Global Financial Crisis - Essay Example

GLOBAL FINANCIAL CRISIS Name Course Professor Institution City and State Date: Global Financial Crisis The substantial worsening of global dimensions not occurring in closed economies is known as the global financial crisis. This excludes situations like poor performance of the national economies leading to problems of debt servicing and crises affecting the currency forcing countries to adjust their stock exchange rates (p.4). During the 1990s, six financial crises in the international boarders experienced include Mexico (1995); Indonesia, South Korea and Thailand (1997-8); Russia (1998); and Brazil (1998-9). The articles under discussion present similar factors contributing to the present global financial crisis. The authors have researched well on the topic under discussion and have given solutions and measures of preventing the increase of financial problems. It is evident that the articles present economic proficiency and knowledge regarding the causes of global financial crisis in relation to structural factors. According to Richard Ely, common elements mentioned consist of current accounts dramatic swing, actual depreciation and output decline. However, he mentions three basic elements contributing to the current financial crisis experienced around the globe. Substantial inflows by investors in both foreign and domestic markets contributed to the reduction of asset stocks in affected countries with the aim of initiating fundamental change. The contributing factors to this crisis encompass sources viability of the stock exchange government that includes large concerns of fiscal deficits (p.5). Also, salience increase of long-standing weaknesses of the financial sector relating to banks supervision, inadequate capitalization and excessive guarantee and leverage. This, combined with directed lending is known as crony capitalism. Secondly, emerging markets shifted to investigating the behavior of other shareholders rather than the current situation in the country. This facilitated high rates of withdrawals, which attributed to financial crisis in countries like Mexico and South Korea. Shareholders behavior should be examined before looking at the current situation of the country in question. By not following protocol, shareholders will be given the chance of withdrawing large sums of money that they are not able to pay out and thus, increasing the financial risk of the bank and country. Lastly, all the above factors aggravated the financial-market response. For example, exchange rate depreciation reduced incomes and spending habits of citizens, which increased capital flight pressure. On the other hand, foreign currency increase of their domestic value and creditworthiness reduction of borrowers in the domestic market degraded the ailing financial system. This caused additional lending reductions and fundamentals worsening. Richard also explains the causes of financial crisis in the global economy in relation to contagion models and explanations. They include common shocks simultaneously hurting countries dealing with export of commodities; trade transfer linkages relating to price and demand shocks from one country to another; competitive devaluations of competing third market countries, which promote currency depreciation of countries; correlations of asset-market as a result of financial linkages; liquidity of markets; investors irrationality elements and external reputation of individual countries (p.6). High tariffs related to exporting goods spills over to the financial situation of the country, which increases the risk factor for the economy in the global market. Market liquidity is a common financial risk as it affects the trading principle of commodities used by citizens affected by the financial crisis; it affects the tariffs and terms of trade. The Liberals and Democrats workshop talks about the international financial crisis by looking at what one can ponder on with regard to the current crisis. Policies, market structures, coordination of policy adequacy and whether countries have learnt any lessons from other countries crisis by altering policies in a timely fashion are some of the issues under debate. Other issues include the role of ethics in businesses, paradigm shift and policies theoretical underpinnings (Alliance of Liberals and Democrats for Europe 2008, p. 20). Macroeconomic imbalances and inconsistency of policies and self-fulfilling prophecies are significant causes of the crisis. Other roots of crisis comprise a balance sheet mismatch (financial sector); maturity and currency mismatch; problems associated to capital structure and solvency (structural dynamics). Structural and cyclical factors are roots of the current crisis. Under structural crisis factors, one notes the presence of domineering paradigms (Alliance of Liberals and Democrats for Europe 2008, p. 21); dramatic rise of capital markets role; increased use of emerging financial instruments in the globe; origination and distribution flaws of new businesses; market participants’ conflict of interest; and excessive saving plus global wealth redistribution among other factors. Cyclical factors consist of increased gap between high returns and low capital costs, irrational low credit risk stretched across all instrument and excessive low maturity risk interest rates (Alliance of Liberals and Democrats for Europe 2008, p. 22). Niinimaki’s article is on collateral (house property), analysis and research on the moral hazards of the banking sector with regard to hazardous effects of deposit insurance. Loan terms should not be loosened at any point, but in this case, lenders loosened the terms, which led to the collapse of real estate markets (Niinimaki 2009, p.515). Loan agreement terms are used to facilitate interest rates of bank loan, which ensures that banks receive a small percentage to cover the period money was given to the borrower. This enables the bank to lend out money to other borrowers who fit and are capable of returning the money without defaulting. Having insufficient collateral value covering the loans guaranteed as a result of weakened credit assessment of banks contributes to financial crisis. Credit assessment enables banks to evaluate the right candidate to be given a loan on agreed terms, which should be strictly adhered to in order to ensure that activities of the bank are not put on hold. Banks focused mostly on raising land value, funded by loan capital, and forgot to analyze loans underwriting policies. The willingness of banks to finance projects that deem to be unproductive is a financial crisis for countries. This is because their assumption is based on the value of collateral appreciation level. Failure to this leads to the collapse of key banking sectors lending loans to customers and countries. Policies need to be analyzed and evaluated to ensure that one understands and conceptualizes the loan guaranteed. At some point, banks may decide to add risk mitigation (collateral), which increases volatility of loan returns (Niinimaki 2009, p.516). Risk mitigation increased at some point is unfair and results in a series of problems relating to the financial situation of global markets. In other words, collateral has been viewed as a risk-taking instrument because, the bank refrains from costly efforts imposed on the borrower’s evaluation. This is because, all decisions regarding money lending bases its efforts on collateral. Oversight macro prudential of given financial markets dynamics talks of both upcoming awareness of structural alteration and the capability to evaluate system stability impacts. Systemic risks of many organizations affect their risk liquidity and capital having ensuing negative effects on real markets feedback. Some of the international financial crisis explained in this article relate to the macroeconomic situation and the variance existing between financial and economic variables (Niinimaki 2009, p. 517). Economic and financial variables of a given country need to match in order to facilitate the reduction of macroeconomic factors relating to the environment. Other micro financial factors include contagion, panic, structural market patterns and confusion (endogenous processes). Structural fragility (instability) is when financial systems are vulnerable due to organizational patterns of available systems in the organization. Structural instability increases risks associated to internal breaks risks while intensifying sensitivity of financial markets to both external and internal shocks (Gramlich, Mikhail & Oet 2011). Yield curve and default spreads are observable factors included in early research whereas; spillovers into the financial markets comprise the non-observable factors. Emerging financial crisis issues look at financial market behavioral change due to emerging innovations in the production and processing industries and transition financial regulation. This has led to increased market liberalization, and stronger requirements included in financial requirements. In this article, contagion effects relate to run-like behavior, fire sales, real economy spillovers, direct losses and management of back-office. In their assumption, contagion exposed banks lending structures to incomplete structures, which relates to different loss rates (Gramlich, Mikhail & Oet 2011). This has increased financial crisis in the global market as it affects the GDP which in turn, affects the income and living standards of citizens. Greater diversification risks give room for more extensive linkages in finance, which increases potential disruptions that might spread quickly across markets. In short, diversification increases benefits of portfolio on a micro level whereas, on a macro level, contagion is risked. Connectivity and concentration models also contribute to international crisis in regard to finances. Connectivity in this case refers to risk players/classes providing effective risk transmission channels affecting financial systems. In regard to concentration institutions, it has affected risk mitigation degree within the financial system. Modern techniques and instruments of financial terms include transfer of credit-risk, securitization and leveraging matters (Gramlich, Mikhail & Oet 2011, p.278). Large scale accounts of extensive leverage by market participants have become scarce. As a result, this brings about low returns and reduced volatility due to the spread of globalization and traditional markets opportunities. Other factors of structural fragility include diversification with regard to the size of institutions, correlation, complexity promote, volatility and rationality of participants. Good money lending behaviors are promoted through monitoring of clients in order to assimilate their current financial situations. Global financial crisis affects the current trend of trading patterns, which spills down to the living conditions and economic status of the country’s economy. Understanding the present financial crisis in the country is a step to reducing the current collapse of the stock exchange markets Gramlich, Mikhail & Oet 2011). Economists should educate and enlighten leaders on how to understand the present cause of financial, global crisis. This reduces the chances of promoting financial crisis lowering the standards of living by imposing high tax rates on exporting commodities. The modeling framework in question as presented by the authors gives an in-depth analysis of interactional models and elements of financial systems on the components featured. This includes comprehensiveness, flexibility, consistency, looking forward and suitability on corresponding empirical data. Financial systems need to forecast on future trends of the bank’s prosperity by ensuring that they are sufficient in reacting to common variables of financial crisis. In summary, all the articles share the same information with regard to international financial crisis. Indiscriminate lending habits, complexity of financial products transparency reduction and high costs of leveraging are factors attributing to solvency problems. Enhanced system fragility has been attributed to reduced transparency and contagion effects, which encompass outstanding deficiencies in agencies ratings like slowness in reaction and conflicts of interests among others. Increasingly financial products, defective incentive schemes and speculative trading are some of the magnified crisis with regard to depth and breadth of increased complexity. The present financial crisis roots the cause to structural and cyclical factors attributing to nature of product range of financial innovation aspects, which emphasizes principal banks origination and distribution measures. List of References: Alliance of Liberals and Democrats for Europe 2008, ‘The International Financial Crisis: its causes and what to do about it’? Gramlich, D, Mikhail, V & Oet, M 2011, ‘The structural fragility of financial systems: Analysis and modeling implications for early warning systems’ Journal of Risk Finance, vol. 12, Issue 4. Niinimaki, J 2009, ‘Does collateral fuel moral hazard in banking?’ Journal of Banking & Finance, vol. 33, Issue 3, March, pp. 514-521. Summers, H 2000, ‘International Financial Crises: Causes, Prevention, and Cures’, vol. 90, no. 2, pp. 1-16. Read More