The 2008 Financial Crisis: Causes and Consequences - Case Study Example

The 2008 Financial Crisis: Causes and Consequences Table of Contents The 2008 Financial Crisis: Causes and Consequences Table of Contents 2 Introduction 3 The study is concentrated on a detailed analysis of the 2008 financial crisis. The causes and consequences of the financial crisis during 2008 have also been discussed in the study. The financial crisis refers to the situation in the financial economy, when the value of the assets and institutions goes on losing their value at an increasing rate all over the world. The study is also concentrated on the genesis of the 2008 financial crisis which involves the disastrous circumstances that occurred in the United States as well as in other parts of the world. The origin of inflation was also one of the major factors behind the happening of global economic crisis. Inflation can be defined as a situation in the economy, when there is a continuous hike in the price level of the products and the services and on the other hand a continuous decrease in the value of money. However, a fact should be highlighted that there should be a continuous increase and decrease in the price level and value of the money respectively (Makinen, “Inflation: Causes, Costs, and Current Status”). 3 Origins of the Financial Crisis 4 The financial crisis started showing its effect in the early 2007 in the US along with other parts of the world. The companies started hiking their prices to maintain the value of their assets. The maintenance of value became the most important task of any business entity to exist in the market during 2008. The market went down due to such an attack of devaluation of assets. The business entities in order to maintain stabilization in the market started innovating and introducing new products in the markets. However, the introduction of new products in the market does not acquire enough power to beat the effect of devaluation. Rather, it holds the risk of putting the organization deeper into instability. This is so because, when a company adopts any modifications or a complete change in the product, the expenses on the operations of the business increases which may not be recovered in an unstable economy. Moreover, the demand gradually goes on decreasing due to the decrease in the flow of money in the economy. Thus, it carries a high risk to introduce innovations with due consideration to the varying and unstable market (Baily & Et. Al., “The Origins of the Financial Crisis”). 4 During the early 2008, many companies failed to even control their own risk management procedures. They soon started losing their ability to entertain risk in the market. At the same time, due to a massive increase in prices of the products, certain firms got affected by the decrease in demand of their products and services. Besides, the flow of money in the economy decreased due to a vigorous effect of devaluation of money value, decrease in demand and supply and devaluation of assets and institutions. Subsequently, these factors as a result gave birth to inflation (Baily & Et. Al., “The Origins of the Financial Crisis”). 4 The global financial crisis affected the most at the mid of 2008. The financial institutions globally were affected due to this crisis. The stock markets all over the world started diminishing, a large number of financial institutions started winding up. As a result of such significant losses, the governments of each and every country, even in the developed nations were compelled to provide the financial packages to their financial systems. The financial packages signify that the government of a country asks each financial institution to maintain certain reserves in their account with the government. The reason behind entertaining such criteria by the government is to have a control over the money flow in the economy. The financial institutions are compelled to engage a certain deposit of their capitals or reserves with the government. Moreover, the government can increase or decrease the ratio of reserves to be deposited by the financial institutions (Kramer, “Losing Sleep Over Stock Markets: Its the Season”). 5 The government has the power to control the inflation or the deflation occurring in the economy. For instance, if the country is facing the inflation, the government generally decreases the ratio of the reserves to be kept with the government. Thus, the financial institutions as a result get the opportunity to use much of their capital reserves to re-establish their market. The re-establishment involves that the financial institutions can provide loans to the general public at attractive rates which in turn can improve and heal out the effect of the inflation among them. Hence, these are the tactics which are generally followed by the governments to have an effective control over the economy (Kramer, “Losing Sleep Over Stock Markets: Its the Season”). 5 The major effect of the financial crisis was on the United States of America as compared to the other nations. During the 2008 financial crisis, even after the assistance provided by the government of the US to its financial institutions, it could not come out of the drastic effect of the financial crisis. During the crisis, the 6% of all the mortgage loans of the US were in default. Most of the financial institutions of the US were unable to provide mortgage loans to the general public. Thus, the general public kept on going deeper into financial depression (Halm-Addo, “The 2008 Financial Crisis: The Death of an Ideology”; Davis, “The Cause of the 2008 Financial Crisis”). 6 Irrespective of the scenario, few financial institutions provided the loans to few of the customers in the US. As few borrowers were not enough to fulfill a huge number of loan aspirants. Moreover, the loans were being provided to the general public without any verifications of assets and properties or incomes of the customers and even in low rates because the loan aspirants during that time were facing high financial problems and hence were unable to accept loans at higher rates. Therefore, it can be identified that United States of America was the country which was found to be mostly affected by the crisis of 2008. The US Government even after applying various measures could not pull the economy out of the drastic effect of financial crisis (Halm-Addo, “The 2008 Financial Crisis: The Death of an Ideology”; Davis, “The Cause of the 2008 Financial Crisis”). 6 In another significant development, during the year 2005 and 2006, the prices of the readymade homes went high along with the construction charges to build a home. It became very difficult and unaffordable for the home aspirants to get a home to live in. The rent charges and the hostel charges also went high. As a result, many aspirants got attracted towards the mortgage loans which led to a mortgage loan crisis during 2007. The mortgage loan crisis soon effected the financial institutions of the US but as the mortgage financial products had been dispersed in the rest of the nations, the global crisis took birth (Crotty, “Structural Causes of the Global Financial Crisis: A Critical Assessment of the New Financial Architecture”). 7 Consequences 7 After the significant impact in the global economy, the demand of a number of products and services in the affected countries went down putting the real international economy in a drastic situation. During the late 2008, the international economy faced a major loss with a considerable decline in the growth of the industrial production. The industrial production growth was 8.8% in 2007-2008, which went down showing an unexpected deduction to the economists. The industrial production growth went down to a figure of 2.8% in 2008–2009 (April – February) (Mohan, “Global Financial Crisis - Causes, Impact, Policy Responses And Lessons”; Dietz, “Recession Keeps Hold On Eugene”). 7 However, in the real international economy, the service sectors were able to hold up itself against financial crisis. The service sectors entertained an unexpected growth during such a miserable condition throughout the world. The service sectors had a growth of 9.7% during the years 2008–2009. It was because of the fact that service sectors have to spend a comparatively lesser amount in running the operations of the business successfully than the production sectors. Hence, the service sectors did not face major losses but could not maintain the consistent growth in the real international economy (Mohan, “Global Financial Crisis - Causes, Impact, Policy Responses And Lessons”; Dietz, “Recession Keeps Hold On Eugene”). 8 The service sectors had a growth of 10.5% in the year 2007–2008 which reduced by 0.8% in the following year i.e. 2008-09. Even after the devaluation of money and other causes of financial crisis, the service sectors had maintained a sustainable growth in the community services, social services and personal services (Mohan, “Global financial crisis - causes, impact, policy responses and lessons”; Dietz, “Recession keeps hold on Eugene”). 8 9 The international economy faced deductions in the Gross Domestic Product (GDP) growth by 2.1%, which was 9% in the year 2007–2008 and reduced to 6.9% GDP at the end of 2009. At the same time, the growth of private final consumption expenditure also declined by 1.7%. It was 8.3% in the year 2007– 2008 and reduced to 6.6% at the end of 2009. As a result of such changes in the real international economy, the government final consumption expenditure had a growth of 10.6%, which was 2.7% in the year 2007–2008 and led to 13.3% at the end of 2009. The 2008 financial crisis had a significant effect in almost all the countries i.e., in developing, developed and even in the under developed countries (Mohan, “Global financial crisis - causes, impact, policy responses and lessons”; Dietz, “Recession keeps hold on Eugene”). 9 The countries with good economic policies and effective governance also could not preserve their economies from the global crisis. For instance, the African nations suffered the crisis primarily from direct channels. The direct channels signify the financial sectors i.e., the stock markets faced the fluctuations at a recurring nature and many stock exchange participants lost huge wealth due to the financial crisis during the year 2008. Such similar losses were also faced by the countries like Kenya, India, Zambia, Mauritius, and Botswana (Massa & Willem Te Velde, “The Global Financial Crisis: Will Successful African Countries Be Affected?”) 9 Recommendations 10 Whenever any financial crisis is likely to occur, the public officials along with the governments of the respective countries should identify and start planning certain tactics to avoid the birth of financial crisis. The business entities should employ only reasonable number of employees required to carry out their operations. It may be noted in certain manufacturing industries that there exist a problem of disguised employment. Disguised employment refers to the situation when the business unit is employing the number of staffs than actually required to carry out the operations of the business smoothly. This can help to cut cost in the organizations which can be one of the ways that can help organizations to be better prepared in case of global financial crisis. The financial crisis puts a miserable effect in the real economy of the country which in turn takes a comparatively longer time to restore the smooth operations as it was before the crisis (Atreya, “The US Financial Crisis: Impact on the Indian IT Sector”; Chenery, H. B. & Srinivasan, T. N., “Handbook of Development Economics”). 10 Conclusion 11 The analysis made of the 2008 financial crisis has provided an understanding in relation to the causes and the consequences that resulted in the occurrence of the scenario. Although each and every country started framing plans to ensure the quick recovery from the miserable condition, the crisis lasted for substantial period time. The financial crisis can be made weaker if the financial institutions start providing loans at a relatively cheaper rate before the arrival of the crisis. Providing loans at cheaper rate will have a positive control over the demand of the market. The general public at a very early stage can attain and maintain the stability, if they are provided with appropriate funds at the time when required (Atreya, “The US Financial Crisis: Impact on the Indian IT Sector”; Chenery, H. B. & Srinivasan, T. N., “Handbook of Development Economics”). 11 Works Cited 12 Atreya, Manohar M. “The US Financial Crisis: Impact On The Indian IT Sector”. November 05, 2011. Circle, 2008. 12 Baily, Martin Neil. & Et. Al. “The Origins of the Financial Crisis”. November 05, 2011. Business and Public Policy, 2008. 12 Chenery, Hollis Burnley. & Srinivasan, T. N. Handbook of Development Economics Elsevier, 1988. 12 Crotty, James. “Structural Causes of the Global Financial Crisis: A Critical Assessment of the New Financial Architecture”. November 05, 2011. University of Massachusetts – Amherst ScholarWorks@UMass Amherst, 2008. 13 Dietz, Diane. “Recession Keeps Hold on Eugene”. November 05, 2011. The Register Guard, 2010. 13 Davis, James F. “The Cause of the 2008 Financial Crisis”. November 05, 2011. Accuracy in Media, 2008. 13 Halm-Addo, Albert D. The 2008 Financial Crisis: The Death of an Ideology Dorrance Publishing. 13 Kramer, Lisa. “Losing Sleep over Stock Markets: Its the Season”. November 05, 2011. Huffingtonpost, 2011. 14 Makinen, Gail. “Inflation: Causes, Costs, and Current Status”. November 05, 2011. Report for Congress, 2003. 14 Mohan, Rakesh. “Global Financial Crisis - Causes, Impact, Policy Responses And Lessons”. November 05, 2011. Bank for International Settlements, 2009. 14 Massa, Isabella. & Willem Te Velde, Dirk. “The Global Financial Crisis: Will Successful African Countries Be Affected?” November 05, 2011. Overseas Development Institute, 2008. 14 Introduction The study is concentrated on a detailed analysis of the 2008 financial crisis. The causes and consequences of the financial crisis during 2008 have also been discussed in the study. The financial crisis refers to the situation in the financial economy, when the value of the assets and institutions goes on losing their value at an increasing rate all over the world. The study is also concentrated on the genesis of the 2008 financial crisis which involves the disastrous circumstances that occurred in the United States as well as in other parts of the world. The origin of inflation was also one of the major factors behind the happening of global economic crisis. Inflation can be defined as a situation in the economy, when there is a continuous hike in the price level of the products and the services and on the other hand a continuous decrease in the value of money. However, a fact should be highlighted that there should be a continuous increase and decrease in the price level and value of the money respectively (Makinen, “Inflation: Causes, Costs, and Current Status”). Origins of the Financial Crisis The financial crisis started showing its effect in the early 2007 in the US along with other parts of the world. The companies started hiking their prices to maintain the value of their assets. The maintenance of value became the most important task of any business entity to exist in the market during 2008. The market went down due to such an attack of devaluation of assets. The business entities in order to maintain stabilization in the market started innovating and introducing new products in the markets. However, the introduction of new products in the market does not acquire enough power to beat the effect of devaluation. Rather, it holds the risk of putting the organization deeper into instability. This is so because, when a company adopts any modifications or a complete change in the product, the expenses on the operations of the business increases which may not be recovered in an unstable economy. Moreover, the demand gradually goes on decreasing due to the decrease in the flow of money in the economy. Thus, it carries a high risk to introduce innovations with due consideration to the varying and unstable market (Baily & Et. Al., “The Origins of the Financial Crisis”). During the early 2008, many companies failed to even control their own risk management procedures. They soon started losing their ability to entertain risk in the market. At the same time, due to a massive increase in prices of the products, certain firms got affected by the decrease in demand of their products and services. Besides, the flow of money in the economy decreased due to a vigorous effect of devaluation of money value, decrease in demand and supply and devaluation of assets and institutions. Subsequently, these factors as a result gave birth to inflation (Baily & Et. Al., “The Origins of the Financial Crisis”). The global financial crisis affected the most at the mid of 2008. The financial institutions globally were affected due to this crisis. The stock markets all over the world started diminishing, a large number of financial institutions started winding up. As a result of such significant losses, the governments of each and every country, even in the developed nations were compelled to provide the financial packages to their financial systems. The financial packages signify that the government of a country asks each financial institution to maintain certain reserves in their account with the government. The reason behind entertaining such criteria by the government is to have a control over the money flow in the economy. The financial institutions are compelled to engage a certain deposit of their capitals or reserves with the government. Moreover, the government can increase or decrease the ratio of reserves to be deposited by the financial institutions (Kramer, “Losing Sleep Over Stock Markets: Its the Season”). The government has the power to control the inflation or the deflation occurring in the economy. For instance, if the country is facing the inflation, the government generally decreases the ratio of the reserves to be kept with the government. Thus, the financial institutions as a result get the opportunity to use much of their capital reserves to re-establish their market. The re-establishment involves that the financial institutions can provide loans to the general public at attractive rates which in turn can improve and heal out the effect of the inflation among them. Hence, these are the tactics which are generally followed by the governments to have an effective control over the economy (Kramer, “Losing Sleep Over Stock Markets: Its the Season”). The major effect of the financial crisis was on the United States of America as compared to the other nations. During the 2008 financial crisis, even after the assistance provided by the government of the US to its financial institutions, it could not come out of the drastic effect of the financial crisis. During the crisis, the 6% of all the mortgage loans of the US were in default. Most of the financial institutions of the US were unable to provide mortgage loans to the general public. Thus, the general public kept on going deeper into financial depression (Halm-Addo, “The 2008 Financial Crisis: The Death of an Ideology”; Davis, “The Cause of the 2008 Financial Crisis”). Irrespective of the scenario, few financial institutions provided the loans to few of the customers in the US. As few borrowers were not enough to fulfill a huge number of loan aspirants. Moreover, the loans were being provided to the general public without any verifications of assets and properties or incomes of the customers and even in low rates because the loan aspirants during that time were facing high financial problems and hence were unable to accept loans at higher rates. Therefore, it can be identified that United States of America was the country which was found to be mostly affected by the crisis of 2008. The US Government even after applying various measures could not pull the economy out of the drastic effect of financial crisis (Halm-Addo, “The 2008 Financial Crisis: The Death of an Ideology”; Davis, “The Cause of the 2008 Financial Crisis”). In another significant development, during the year 2005 and 2006, the prices of the readymade homes went high along with the construction charges to build a home. It became very difficult and unaffordable for the home aspirants to get a home to live in. The rent charges and the hostel charges also went high. As a result, many aspirants got attracted towards the mortgage loans which led to a mortgage loan crisis during 2007. The mortgage loan crisis soon effected the financial institutions of the US but as the mortgage financial products had been dispersed in the rest of the nations, the global crisis took birth (Crotty, “Structural Causes of the Global Financial Crisis: A Critical Assessment of the New Financial Architecture”). Consequences After the significant impact in the global economy, the demand of a number of products and services in the affected countries went down putting the real international economy in a drastic situation. During the late 2008, the international economy faced a major loss with a considerable decline in the growth of the industrial production. The industrial production growth was 8.8% in 2007-2008, which went down showing an unexpected deduction to the economists. The industrial production growth went down to a figure of 2.8% in 2008–2009 (April – February) (Mohan, “Global Financial Crisis - Causes, Impact, Policy Responses And Lessons”; Dietz, “Recession Keeps Hold On Eugene”). However, in the real international economy, the service sectors were able to hold up itself against financial crisis. The service sectors entertained an unexpected growth during such a miserable condition throughout the world. The service sectors had a growth of 9.7% during the years 2008–2009. It was because of the fact that service sectors have to spend a comparatively lesser amount in running the operations of the business successfully than the production sectors. Hence, the service sectors did not face major losses but could not maintain the consistent growth in the real international economy (Mohan, “Global Financial Crisis - Causes, Impact, Policy Responses And Lessons”; Dietz, “Recession Keeps Hold On Eugene”). The service sectors had a growth of 10.5% in the year 2007–2008 which reduced by 0.8% in the following year i.e. 2008-09. Even after the devaluation of money and other causes of financial crisis, the service sectors had maintained a sustainable growth in the community services, social services and personal services (Mohan, “Global financial crisis - causes, impact, policy responses and lessons”; Dietz, “Recession keeps hold on Eugene”). The international economy faced deductions in the Gross Domestic Product (GDP) growth by 2.1%, which was 9% in the year 2007–2008 and reduced to 6.9% GDP at the end of 2009. At the same time, the growth of private final consumption expenditure also declined by 1.7%. It was 8.3% in the year 2007– 2008 and reduced to 6.6% at the end of 2009. As a result of such changes in the real international economy, the government final consumption expenditure had a growth of 10.6%, which was 2.7% in the year 2007–2008 and led to 13.3% at the end of 2009. The 2008 financial crisis had a significant effect in almost all the countries i.e., in developing, developed and even in the under developed countries (Mohan, “Global financial crisis - causes, impact, policy responses and lessons”; Dietz, “Recession keeps hold on Eugene”). The countries with good economic policies and effective governance also could not preserve their economies from the global crisis. For instance, the African nations suffered the crisis primarily from direct channels. The direct channels signify the financial sectors i.e., the stock markets faced the fluctuations at a recurring nature and many stock exchange participants lost huge wealth due to the financial crisis during the year 2008. Such similar losses were also faced by the countries like Kenya, India, Zambia, Mauritius, and Botswana (Massa & Willem Te Velde, “The Global Financial Crisis: Will Successful African Countries Be Affected?”) Recommendations Whenever any financial crisis is likely to occur, the public officials along with the governments of the respective countries should identify and start planning certain tactics to avoid the birth of financial crisis. The business entities should employ only reasonable number of employees required to carry out their operations. It may be noted in certain manufacturing industries that there exist a problem of disguised employment. Disguised employment refers to the situation when the business unit is employing the number of staffs than actually required to carry out the operations of the business smoothly. This can help to cut cost in the organizations which can be one of the ways that can help organizations to be better prepared in case of global financial crisis. The financial crisis puts a miserable effect in the real economy of the country which in turn takes a comparatively longer time to restore the smooth operations as it was before the crisis (Atreya, “The US Financial Crisis: Impact on the Indian IT Sector”; Chenery, H. B. & Srinivasan, T. N., “Handbook of Development Economics”). Conclusion The analysis made of the 2008 financial crisis has provided an understanding in relation to the causes and the consequences that resulted in the occurrence of the scenario. Although each and every country started framing plans to ensure the quick recovery from the miserable condition, the crisis lasted for substantial period time. The financial crisis can be made weaker if the financial institutions start providing loans at a relatively cheaper rate before the arrival of the crisis. Providing loans at cheaper rate will have a positive control over the demand of the market. The general public at a very early stage can attain and maintain the stability, if they are provided with appropriate funds at the time when required (Atreya, “The US Financial Crisis: Impact on the Indian IT Sector”; Chenery, H. B. & Srinivasan, T. N., “Handbook of Development Economics”). Works Cited Atreya, Manohar M. “The US Financial Crisis: Impact On The Indian IT Sector”. November 05, 2011. Circle, 2008. Baily, Martin Neil. & Et. Al. “The Origins of the Financial Crisis”. November 05, 2011. Business and Public Policy, 2008. Chenery, Hollis Burnley. & Srinivasan, T. N. Handbook of Development Economics Elsevier, 1988. Crotty, James. “Structural Causes of the Global Financial Crisis: A Critical Assessment of the New Financial Architecture”. November 05, 2011. University of Massachusetts – Amherst ScholarWorks@UMass Amherst, 2008. Dietz, Diane. “Recession Keeps Hold on Eugene”. November 05, 2011. The Register Guard, 2010. Davis, James F. “The Cause of the 2008 Financial Crisis”. November 05, 2011. Accuracy in Media, 2008. Halm-Addo, Albert D. The 2008 Financial Crisis: The Death of an Ideology Dorrance Publishing. Kramer, Lisa. “Losing Sleep over Stock Markets: Its the Season”. November 05, 2011. Huffingtonpost, 2011. Makinen, Gail. “Inflation: Causes, Costs, and Current Status”. November 05, 2011. Report for Congress, 2003. Mohan, Rakesh. “Global Financial Crisis - Causes, Impact, Policy Responses And Lessons”. November 05, 2011. Bank for International Settlements, 2009. Massa, Isabella. & Willem Te Velde, Dirk. “The Global Financial Crisis: Will Successful African Countries Be Affected?” November 05, 2011. Overseas Development Institute, 2008. Read More