset any decline in aggregate demand by adopting a suitable interest rate policy. During this period, the U.S. was facing a current account deficit, (which is measured as the surplus of imports over exports), signifying the weakness in domestic savings compared to national investments. The amount of this deficit increased from 0.5% to 1.9% of global output. A persistent deficit implied an increased reliance of the U.S. economy on outside sources for meeting financing needs. By 2005, a rise in global imbalances was perceived as a serious threat to the stability of the global economy. Gourinchas (2010) states that stable monetary environments do not always indicate a “stable macroeconomic outcome”. According to Obstfeld, (2009) though the pre-crisis period was characterized by stability in the rate of inflation, consumer prices and output, it was marked by an uncontrolled leverage (both on the part of households as well as financial intermediaries), which is believed to be one of the main reasons behind the crisis. The excessive leverage conditions had mainly developed due to low real and nominal interest rates, which ultimately fuelled rising asset prices. After the emergence of the credit crisis, it became ostensible that interest rate regulation policy is not enough to achieve stabilization in output and to nullify any demand contraction. The federal rates rapidly reached levels of less than zero, which called for supplementing traditional monetary tools with vigorous fiscal measures and some non-conventional monetary tools (Gourinchas, 2010, p.1). Effectiveness of the Monetary Policy The strictness of credit standards and the failure of a fall in the cost of credit directed towards businesses and households, gave rise to the view that monetary policy was ineffective in the context of the crisis, despite an eased monetary policy throughout the greater part of the decade. These views have been seconded by Paul Krugman (2008) and have also been affirmed by the minutes of a meeting of the Federal Open Market Committee (FOMC). These views are also in line with the earlier Keynesian discussions regarding failure of monetary policy in during the Great Depression. Based on these views, many arguments exist about the efficacy of monetary policy in coping with a credit crisis. The easing of monetary policies in times of crises, can be counterproductive because it can considerably weaken the ability of regulatory authorities in taming inflation. However, the abovementioned views have been challenged by several economists such as Mishkin (2009), who argues that in order to nullify the effects of the crisis, monetary authorities need to adopt a more aggressive easing of monetary policy. Friedman and Schwartz (1963) have argued that in the absence of sufficient liquidity allowed by the Fed (and an eased set of monetary norms), the impact of the recession would have been even more severe. Their opinions are followed by the logic that monetary policy has been effective during the recent financial crisis. In fact, it is said that monetary policy has been more potent during times of crises (compared to normal situations) because not only did it lower interest rates on default-free or government securities, but it also lowered credit spreads. However, it cannot be said that monetary policy can nullify the contractionary impact arising from a financial disruption similar to the one that the economy most recently experienced. The recent financial crisis resulted in such levels of credit spreads widening and credit standards tightening, that even an aggressive easing of monetary policy failed to put a brake to the crisis (Mishkin, 2009). Works Cited Blackburn, R. (2008). The Subprime Crisis. Available at: Board of Governors of the Federal Reserve System. (2010). Statistical and Historical Data. Available at: Cecchetti, G.S. (2008). Monetary Policy and the Financial Crisis of 2007-2008. Available at: Cheung, L. Tam, C. Szeto, J. (2009). CONTAGION OF FINANCIAL CRISES: A LITERATURE REVIEW OF THEORETICAL AND EMPIRICAL FRAMEWORKS. Hong Kong Monetary Authority. Available at: Domash, H. (2002). Fire your stock analyst!: analyzing stocks on your own. New Jersey, USA: Financial Times-Prentice Hall. Dow Jones & Company, Inc. (2011). 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