Causes and Implications of the Global Financial Crisis - Essay Example

GLOBAL FINANCIAL CRISIS Student’s Name: Instructor’s Name: Course Code: Date of Submission: Executive Summary Global financial crisis is the situation which arose that led to unstable global economic stability. This report discussed the GFC and how it came into existence. It started back in the United States and spread to all other economies globally. The main causes of the global financial crisis as discussed in this report include increased use of electronic money, ease lending conditions, housing bubble in America and ineffective application of the monetary and fiscal policies. The implications of the global financial crisis discussed include high interest rates on bonds and shares, low economic growth in low income countries and decline in GDP of many economies. The regulatory actions taken to manage the global financial crisis include effective application of monetary and fiscal policies and schemes for sharing risks. This report therefore discussed in depth of the global financial crisis, its implications and regulatory actions taken to manage the situation. Table of contents Introduction………………………………………………………………………………………4 Causes of global financial crisis…………………………………………………………………..4 Implications of global financial crisis……………………………………………………………..5 Regulatory against GFC…………………………………………………………………………..7 Conclusion………………………………………………………………………………………...9 References……………………………………………………………………………………….10 Appendix…………………………………………………………………………………………11 Introduction Global financial crisis is the situation where many consumers and businesses face difficulties in terms of economy. It is the situation which affects all the business operations globally, making it hard for the both consumers and markets to sustain their operations. The global financial crisis showed its roots back in the year 2007. Since the crisis started, there have been many impacts on all economies globally. Global economy comprises of many economies coming together to conduct business operations (Fried 2012). If global financial crisis is not well managed, it could lead to severe effects which could make it hard for many markets and businesses to succeed. In this regard, this report will investigate various aspects of the global economy. First, it will look at the causes of global financial crisis, its repercussions and the regulatory responses which have been taken to manage the global financial crisis. Causes of global financial crisis The following are the main causes of the global financial crisis. The first cause is the growth of the housing bubble in America. The prices of the American houses in America increased by 124% between the year 1998 and 2006. The household income median ranged between 2.9 and 3.1. The effect of the housing bubble is that many households had the opportunity to finance their own homes. Unfortunately, in the year 2008, the prices of the houses in America declined for about 20% (Harman 2009). This implies that the borrowers who had borrowed the money could not refinance so that they can be able to avoid the interest rates which was increasing steadily. In the year 2008, there was 9.2% of the mortgages which were either foreclosure or delinquent. This implies that many borrowers could not be able to repay the mortgages and this affected the performance of other markets globally leading to financial crisis. Appendix 1 below indicates the median and average the houses in America cost between the year 1963 and 2011. Another cause of the global financial crisis is the easy lending conditions. Before the year of 2007, there was easy lending of financial resources to the borrowers. This is because there were low interest rates, which encouraged borrowing (US Bureau of Economic Analysis 2013). The federal funds were reduced from 6.5% to 1.0%. Through this high borrowing, the government of US experienced a high deficit. Between the years of 1996 and 2004, the government of US experienced a deficit increase from 1.5% to 5.8%. To manage this deficit, there government of US had to borrow from abroad large sums of money to bridge the deficit. Many foreign firms and investors invested in the US market. The adjustable rate mortgage increased the interest rates, thus the homeowners found it expensive (Woods 2009). The housing bubble as a result deflated and the prices moved inversely to the interest rates thus it was risk to invest in the housing sector. The impact was that the government of US could not be able to repay back the large sums borrowed. This affected the global economic stability since many investors invested in the US market which was facing financial difficulty. Appendix 2 below indicates the US current account deficit which led to borrowing large sums of money from abroad as explained above. In addition, another cause which led to the global financial crisis is because the US government allowed excessive use of electronic money (Read2009). There were computer aided designs which helped to improve communication among businesses and the transactions were faster. This implied that the exchange of money. The effect was that the money lenders increased their lending rates which increased the money supply. There were many borrowers due to easy access to financial resources. Unfortunately, as the interest rates increased it was difficult for many borrowers to pay back the money taken in form of loans. The number of creditors increased and because many of them failed to pay back their loans borrowed, many of the lending institutions became bankrupt (US Bureau of Economic Analysis 2013). In this regard, there was no more finance to give as loans to investors hence the investment rates declined leading to unstable economy. Since US economy determines the global economy, this unstable economical situation led to global financial instability as it affected all the economies which depended on US for business. Implications of the global financial crisis The global financial crisis has had great implications on the global economy. To start with, during the time of the global financial crisis, the money in America became very expensive due to high interest rates. Initially, people invested in banks, but since the global financial crisis hit the American banks, many investors felt unsafe to invest banks (Fried 2012). This is because the investors felt unsafe to invest in banks since banks became bankrupt due to large sums of money borrowed and many investors failed to pay back the borrowed cash, hence the investors feared that they could not get the return on their investment. This lowered the economic growth of US GDP. Another implication of the global financial crisis is that it led to decline in the gross domestic products of many economies. This is because there was a market crash in terms of stock which affected the markets and there was a depression. The most affected economies are the economies which depended on oil. For instance, Saudi Arabia’s economy was greatly affected since it could not export oil to the American market. Since Saudi Arabia contributes to about 70% of the gross domestic products of its economy, the country’s economy was affected negatively (Zarrouk 2011). The global financial crisis led to severe in developing economies or low income countries. Since many of the developing countries depended on international funding for their growth, this financing has been declining due to lack of finance to fund the development projects in the low income countries. Due to this effect, there is investor liquidity needs and have moved to high quality assets. However, in late 2008 the low income countries proved to improve their stability (International Monetary Funding 2009). Since many of the banks in the US and other global economies became bankrupt, many of the subsidiary banks were closed in the low income countries due to low liquidity. Many of the LIC which includes Albania, Kenya and Zambia have postponed their plans of issuance of since the liquidity risks are increasing as indicated. Because the global liquidity conditions have tightened, the financing of businesses and markets have been greatly affected. The financial crisis has therefore led to constraint in accessing finance by low income countries like Lesotho and Pakistan. In addition, the banks in low income countries have also been impacted. There is the direct impact of the global financial crisis on the bank systems in low income countries. This is because there are several controls of capital in many countries as well as the structural factors which have impacted on the banks due to the global financial crisis. The result is that the banking systems have no or little exposure to financial instruments which are complex. This has led to lower risks in banks and the potential of banks making losses have been minimized and has also led liquidity and domestic deposits to cost low (International Monetary Funding 2009). In this regard, the domestic banks have been able to finance themselves locally and therefore their balance sheets have low wholesale leverage. In this regard, the local banks are becoming more liquid which implies that they are making more profit margins thus creating up buffers in the capital. Another implication of the global financial crisis is that it led to damaging of many industrial sectors globally. This is because there was a declaration in terms of credit which resulted from the corporate sectors. The main sectors which were affected include transport and consumer product sectors. These sectors were greatly affected because there was a decline in consumption among the consumers (International Monetary Funding 2009). The impact was that many sub sectors were affected since the rate of conducting business declined and therefore the global financial crisis affected the sub sectors which also affected the end user of the products who are the consumers. Global financial crisis led to crashing of many stock markets in the global economies. This is because many investors lost confidence in investing in stock markets. Due to lack of confidence, there was a mass sale of shares in many stock markets. The sale of shares was a higher than the demand for the shares which implied that the prices of the shares declined. The most likely impact was that there was a depression in the stock markets (Woods 2009). Most of the financial institutions were affected negatively by the global financial crisis. The profitability of banks and investments declined, thus loans became hard to access by many investors, thus investments declined which implies that each economy experienced decline in productivity thus lowering the economic growth. Regulatory responses to global financial crisis Since the global financial crisis affected al the global economies, there are regulatory responses which were imposed by many economies. To start with, The Federal Reserve and European Central Bank (ECB) had the efforts of managing the liquidity issues by providing short term credits. This was intended to restore confidence among the investors (Woods 2009). The aim of the short term credit was to ensure there credit flowing so that the businesses do not come to a standstill. This helped to ensure that world trade continued to flow. Various governments have since then implemented the fiscal stimulus policy so that their economies could grow. For instance, in the US, the stimulus programme amounted for about 1% of the gross domestic products. The government also took the economic stimulus in the form of tax rebates. Another regulatory response to manage the global financial crisis was the government strategies which were imposed to manage the investments and the repercussions of the global financial crisis. For instance, the government of Saudi Arabia applied the fiscal policy to manage the price of bonds. Through the fiscal policy, the government was able to lower the interest rates (Zarrouk 2011). The aim of lowering the interest rates was to attract investors into the economy so that they can create investment opportunities to create employees to improve the productivity of the economy. The Supreme Economic Council announced that there was a plan to encourage investors and improve their confidence by guaranteeing local deposits. Through the local funding, there was high liquidity, which helped to improve various sectors in the economy thus stabilizing the economy of the country. The government of Singapore took the initiative of developing a scheme which could help to ensure there is risk sharing. This special risk sharing scheme provided the employer should a grant to their employees depending on the wages of up to 12% of the employees’ salary. The implication of this scheme was that the employers should retain their employees. The employers feared the scheme since it forced them to retain the employees despite the economic downturn (Read2009). When there was an economic downturn, the employers could not be able to lay off their employees since they still have the grant to repay and laying them off implies that they could not recover the grants. In this regard, their risk sharing between the private investors and the government. The scheme also ensured economical stability despite the economic downturn. This is because there was no retrenching of employees as a way of cutting down costs, hence there could always be employment opportunities for the employees. In addition, many governments effectively applied the monetary policy to manage the global financial crisis. The monetary policy is made possible by the operations of the central bank. Through an effective application of the monetary policy, it was possible for many economies like the Chinese economy to manage the supply of money (Read2009). The government wanted to encourage investments by ensuring stability of its currency. This could help to attract investors into the economy who will improve the productivity of the economy. This policy was successful in UK thus promoting the economic stability. Conclusion Global financial crisis is the state of being unstable in terms of economy. Global economy comprises of many countries involved in world trade. GFC started way back in the year 2007 and 2007 and it affected the economic stability of many countries globally. It started from US and speared to various economies. The main causes of the global financial crisis include increased use of the electronic money and lack of effective implementation of the monetary policy by the US government. Others include easy lending conditions in American and housing bubble in America. The implications of the global financial crisis are high interest rates both in America and other economies, decline in gross domestic products, low development in low income countries and led to crashing of global stock markets. The regulatory responses to the global financial crisis include managing liquidity issues and effective application of tools like fiscal and monetary policies to stabilize the supply of money and encourage investments. References Fried, J 2012, Who Really Drove the Economy into the Ditch? New York, NY: Algora Publishing. Harman, C 2009, Zombie Capitalism: Global Crisis and the Relevance of Marx / London, Bookmarks Publications. International Monetary Funding 2009, Implications of the Global Financial Crisis for low income countries, IMF. Read, C 2009, Global financial meltdown: how we can avoid the next economic crisis / Colin Read, New York, Palgrave Macmillan. US Bureau of Economic Analysis 2013, Gross domestic products, Bureau of Economic Analysis, US department of commerce. Woods, T. E 2009, Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse, Washington DC., Regnery Publishing. Zarrouk, J 2011, The Global Financial Crisis and Channels of Influence on the Economies Of the Arab Countries, Arab Monetary Fund. Appendix Appendix 1: Average cost of houses in America Appendix 2: US trade deficit and GDP Read More