The Global Crisis of 2007 - Example

The Global Crisis of 2007 Name: Instructor’s Name: Date: Abstract A financial crisis impacts negatively on the economies of many countries. More so if the crisis spreads to the global market, the economies of international communities and countries get destabilized completely. This is a paper which discusses the components of the global 2007 crisis. The components were both microeconomic and macroeconomic. One of the microeconomic components discussed in the paper that caused the global 2007 crisis is the regulatory philosophy of “hands-off” also known as laissez faire. The other microeconomic components of the 2007 global crisis discussed in this paper are the global financial integration and financial innovation. On the other hand, the macroeconomic component of the 2007 global crisis discussed in the paper is there being large global imbalances between high-savings and high-spending nations during that period. The paper also discusses the impact of the global 2007 crisis on the international economies. The paper finally recommends what should be done in case of a financial crisis and to avert future financial crises. Introduction A financial crisis is an economic situation where a country’s system of banking cannot sustain its operations that involve intermediation between the people who save and those who invest (Gerber, 2001, p. 12-4). With the rapid development of economic integration, it is much easier for a financial crisis to spread across a country’s borders and eventually become global. A financial crisis could also occur when a nation’s currency declines in value suddenly and in an unanticipated way. As a result, the country cannot engage in international trade as easily. The economies end up plunging in severe recessions. Mostly, it calls for the governments to bail out certain financial institutions as a remedy for financial crises (Jones, 2009, p.2). The effects of financial crises can be quite severe because it involves acute rises in unemployment rates and inflation. The general cost of living becomes a scare. When a country’s population is in a struggle for bare survival, the individual households will most likely reduce their consumption. This cuts down the demand of the economy’s products. Households exhaust all their available assets in order to survive the harsh economic times that characterize a global crisis. The 2007 global crisis was majorly caused by acute macroeconomic imbalances in the United States. There was a very sharp decline in US housing prices in 2007 after an equal peak earlier in 2006. This resulted in most homeowners owing more than they could refinance for their housing loans. A fluctuation in oil prices in Asia also contributed to this crisis. What followed were banks raising their interest rates and intense exchange rates as the crisis spread to other parts of the world. To date, most economies are still reeling from the effects of this crisis. The main terms used in this paper are international crises which could involve banking crises and/or exchange rate crises. Components of the Global Crisis of 2007 Microeconomic Components Financial Innovation It is notable that over the past years the financial markets have morphed and developed by a very large margin. Many financial institutions have gone international in the recent past owing to the lack of regulation in the financial market (Norgen, 2010 p. 27). This sort of innovations in the financial sector led to the up rise of a very complex system of networks among these institutions of finance. The main cause of these financial innovations was a developed theory of finance and a technically advanced market in the financial infrastructure. For instance, the securitization of banking systems was a financial innovation that was embraced by many banking institutions in the past years. It was perceived as a measure to obtain high returns and cut down on risks in the banking sector. Securitization was meant to ensure investment of assets in people with a better managing ability for the assets. However, with the financial crisis that occurred later in 2007, it emerged that all that the securitization achieved was an acute lack of reconciliation between the bankers’ books and those of investors. Global Financial Integration The recent past has seen many financial institutions integrating their position on a global scale. This kind of integration of financial positions makes developing economies very vulnerable as compared to the developed ones (Lane, 2012, p. 2). The global financial integrations before crises are normally very fruitful especially for the advanced economies. Such integrations result in a developed scale of international trade and an increase in the gross financial flows. The other advantage of global financial integration before a crisis is that it can enable nations to specialize in diverse fields then come together for trading purposes. The surge in global financial integration definitely contributed a lot to the development of the global crisis of 2007. The investment by foreign banks in U.S.A made the regulation in the banking sector less effective. As a result, the banks developed much more rapidly and increased their lending capacities. This is because the banks could even lend to international investors within the U.S. The global crisis of 2007 was also caused by a vulnerable credit market in the United States. It is definite that an increase in the scale of these credit markets was majorly fuelled by the rise in global financial integration (Lane, 2012, p.9). In addition to that, global financial integration contributed to there being massive imbalances of accounts in the economies. This is because it was much easier for domestic savings to be channeled outside the countries while funding from external sources also was much easier. An increase in securitization in the U.S was also a result of this global financial integration. This securitization ended up to be one of the major causes of the global financial crisis of 2007. Global financial integration also caused the spread of the financial crisis across multiple nations. This is because evaluation of ownership of foreign assets was not very easy with the widespread integration of financial positions. The exchange of currencies, goods and services across borders was also a contributor to the spread of the financial crisis across global borders. The Regulatory Philosophy of “hands-off” or Laissez-faire The regulatory philosophy of laissez faire involves the government withdrawing any tariffs and subsidies or any other restrictions from private transactions. Economic analysts have brought forward the finding that such deregulation on economies served as a leeway for some individuals or groups to obtain massive wealth (Caldentey & Vernengo, 2010, p.10). This is a widespread form of capitalism that has come to be embraced by many governments. However, what the governments fail to realize is that the laissez faire deregulation leads to massive frauds in the economies and their eventual collapse. The regulatory philosophy of laissez faire does not feature redistribution of wealth in the economy (Wadhhwa, 2012). Once the wealth from sectors with higher production cannot be transferred to those sectors with lower production, the populace is highly demoralized. They are demotivated from working hard in innovation and production circles. It should be noted that not all people have similar skills and levels of motivation. Their preferences for economic alternatives are therefore very much different and should have some kind of regulation in order to achieve any desired form of economic sanity. Macroeconomic Component Presence of Large Global Imbalances Between High-saving and High-spending Nations There were major noticeable account imbalances in the economies of world nations in the 2000s that most likely led to the development of the 2007 global crisis. There were main imbalances between United States and China which comprise the major world economies. There were deficits recorded in the U.S while most Asian countries recorded increasing surpluses during this time (Dunaway, 2009, p. 13). This imbalance between saving nations and spending nations caused a major flow of capital from emerging countries to the developed ones. This resulted in a decline of interest rates worldwide. Many private investors went for assets characterized by low risks but high returns at the same time. The overall result was there being finances in excess that eventually led to the global financial crisis. Impact of the 2007 Global Crisis The 2007 global crisis reduced the growth of consumption of households. This is because households tended to reduce consumption of their economy’s goods and services. In the event of a financial crisis, most households struggle for bare survival and is therefore a common thing for them to start cutting down on their consumption rates. Normally this is in an effort to save more and maximize on the available resources and assets. The result is a reduction in the demand of an economy’s goods and services. The economy starts declining as a result of this. In the event of a global crisis too, an increase in poverty rates gets distributed across all nations globally. This reduces the overall international living standards (Ravallion & Chen, 2009). The impacts of a global financial crisis are far-felt in developed countries more than in the emerging countries during the initial phases. This is because the emerging countries are less engaged in global financial integration activities. However, the situation takes a complete turn of events during the later stages of the global crisis as the emerging countries begin to get more affected. The 2007 global crisis impacted negatively on the prices of commodities because of the reduced scale of world trade. This definitely took a huge toll on the developing countries. The onset of the 2007 global financial crisis triggered discouragement of investments by foreign bodies. The morale of foreign investors in the developing countries was lowered and some investors did away with their investments all together. The developing nations were also severely affected by the 2007 global crisis because increased unemployment rates in the developed countries placed constraints on the exportation of labor to these countries from the developing ones. As expected, the global financial crisis also impacted negatively on the fiscal positions of the developed nations. Recommendations First, it is recommended that banking systems be put under one authority for regulation of policies and formation of rules of operation. This will ensure control over the lending capacities of these banks and prevent unanticipated events like financial crises. In addition to that, it is recommended that financial institutions should be made smaller and more independent in order to prevent the spread of financial crises to global scales in case any occur (Thoma, 2009). In case there are already existing dependent and connected financial institutions, it is recommended that there be regulations regarding these institutions’ operations. Relevant authorities should also establish frameworks to deal with these institutions in case they lose their solvency. In case a global financial crisis has already occurred, it is recommended that the government could bail out certain financial institutions. Banks are also advised to issue short term credits that would see a fresh increase in investments. It is also recommended that a nation regulates money flow into the economy by establishing concrete fiscal policies. The bank operations ought to be monitored closely and economic regulations put in place succinctly. Conclusion In conclusion, many financial crises have occurred in the past and more are expected to occur in the future. The case study of the 2007 global crisis shows it involved both microeconomic and macroeconomic components. The microeconomic components of this global crisis include financial innovation, global financial integration and the regulatory philosophy of “hands-off” or laissez faire. On the other hand, the macroeconomic component of this global crisis was the presence of large global imbalances between high-savings and high-spending nations. The global crisis of 2007 impacted negatively on both the developed and emerging nations. Global crises lead to high rates of unemployment and labor remittances. The rate of consumption of a nation’s population also declines alongside a decline in in the world trade because the prices of commodities fall by a large margin. It is therefore recommended that nations regulate institutions in the banking sector and put in place obsolete fiscal policies as a measure to avert future global crises. References Caldentey, E. & Vernengo, M. (2010). Modern Finance, Methodology and the Global Crisis. Department of Economics Working Paper Series. Working Paper No. 2010-04. Retrieved on 12th May 2014 from http://www.economics.utah.edu/publications/2010_04.pdf Dunaway, S. (2009, March). Global Imbalance and the Financial Crisis. Council Special Report No.44. Retrieved on 12th May 2014 from http://www.relooney.fatcow.com/0_New-8566_pdf Gerber, J. (2011). International Economics. 5th Edition. Wesley: Pearson Madison Jones, C. (2009, March 12). The Global Crisis of 2007-20?? A Supplement to Macroeconomics. Retrieved on 12th May 2014 from http://www.economics.sbs.ohio.state.edu/mccafferty/econ502.02/CurrentEvents2009.pdf Lane, P. (2012, June). Financial Globalization and the Crisis. Trinity College Dublin and CEPR. Retrieved on 12th May 2014 from http://www.lse.ac.uk/researchAndExpertise/units/growthCommision/documents/documents/pdf/contributions /lseGC_lane.FinGlob.pdf Norgen, C. (2010, October). The Causes of the Global Financial Crisis and Their Implications for Supreme Audit Institution. Report of the Auditor General of the Swedish National Audit Office. Stockholm. Retrieved on 12th May 2014 from http://www.intosai.org/upload/gaohq4709242v1finalsubgroup1paper.pdf Ravallion, M. & Chen, S. (2009, April 30). The Impact of Global Financial Crisis on the World’s Poorest. Retrieved on 12th May 2014 from http://www.voxeu.org/article/impact-global-financial-crisis-world-d-poorest Thoma, N. (2009, November 6). How to Prevent the Next Financial Crisis. Retrieved on 12th May 2014 from http://www.cbsnews.com/news/how-to-prevent-the-next-financial-crisis Wadhhwa, R. (2012). Was Laissez Faire Responsible for the Economic Crisis? Retrieved on 12th May 2014 from http://www.wahwarakakesh.com/was-laissez-faire-responsible-for-the-economic-crisis Read More