Economic Recession - Research Paper Example

Economic recession   The concept:  According to many economist and scholars, economic recession is defined by negative growth in Gross Domestic Product (GDP) for two or more chronological quarters. The crux of recession and its foundation lies in many quarters of positive but sluggish growth. After that the cycle of recession actually begins. Often in a temperate recession, the beginning quarter of adverse growth is succeeded by an insignificant positive growth. From then onwards adverse growth comes back and the recession cycle resumes. ‘Two-quarter’ concept is universally accepted but then again many economists believe that it does not take into account the change in other economic variables. For instance, the national unemployment rates and level of spending are all macroeconomic variables, which should be incorporated while defining the economic recession. The National Bureau of Economic Research (NBER) is the organization, which formally declares a recession in U.S. According to this agency, economic recession is defined as “significant decline in economic activity lasting more than a few months.” Although economic recessions are predictable, they are basically not ascertained until they are already in action. It is very much common for the countries to experience gentle recession. Recession is the congenital outcome of the economic era and will accommodate for changes in consumer consumption and expenditure or accelerating or declining prices of commodities and labor. The experience of a chain of adverse events will lead to acute recession or even to a long-term depression (“What is Recession? Economic Recession Definition”)   Probable Causes:  An economic recession is basically associated with the activities undertaken to control the money supply in the economy. The Federal Reserve is an organization accounted for managing the balance between the supply of money, rates of interest and inflation. When this delicate equilibrium is disturbed or knocked over, the economy is compelled to rectify itself. The Federal Reserve sometimes handles these kinds of situations by evacuating the supply of money into the money market. Due to this Fed operations, the rates of interest remains low although inflation goes up. Inflation is the increase in the price level of commodities and services within a given time period. The increase in rate of inflation signifies decrease in purchasing power of the consumers as the goods and services tend to be more expensive than before. People tend to give up certain things like expenditure and leisure in a surrounding where inflation prevails.  Individuals make a budget to save more and spend less in those situations. Hence as a result GDP starts decreasing. It will lead to an increase in unemployment rates because the organizations start to fire workers due to cost cut and their customers have also declined. All these factors compel the economy to move to a state of recession. A cycle of unendurable economy activity drives the economy to a state of stuttered existence because of the demand for greater amounts of loan due to indefinite loan habits (‘What is Recession? Economic Recession Definition’).  Thesis: In this paper we will be focusing on liquidity crisis characterized by the effect of Northern Rock, Bear Stearns and Lehman Brothers with equivalent risk fallout on other financial organizations, which is one of the crucial phases of global financial crisis. By liquidity crisis we mean a situation when a company fails to pay its accounts of charges or has insufficient money for expansion of its inventory and production. The crisis may also occur if a firm disregards a bond by allowing its financial ratios to cross its limits (Grambo).  The incident:  The global financial crisis has begun to show its results from mid 2007 till 2008. The stock market crash, the breakdown of the giant corporations has compelled even the government of the developed nations to come up with some economic policies to pick up their financial systems. This crisis has affected livelihoods of all the individuals around the world. The household sector and the financial intermediaries are trying to reduce their leverage as they have amplified large number of debts. Declining quality of credit has increased the accounts of banks write-downs leading rising pressure on banks and other financial organizations to build up capital and discard assets (IMF, 5). Recent reports suggest that the expected balance in macroeconomic and financial fluctuation, which promised to support their equilibrium, was an illusion. If the fluctuations are high, then leverage increases the chance of bankruptcy. According to Global Financial Stability Report (GFSR) report, the considerable inflow of capital into the banking system and the sale of assets to obtain higher ratios of capital had led to decrease in the credit rather than contraction of credit. This had proved to be a boon. The equity capital for banking system was not so easy to obtain from private sector. The pressure driving deleveraging has been intensified as the extent of economic turmoil has become transparent and credit expansion at many circumstances stayed at remarkable heights (IMF, 6). Pressures on uprising markets strengthened in September 2008, following the breakdown of Lehman Brothers, as equivalent uncertainty rose and as the credit shortage’s effect on economic activity became undeniable (IMF, 10).  The global meltdown affecting the titanic corporations:  Northern Rock, Britain’s leading mortgage lender got an aid form the Bank of England on September 2007. The strategies that were adopted by the bank failed simultaneously. In the first half of 2007, it used security mortgages and other capital market instruments to get of 19 per cent share in mortgage market of U.K. By mid-September, the company had lent out $2 billion. The company is said to have lent out $40 billion and after that had tightened up (Crisis at Northern Rock). JP Morgan Chase also bought Bear Stearns, one of the leading U.S. investment firms. The firm whose share price was $170 per share was sold out at $2 per share after the crash. From the purchase price of the shares, one can understand that how things have fallen on the firm. The deal was finalized at $236 million. At the end, the brokerage and the back-office operations were not found to be wonderful. Those assets, which are less liquid, will be provided with $30 billion by Federal Reserve. This has led to lay-offs of thousands of workers at Bear especially those who used to hold stocks for their long-term compensation (“JPMorgan Buys Bear on the Cheap”). Lehman Brothers, one of the major players in the field of investment banking has been bankrupted due to belligerent leverage policy in connection to global financial crisis. The causes of this meltdown have been due to adoption of poor regulation, lack of clarity and indulgence of market, which led to positive outcomes for several years. The seeds of crisis have been sown during the real estate crash.  An extended period of low rates of interest led to an abnormal increase in the prices of houses by significant standards (Zingales). Lehman Brothers filed for protection from bankruptcy on September 15, 2009. Announcing a chaotic day in financial markets, the company declared that it will opt for chapter 11 bankruptcy protections, leading the company to be the victim of credit crisis and sub prime mortgage crisis in the history of United States. This massive shock has put one per cent of jobs at risks. This incident has sent electrifying shocks around the world of banking. The bank has made expansion in property-related investments which includes the sub prime mortgages- providing loans to low income group people which resulted in loss of $14 billion within one and half years. This has compelled the bank to take write-down on those funding. This led to depreciation of dollar against euro and yen (Wearden, Teather and Treanor, 1).   The consequences: Economic recession can be predicted before it starts. Thus one can see GDP growth even if unemployment, real estate price decline, stock market crash and stagnation in business prevail. The only actual advantage of recession is that it helps to control inflation. I hope I have been able to provide valid information to the readers of this paper to make them aware of the crucial crisis in the world history. Still future study and research is possible in this paper of how to come out of this recession and how the other sectors of the economy are affected.                           References: 1. “Crisis at Northern Rock.” Business Week. September, 2007. Available at: http://www.businessweek.com/globalbiz/content/sep2007/gb20070914_343931_page_2.htm (Accessed on July 2, 2009). 2. “Global Financial Stability Report”. International Monetary Fund. April 2009. Available at: http://www.imf.org/external/pubs/ft/gfsr/2009/01/pdf/text.pdf (Accessed on July 2, 2009). 3. Grambo, Ralph. Liquidity Crises management. n.d  Available at: http://academic.uofs.edu/faculty/gramborw/tucrisis.html (Accessed on July 2, 2009). 4. “JPMorgan Buys Bear on the Cheap”. Business Week. March, 2008. Available at: http://www.businessweek.com/bwdaily/dnflash/content/mar2008/db20080316_356646.htm (Accessed on July 2, 2009). 5. “What is Recession? Economic Recession Definition”. Recession.Org. n.d. Available at: http://recession.org/definition (Accessed on July 2, 2009), 6. Wearden, Graeme, Teather, David, Treanor, Jill. Banking crisis: Lehman Brothers files for bankruptcy protection. guardian.co.uk. September, 2008.available at: http://www.guardian.co.uk/business/2008/sep/15/lehmanbrothers.creditcrunch (Accessed on July 2, 2009). 7. Zingales, L. Causes and Effects of the Lehman Brothers Bankruptcy. United States House of Representatives. October, 2008. available at: http://www.scribd.com/doc/11096014/Causes-and-Effects-of-the-Lehman-Brothers-Bankruptcy (Accessed on July 2, 2009). Read More