The Current Financial Crisis - Essay Example

The Current Financial Crisis Introduction According to Magdoff and Bellamy, the global financial crisis, whose effect still spills today, began in mid-July of 2007 with a credit crunch that was a result of liquidity when the US investors lost confidence in the value of subprime mortgages. As a result, the US Federal Bank put a large amount of capital in the financial markets, but as the situation in 2008, the situation had worsened with a crash in the global stock markets. The consumers, being in fear of the effects that this crisis would produce, held up their credits. The financial institutions were hit with a sharp shortage of funds resulting from the increased number of loan defaulters. The banks had a liquidity issue in their hands making the given and receiving of loans very difficult as the fallout from the subprime lending bubble burst. (Magdoff and Bellamy). This paper discusses the subprime crisis of America in 2007 and the Asian financial crisis of 1997 - 1998, and explaining the possible causes of the crises. The 2007 Subprime Crisis in America The subprime crisis happened in America in the year 2007 and involved a national banking emergency which resulted in the famous economic US economic recession of 2008 (Raymond). The American business community had involved itself extensively with mortgage-backed securities (MBS) and collateralized debt obligations (CDO) due to the high returns from the high interest rates on mortgages. When lower credit quality was onset, however, there was a massive default with the disruptions in the flow of credit to both the businesses and the consumers. The result was a marked severe global recession. Several reasons were put up to explain the cause of the crisis but the fallout is generally considered to be from the sudden rise in the rates of subprime lending. According to Pierre (233), the rates of mortgages were originally low, about 8%. However, when the rates suddenly hiked to about 20% in the year 2006, it became apparently very high for the institutions offering these mortgage services. This hiked lending lead to a lowered standard of lending and a rise in higher-risk products from mortgages. Consequently, the US households became highly indebted with a sharp rise in the ratio of the amount that each of these households would dispose to the amount of debt in mortgages (Robert, 126). As was observed in mid-2006, it became very difficult for borrowers in the US to refinance their loans following a deep decline in the US home prices (James, 198). Mortgage felony was observed to rise following a reset of adjustable-mortgage rates to higher interest rates. The effect that was observed with this trend was an equal rise in the rise of monthly payments for the mortgages, and as could be expected, the business boomed with a large number of untrustworthy mortgage dealers. James (199) reports that securities backed with mortgages (MBS) that had been previously held by financial institutions worldwide, lost their value. This category of mortgages includes even the subprime lending mortgages. Given the fact that the private financial systems withdrew their ability and willingness to support lending, there was a rapid and abrupt decline in the purchases of mortgage backed debts and other forms of securities by the global investors. As a result a lot of concern was raised about the reliability of both the US credit and other financial markets in the US. This lead to the holding back of credit throughout the world hence, slowing down economic growth in the whole of the US and the Europe (James, 200). The1997 - 1998 Asian Financial Crisis The Asian economic crisis of 1997 was also a major financial issue that raised fears of a worldwide economic meltdown due to financial septicity (Robert, 137). The crisis found its root when the Thai government was lacking in foreign currency to support its fixed exchange rates. There was a financial collapse of the Thai baht as the Thai government was forced to float the baht, a move that saw the Thai government cut its peg with the US dollar. The decision of this government to delink from the US dollar was contradictory given the fact that it had, previously, put meticulous efforts to support the US dollar even in the face of a severe financial overextension, a move that was partially caused by real estate (Robert, 137). The move to float the baht coincided with a time when the Thai government had accumulated a lot of foreign debts and the country had gone bankrupt even before the collapse of the value of its currency. The consequences of the move were slumping currencies, a sudden rise in private debts, and devalued stock market and other assets in the most parts of Southeastern Asia and Japan. The most devastating effect was a general loss of demand and confidence in the whole of this region by the rest of the world countries who had been partnering with the region in trade (Raymond). Most governments of Asia had seemingly sound fiscal policies regarding the crisis, though the International Monetary Fund (IMF) stepped in with a program to stabilize the currencies and save the economies of the countries that were hard hit by the crisis. From the foregoing, it is evident that the government is a major contributor to the rise of these crises. The American subprime crisis was partly contributed by the government in the sense of its overregulation, failed regulation and deregulation of the activities of the subprime mortgage lending. The US government had decreased its regulation of the financial and banking institutions with a hope that this would lead to an ease for the Americans to own homes. It, however, emerged that the major investment banks that were hard hit by the crisis were not under any regulation that applied to the depository banks. According to Pierre (239), most critics of the causes of the crisis believe that changes in the capital reserve calculations rules enabled financial banks to increase the amount of debt they were taking on. This fueled the growth in the securities backed mortgages and lead to the rise of the subprime lending mortgages. The banks thus, increased their risk taking and as a result by 2007, the largest US banks had debts implying that a small decline in the value of their assets was able to render them bankrupt (James, 201). Another factor to consider in the contribution of the US government to this crisis is that it advocated persistently for affordable housing for the citizens. The rate of home mortgages was supposed to be reduced as possible to cater for the capability of every American Citizen. As a result, an affordable housing loan mandate was issued to Fannie Mae and Freddie Mac, the body charged with regulation of housing loans, for the provision of affordable housing loans. To comply with these mandate, the body established a program to purchase $5 trillion in affordable housing loans. This encouraged lenders to relax underwriting standards to produce those loans; hence the crisis began (Raymond). In the case of the Asian financial crisis of 2007, the governments of the region contributed to the crisis by their involvement with loans that were summed up in terms of the US dollar. The government of Thai, for instance, had taken out a lot of loans in the US dollar and as the crisis was almost hitting, its local currency had already lost meaning relative to the US currency. This made it difficult for it, and other countries in the region, to settle these debts given the fact that the income of these countries are in terms of their low value currency (Brian, 460). The other causes to these crises to be considered are the business institutions themselves. As in the case of the US subprime crisis, the housing mortgage business was much booming with the increase in the number of customers who actually was soliciting for their services due to the reduced lending rates as was advocated for by the government. This saw an increase in the number of mortgage lenders rising which, obviously, destabilized the lending rate. As the subprime mortgage lending rates suddenly increased at the end of the year 2006, a number of borrowers were caught unable to settle their debts. The result was the observed bankruptcy of the mortgage institutions (James, 201). In the Asian financial crisis, the lenders were also other economists who led to the crisis. The panic that the impending economic crisis arose led them to withdraw their credit from these crisis states. This move by the foreign investors and lenders in these crisis countries of Asia caused a credit crunch and an increase in the level of bankruptcy in these countries. Another issue that followed their withdrawal of these credits was the flooding of the exchange markets with the currencies of these crisis states. The effect was a depreciating pressure on their exchange rates and this increased further the crisis level. The governments, as a result, increased the domestic rates to exceedingly high rates to cater for the depreciating local currency. This move was, as well, meant to prevent the flight of the capital out if these countries and to attract the investors by these fair rates. However, none of these policies could hold for long to save the countries from the crisis. As depicted in these issues, there are a number of controversies around these crises: i) The governments of both America and the Asian countries are both depicted to be careful of their citizens. In ensuring that fair house loans are offered to its citizens, the American government pressed the lenders of the home loans by suppressing the mortgage lending rate. It later turns out that the move attracts a lot of players in the mortgage industry and as a result the interest rates manage to go down. However, the failure of the mortgagees to pay their loans in time leads to a sharp decline in the amount of capital available for the financial institutions. This further, leads to a hike in the rates of the mortgages and the previous borrowers are caught unable to repay their loans (Pierre, 241). The result thus, is a nationwide bankruptcy in the financial institutions and thus an inevitable economic crisis. For the Asian financial crisis, the controversy that emerges is that the governments in these countries put the effects of the crisis on its citizens. When the Thai government was unable to repay its debt due to bankruptcy, it decides to charge high taxes on the purchase within the country to attract the foreign investors into the country by fair rates of the local currency. This is controversial in that a country should protect its citizen at all cost and not over burden it at times of economic crisis. As discussed above, this method never worked and the countries still had to suffer the dire effects of economic and financial crisis. ii) Currently, there are many policies that may lead to economic crises in some parts of the globe if unsettled. Taking the consideration of the current currency wars, most of the world countries are in a move to ensure that their currency is more dominant and of higher value (Pierre, 242). These leads to a situation in which the value of the currency of other countries are diminished to the extent that they do not get recognized out of their region. If these currencies are continued to be in use in these countries, international trade becomes imbalanced as the value of the goods are dependent on the value of the concerned countries’ currency. If a country with a low value of currency relative to another is in economic recession, it would become very difficult for it to settle its debt in terms of its low value currency. This will affects all the other countries in its region that are involved with it in the trade and may lead to economic crisis in this region as well. Hence, the values of any country’s currency should be, at least, comparable to an international currency like the dollar. On my own opinion about this topic, it is very important for countries around the world to avoid cases of economic or financial crisis by ensuring that their financial institutions are firm finally and controlled by a set rule of laws. No financial institution has ever been in respect of its customers if no external body is available to monitor its activities. The case in the American subprime crisis of 2007, the banks that were issuing the mortgage services were not under any regulation from the government except for the depository bank. This lead to their monopoly of the market and the situation got worse when their borrowers were unable to refinance their loans after the increase in the subprime mortgage lending rates. The banks began losing money and the whole of the financial institution was hit by lack of money to drive their normal activities or to fund other sectors of the American economy. Another aspect to be considered in this concept is constant but unreliable dependence on foreign currency, as was the case with the Thai government. Endorsing the American dollar in its foreign and some local transactions and assuming the value of its currency, the Thai government found itself in an economic crisis of which it was not prepared, as evidenced in the text, to battle. The government of Thai could have saved itself from the crisis if it had carried out a limited number of financial transactions with the dollar and mostly involve its foreign borrowing in terms of its currency, the baht. Works Cited AgeÌ nor, Pierre. The Asian financial crisis: causes, contagion and consequences. Cambridge, UK: Cambridge University Press (1999): 230-242. Print Bridges, Brian. "Europe and the Asian Financial Crisis: Coping with Contagion." Asian Survey 39.3 (1999): 456-467. Print. Foster, John Bellamy, and Fred Magdoff. The great financial crisis: causes and consequences. New York: Monthly Review Press, 2009. Print. Ovanhouser, Raymond T. Financial crisis in America. Hauppauge, N.Y.: Nova Science Publishers, 2009. Print. Shiller, Robert J. The subprime solution: how todays global financial crisis happened and what to do about it. Princeton, N.J.: Princeton University Press (2008): 123-156. Print Sidaway, James D. "Subprime crisis: American crisis or human crisis?" Environment and Planning D: Society and Space 26.2 (2008): 195-201. Print. Read More