Current Financial Crisis - Example

Running head: Current Financial Crisis Current Financial Crisis [Writer’s Name] [Institution’s Name] Current Financial Crisis Abstract In the underlying report, we have to locate the causes and effects of the current economic crisis. What the reasons are behind that and how it became to be the cause of certain disintegration that affected the economy of the whole world. Introduction In the contemporary era, the world’s economy revolves around the super powers, which create a monopoly, extract surplus to the other countries and accumulate wealth. The economy is not stagnant; it always moves in a circular manner rather than linear. It is not the case that economy only affects particular regions; in fact it has left its effect all over the world and has generated a crisis. Crisis always emerges due to weak policies made by the metropolitans. The history of economic crisis goes back to the “Great Depression” that started in 1929-1935. It gives us a brief understanding of the economic crisis. America had joined war late; during the war America was the only stabilized economic country and she had financed Europe for its reconstruction. America had invested a lot in the making of Europe. Due to this financial aid the American economy had declined, due to the accumulation of debt and ultimately the economy boomed. The sole aim of the war recovery was to produce more capital; the American economy was most affected in this era, due to lending the loans. There are various causes behind these crises. It is possible that it was due to the weak institutions, inflation, unemployment and agriculture. So here we will locate some cause and effects of the current economic crisis. The crisis first started in the 1930’s but the remedies for removing that crisis remain since 60 years. Now some new suggestions are required to overcome this financial crisis. There must be some monetary institutions like IMF. Also, banking system must be stabilized. Causes and Effects of Economic Crisis The collapse of the American co-operative sector in the midst of the global financial crisis and its co-committed efforts on the European economies has set tide global recession. Besides, it has also exposed or brought about some inherent flaws of global capitalism ranging from mindless deregulations to the limitations or fragility of market economy. The first cause may be ascribed to the present crisis in increasing greed. It has been a tendency of the capitalistic dispensation / system to always allow for this excessive greed in the name of innovation, creativity, individual enterprise and incentive for progress. So, this resulted in a concentration of wealth and development of monopolies and cartels. Unfortunately, this behavior is not confided to individuals; rather it also provides justification for various civilizations like colonialism, imperialism exploitation and other forms of human exploitation. This greed becomes more conspicuous after new liberal consumers, which necessitated minimal role of state and supported doctrine of deregulation. In the context of the present crisis, this led to the phenomena of credit expansion through banks without under substantive state control, which invariably led to the accumulation of huge amount of risk capital. Thus this very phenomenon led to the bubble economy. Another manifestation may be described as a lack of restrain on banking sector which permits this sector to steer away from state control. In this situation it is eventually the collapse of the banking system. There is no check on the prevention to defaults of bank. In this case, there are some private financial systems or institutions that may exists other than banks. They start offering deposits that are slightly risky. They also pay higher returns than the traditional banking systems and these may include actual banking, insurance companies, housing loans etc. A foreign investor depends upon many multinational products for the production of high commodities. A fall in any raw material producing country also harms the production of foreign investors. Another cause brought about by the global recession is the ferganity of public confidence. This is mainly due to the absence of any medium of exchange i.e. it is free from default risk. This is basically concerned with the nature of the financial sector. One more cause of global crisis can be traced in the failure of IMF and its member countries, to anticipate the crisis and to initiate the preventive measures. Also, the cause responsible for the economic crisis of capitalism is limited market structures, which are laid bare by the present economic crisis. It has smashed various myths about the crisis that they provide stability. These are also self correcting and can function as deregulation capitalism. These can ensure more prosperity and stability outside the state control public policy. Current crisis are linked with the past and with the rise of capitalism. Where the economy was based on the mode of production, these modes of production determined the social relation that gave birth to industrialization. With the arrival of industrialization, capitals began to consume with metropolis, they extracted the surplus from the satellites. With the advancement of technology the capital also invested high amounts, multinational played a remarkable role in creating its monopoly over the third world countries. Resultantly, it caused a boom in the economy. In the recent years the economic crisis emerged due to credit- debt scheme which was exercised in US & UK at a higher level. Another cause which contributed to the crisis was the defective regulatory mechanism of capitalism. Which not only resulted into regulatory finance but also led to the accumulation of capital into one sector of economy i.e. finance market and these markets was far less stable than other markets fir goods . The economist also maintained that false expectations often arise in these markets. Many expected the rise in real state price in America. The role of state in finance system was credited as backwardness of a country‘s economy. So demand of housing finance was to be fulfilled by private sectors of economy which ultimately led to deregularization. It was remained successful in accumulation of 2.3 trillion dollars but inefficient in regularization. Germany and Russia as being private investor was also involved in this act. Governments are interdependent only in case of finance but not in case of regularization (causing less harming their economy). Turn of housing cycle in U.S. & U.K. is the first and foremost root cause of the turn of housing cycle. The policy made buy the U.S & U.K governments, that every one should have his house / house ownership. The procedure is very easy to buy the home, they have to pay lease of house to bank every month, and after few years they become house owner. Issue of over valuation of asserts by financial companies, the overvalued real sector due to scarcity of land and huge finance, they do not take into consideration the gloomy scenario rather they overvalued asserts of the future. In 2006, the buying mortgages for packaging, the bank exported to the rest of the world a profusion of asserts that were overvalued by the finance companies that purchasing them. The rating agencies which made their calculation based only on rosy scenario and never on a worst case basis, these rating agencies also complicit in this over valuation. Another cause ascribed to global financial crises is the issue of sub prime mortgage which led to increasing involvement of risk capital. Bank sold more and more of new types of security, in which hundreds of mortgages are receivable with roughly the same risk with credit worthiness, the same risk with credit worthiness, were combined into a simple security, as a bundle of highly risk loans. It was not expected that the borrower would default the mortgage at the same time. Banks were intermediary who don’t have to provide loan rather the security which was converted through the issue of bonds into new flow of finance. These bonds were to be providing to investors in order to hedge their risk capital. Besides these modalities, this mechanism further involved the issue of SPV (Special Purpose Vitals). Through the SPV, all the payments of interest as well as redemption of bonds were legalized. In this whole process the lender was to be bestowed with re-salable bonds while the borrowers’ investor got loans from lenders, whereas the bank was neither land nor borrower; rather bank performed only intermediatory function and just provided security among them. Another cause which contributed towards the financial crisis is the fluctuation in rates of interest by financial reserve bank of USA. For instance, in 2001 it lowered the rate of interest, but it doubled it in 2006. In 2001 some borrowers were encouraged to buy as many houses as they can. But 2006 proved to be reciprocal in this activity. The federal reserved bank did not increase rate of interest. Therefore, many mortgage borrowers chose to turn over their keys to bond for sale of their house. This caused panic in the whole market. In US if the loan is 1/3rd of income they have to pay but if it raises more they don’t have to pay and many of them became defaulters to their payments to bank. The supply of houses due to the withdrawal of borrower was becoming extremely large and the demand was zero. So the prices of property were reduced to such a point that was even lower than the amount spent upon them. Profit was a far away concept only, original was different to gain things led to vicious credit. The price fell to such an extent that for many buyers the amount they owed to banks was more than the value of the house they owned. This situation of negative equity led to more defaults and vicious cycle was in full operation. As all profit had to belong to state that is why they made overvaluation by considering the value of housing ever increasing. Moreover a person also got a house and when he became unable pay them to government got money by selling houses. Low rate of interest at the of lending attract many a investors on the country, after a few years , increase in rate of interest , approximately doubling, discourage and ultimately compel to sell their house, rewarded in the scheme. The investor demand their money back from banks, and bank only own securities of that houses not money, refuse to return causing global financial crisis. The hugest companies of the world was also involved in this business, throw this effect to whole world. Small investments like Pakistan save it from huge catastrophe but it got less in did grant because such crisis effects its major donors. CDS (Credit Demand Swap) asserts was converted into bill exchange which further converted into exchange and re exchangeable bill. It resembles an insurance policy as it can use by the debt holder / investor to hedge i.e. insurance against risk. It is such kind of capital lending which do not have asserts against it. Bankers take into account asserts of borrowers before lending loans to avoid risk capital. In this case the lending was against such houses that were not in existence at the time of lending. So bank was facing huge risk capital securitization. The substitution of securities for loans i.e. the banks instead of lending to customers, accepts a bill of exchange or any other security from them. Securitization converts inflexible asserts i.e. long term bank loans into readily salable papers. About 2.3 trillion dollars involves the new concept of securitization, involved, loans or group of loans which were to be disbursed through banks. But not in a sense that the bank was to provide those loans rather banks were to provide security only. Another caused for this is the failure of financial markets, is also responsible for global financial crisis. The markets are supposed to be a means of an end a more prosperous and stable economy but a result of goal allocation of revenue and better management of risk. But financial market failed to play role as it supposed to play i.e. the financial market could not manage the risk rather they create it. The uncoordinated macroeconomics policies have contributed to Europe problems. Because the macroeconomics policies as it is related to one’s country was confided to its specific economy. There is no macroeconomic policy for global financed. The collapse of American co-operating sector is one other cause. The financial crisis felt some main American organizations e.g. Fradimmme Mae and Fanni Mae. They were mortgage against, who owned or guaranteed about half of Americans ($ 12 trillion mortgage). The other were Lehman Brothers, were largest fourth bank. It collapse and filed for bank corrpcy. It was under $ 23 billions of debt. The Americans has find $ 713 billions takeover, in which American would levied tax upon it. All these causes and its deal at the macro and micro level or in other sense the part of macroeconomics or microeconomics, which deals with the world economic policies, all these causes pinpoint certain notable effects, which obviously belong to the world economy. When the crisis emerged at a micro level it wiped out the whole menial industries, it dispossessed the labor class, the working class expelled poorly, rate of inflation rose due to zero demand and the rate of unemployment rose. At a macro level, it left disastrous effects because high amount were being invested in the real estates and banking corporating sector. When capital was invested in soaring quantity, resultantly the surplus consumed due to demand and supply. Third world or underdeveloped countries were affected by these entire economic crisis; they already depended on the metropolis countries. At a macro level, banks became defaulted, consumption of capital, the monopoly created by the oil producing countries, strategies and policies made by multinational. The phenomenon of crisis in economy brings drastic changes in the lives of the people both at micro and macro level. The other effect that left a mark on people is the credit. Credit is often taken as a cash power, or as an instrumental tool. It fulfilled our demands. But in the current economic crisis this led people towards recession. Because, in economic system, there is a certain trend that creates or holds the capital. When these trends were over produced and supply was near to the ground, the economy boomed. Despite the preventive curatives strategies, one thing is clear that the occurrence of economic crisis cannot be prevented or kept beyond certain limits. As any system whether economics or social, is the product of human situation and these systems are contextual. Therefore, any system is not perfect and is prone to limitations, but if these limitations are not addressed, eventually it leads to a crisis. The crisis may further lead to a collapse that eventually may intense catastrophic implications which may further compound human miseries. Therefore, a concrete effort must be made to avert these crises. The need is to legitimate the crisis and to strengthen the institutions. We clearly need a new co-operative economic frame work within the states in order to address or overcome the inherent tension between unregulated globalize finance and system of regulation rooted in the nation state. Dollar reserved system is being already fray. Dollar had not proved to be good store of value. World moving dollar, euro or dollar, euro and yen system, could be even more unstable. We need a global reserve system i.e. it required to a globalize solution. We have a global financial system but we are leaving its management to that of individual country. This system cannot work e.g. it is inconvincible that America would have prospered, laid it left the management to global financial system upon it 50 prosper states. The global crisis need globalize solutions. Therefore, new rules and regulations should be formulated in order to negotiate the recurrence of such global financial crisis in future .of course detailed institutional or legal knowledge ids required to construct such regulations or rules. Moreover, the concerted response is requiring from all the stake holders. References Blanchard, O. (2008). Cracks in the system. Finance and Development, (December). Collyns, C. (2008). The crisis through the lens of history. Finance and Development, (December). El-Erian, M. A. (2008). A crisis to remember. Finance and Development, (December). Kilmister, A. (2008). The Economic Crisis and its Effects. Retrieved 09 September 2009, from http://www.internationalviewpoint.org/spip.php?article1581 Sacasa, N. (2008). Preventing future crisis. 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