The Global Financial Crisis - Lessons for the Australian Financial Institutions - Research Paper Example

The Global Financial Crisis: Lessons for the Australian Financial Institutions Insert Name Course, Class, Semester Institution Instructor Date The Global Financial Crisis: Lessons for the Australian Financial Institutions Introduction The Global Economic Crisis, commonly referred to as the Global Financial Crisis is arguably the greatest financial disaster in the history of the world ever since the Great Depression of the 1930s. When the Great Depression hit the United States of America, the effect rippled out to the rest of the world. Similarly the effects of the Global Economic Crisis of the year 2008 were felt by most countries on the international scene (Savona et al 2011). Worth mentioning, however, is the actuality that not all countries were affected by the crisis. New Zealand and Australia are among the few countries that narrowly escaped the devastating effects of the financial crisis. However, most part of Asia and Europe felt the negative effects. The effects, as felt by the euro area, constituted proof that not all economic and monetary unions shield the member countries from the happenings on the international financial sector. This paper is a detailed research outlining the causes of the 2008 global economic crisis and how such causes and effects can be worthy lessons to the banking sector of Australia. The paper prominently borrows from such prominent journals as the Wall Street Journal and other books written by prominent international political economists. The lessons that can assist the Australian financial sector are prominently borrowed and analyzed from the commentaries of prominent economists and synthesis of existing research. The Research Questions What are the lessons we can learn to avoid future crises? What are the economic policy lessons? What are the investment lessons? Do we need more financial market regulations or fewer regulations? Who Predicted the Financial Crisis - The Financial Crisis Winners and Losers? Objectives of the Study Among the primary objectives of this research paper are such goals as: To comprehend what exactly caused the 2008 economic crisis on the global scene To understand what exactly can be done to prevent a possible future crisis How interconnectedness contributed to the crisis The lessons to the banking sector to Australia To find out if it is possible to predict a possible financial crisis The Scope of the Study The study covers the causes and effects of the global financial crisis of the year 2008. While the study will prominently focus on the Australian case, it will borrow from the effects of the crisis on the countries that were players in all factors contributing to the crisis either directly and indirectly. The study will mainly borrow from the studies and commentaries of prominent economists while trying to understand how a crisis occurs and why the biggest economic players on the global scene can fail to predict a potential crisis. While this is the case, commentaries in most economics based journals form the most relevant periods are exceptionally useful. Worth mentioning also is the fact that the lessons as outlined in this paper rely on the views of the author from his understanding of the various economic phenomena associated with the global financial crisis. Summarily, the scope of the study is limited to the causes, effects and lessons learned from the 2008 crisis. While the lesson part of it is the most important for the purposes of this paper, a connection is made between the causes and effects. The methodology used In trying to achieve the objectives of the study, and ultimately answering the research question, the researcher used various methods of collecting information. Worth mentioning is the reality that in seeking to understand the primary lessons from the global economic crisis, secondary sources are the most important as the primary sources would not yield any relevant information for purposes of decision making. What this means is that the primary methods are impracticable as far as a global phenomenon is concerned. However, research literature being universally accessible, can be exceptionally reliable. For this reason, the research paper prominently relies on journal articles, magazine articles and economics books. The newspaper articles and journals provide information that will help arrive at the much sough worthy lessons. The Background of the Global Economic Crisis The global financial crisis was a period when the global economy was characterized by foreclosures and bailouts for the brand name financial institutions in both the developing and the developed world. Apparently, the global economic crisis, which began as a housing crisis in the United States of America degenerated to become the worst economic disaster since the 1930s economic depression commonly referred to as the great depression (Savona et al 2011). It is imperative to mention that the great global crisis began in one sector – the housing and real estate sector – and became widespread, affecting not on the concerned sectors, but also other sectors that rely of the financial wellbeing of the financial institutions. The financial crisis saw the liquidation of some businesses and banking institutions. This saw the national policy making bodies to swing into action trying to come up with economic policies that would both reduce the effects of the crisis and prevent the potentiality of their being another crisis. The Causes of the Global Economic Crisis In explaining the major causes of the global economic crisis, many economists have greatly differed as to which was the main cause. Similarly, they have failed to agree as to which causes were direct, and which ones were indirect. The primary immediate cause however, remains one and known to all – the US housing bubble that emerged as a result of easy lending due to low interest rates. Noteworthy, however, is the fact that the immediate cause is connected in one way or another to all other causes, at least to some extent (Nanto 2009). The conditions created by the easy loans saw an abnormal influx of funds, prominently from Russia and other Asian countries. It is imperative to point out the fact that although the causes of the crisis are prominently associated with the United States, the effects reached both developing and developed nations. The immediate cause of the global economic crisis of the year 2008 is the US housing bubble, which led to the presence of too much capital chasing fewer investments. In point of fact, the US housing bubble is one among the reasons for the hard crisis because, at the onset of the crisis, foreign funds, prominently from Russia and other parts of Asia were flowing in to the US economy that was, back then, characterized by high demand for currency due to low interest rates (Savona et al 2011). The interest rates saw investors rush for mortgages and loans. The investors easily accessed credit, and this was the beginning of all trouble for the financial institutions. It is worth mentioning that the easy credit led to more risky investments by both the financial institutions and the individual investors. The risky investments make the repayments of the loans difficult and practically impossible. The impossibility of repaying the loans was the core of the global economic crisis. The bankruptcy of major investors saw them liquidated in a bid to recover the lost amounts. The banks that could not recover the loans were as well stagnated. This can be explained as: the easiness with which the investors’ accessed credit saw the real estate industry grow abnormally (Nanto 2009). The end result was the fact that the homes that were constructed became virtually worthless and the homeowners could not reap adequate returns on investment. Failure to return the invested amounts together with the due interest caused the institutions to face foreclosures and liquidation. The causes of the global financial crisis are mainly associated with the banking and insurance industries. The insurance industries contributed to the global economic crisis through adequately engaging in weak and fraudulent underwriting practices. Such practices did not adequately cover the investments made from the increased consumer spending associated with easy loans. On the other hand, the activities of the predatory lending parties contributed adequately to the weaknesses in the economic infrastructure (Grant 2012). Predatory lending refers to the unscrupulous and unsafe loans that are based on low value collateral and governed by poor security rules and structures. Speaking of easy credit, overleveraging is a primary problem in the economy as it causes liquidity problems to the lending institutions. According to the US Senate’s Levin Coburn Report, the crisis can primarily be attributed to high risk and complex financial products and the failure of regulators. The report further mentions that other causes revolve around hidden conflict of interest and credit rating agencies. The credit rating agencies did not adequately consider all factors associated with assessing the borrowers for purposes of credit worthiness (Savona et al 2011). The agencies, in straightforward terms, did not effectively assess the borrowers. This increased the defaulting rates. The high number of defaulters implied higher unpaid loans and ultimately the impossibility to pay. The main victims became the financial institutions and this was the root of the liquidity crisis. Summarily, the causes of the financial crisis was: easy credit lending, which led to high borrowing, low house prices, low value of homes, high defaulting rates and finally, liquidity problems, which saw the liquidation, foreclosures and bailout of many institutions. The Devastating Effects of the Global Economic Crisis The effects of the global economic crisis were devastating. Many organizations were liquidated with many banks being held in liquidity problems. The global economy was greatly affected especially with regard to the financial flexibility. Many financial institutions learned to shy away from high risk investments as they were among the contributory factors that saw the downfall of the American economic strength (Obstfeld et al 2012). The insurance firms were as well forced to close down following the problems they encountered in servicing the high risk loans that were covered. The euro area restructured its policies as a way of guarding against potential failure, as the real estate industry in the United States faced difficulties. The global economic crisis caused the collapse of financial institutions – a situation that would later see the global economy revise the interest rates. Another devastating effect of the global economic crisis was the unforeseen obligation of various national governments to bail out banks and financial institutions. Such bailout efforts saw the national governments face a fresh crisis in servicing the budgets – this was especially so in the South American economies where the nations consistently operate on deficit budgets (Dolezalek 2012). The global economic crisis saw the downturn of the stock markets – a condition that adversely affected investments, not only in the United States but also the rest of the world. In addition to the failure of the stock markets, the global financial crisis saw the failure of business organizations that had policies that could not sustain resilience in the organizations. In addition to the above effects, the global economic crisis saw many tenants evicted from their houses – evictions that destabilized people greatly as such people could not sufficiently access opportunities when they lacked the essential human need, Housing. Associated with this is the actuality that the global financial crisis saw great losses in terms of consumer wealth valued at trillions of United States Dollars by many economists. The global crisis, commonly labeled the 2008 recession saw the emergence of European sovereignty debt crisis due to the liquidity crisis which began on the seventh day of august 2007 (Mitchell 2012). Other effects of the crisis include the aspects of bank solvency and prolonged unemployment, which saw deterioration in the economic circumstances causing poor living standards in both the developed and the developing nations. Worth noting however, is the fact that, contrary to common misconception, the global crisis is as well associated with some positive lessons. For instance, the global economic crisis served as a big warning to most players in the international economy. The financial institutions, both the affected and the unaffected nations, have come up with strategies that will help minimize chances of their being another global crisis (Obstfeld et al 2012). The financial institutions in such countries as Australia and New Zealand have sought to understand the possible causes of such a crisis. As mentioned earlier, these two nations narrowly escaped the devastating effects of the crisis. Additionally, the banking institutions are now in a position to guard against liquidity problems. The Findings – The Valuable Lessons for Australian Financial Institutions Unexpectedly, Australia remained stable all through the 2008 global economic crisis. However, in December the same year, the country saw an unexpected increase in the demand for currency, which saw an increase in the number of notes amounting to five billion dollars translating to approximately 12% increase. This was a scary phenomenon as it threatened to extend the impacts of the global crisis to Australia and New Zealand. On the seventh day of May 2009, Ben Bernanke of the Federal Reserve Bank of Chicago conference said “the best way to avoid future crises is to improve supervision of the banking sector by strengthening capital, liquidity, and risk management”. Additionally, the economics expert also called for the national regulators to address the potential systemic risks within the financial system. According to Nanto 2009 among the primary lessons for the Australian financial institutions is the fact that they should by all means device strategies and policies that will prevent extraordinary demand for currency. As mentioned above, the end 2008 occurrence was a threat of potential economic crisis in Australia which was characterized by an increase in the demand for notes which saw more than five million dollars issued in addition to the normal amount. This if taken up by the real estate industry or other low risk high income sectors, there is likely hood of there being a financial crisis due to the ability of individual investors and firms to assess easy loans which facilitate the putting up of assets that become worthless in the long run. Contrary to common misconceptions, the financial institutions of the United States were among the key contributors to the U.S housing bubble which saw the real estate industry become the beginning of the global crisis (Mackenzie 2012). The United States Financial institutions contributed to the global crisis through issuing low interest loans that were secured on unreliable collateral – unreliable because, ultimately, the insurance firms in the United States were unscrupulous, and engaged in poor practices in relation to underwriting. While most economists have argued that educating the bankers on the causes and effects of the 2008 and other previous financial crises is a way of preventing future crises, others contend that this cannot adequately solve the matter since the banking sector is not the only player in the shaping of the economy. On the contrary, other players such as the heavy borrowers from among the public are likely to affect the manner in which the economy changes. The economists opposed to the idea of bankers learning from history argue that the economic crisis of the year 2008 was not only a result poor banking practices, but also weak insurance practices and regulatory practices at the financial sector and the national levels. What this means is that in coming up with the strategies to bar a possible economic crisis, the Australian banking institutions should consider integrating other stakeholders such as the general public and others such as the insurance firms, the investors interested in such permanent and long term investments as the real estate industry and so on (Rhode 2011). Speaking of Australian financial institutions, each financial regulatory regime in major markets should endeavor to adopt structures that are sufficiently in the same line – in the same line to the extent of having similar institutions such as the minister for finance at the political level, a powerful central bank as well as a single financial services regulator. These will sufficiently eliminate the inconsistencies, which are associated with high competition which may finally bring about ease loans due to the presence of the low interest loans in the market. Where the regulators are effective, it is critical to point out that the banking institutions, much like all other institutions in the finance sector should adopt a policy of absolute transparency (Mosley & Singer 2012). Such transparency will finally see the finance sector aligned appropriately since the regulators will know which policies suit the circumstances of all institutions. Full transparency in this case should be practiced in relation to financial statements and all financial instruments relating to the financial position of the banking or financial institution. In addition to absolute transparency, the banking and financial institutions of Australia should practice full disclosure of financial instruments to the regulator for purposes of assessing risks and projecting the economic conditions of the foreseeable future. Additionally, such disclosure should be practiced by the borrowers in relation to hedge funds for purposes of appropriate credit rating. Unlike the financial institutions, the borrowers should not practice such disclosure to the regulators but rather to the credit rating agencies, whose failure to perform such rating well contributed to the global financial crisis of 2008 (Schwartzman 2008). Still on the regulator, such bodies or entities should have oversight over all the financial institutions that take part in the markets. This extends to major borrowers of hedge funds that greatly affect the dynamics of the market. To this extent, the financial institutions of Australia ought to acknowledge the realization that all stake holders in the financial sector ought to be included or considered in the designation of appropriate strategies and policies aimed at preventing a potential economic crisis. According to the most prominent economists on the global scene, one of the most potent ways of preventing a potential economic crisis is to shift from a rules based system to a principles based system. This is because rules are associated with rigidity in the financial sector – a condition that is likely to trigger an economic crisis because economic circumstances change with time. This, in part explains why the banking sector cannot learn from history as advocated by some economists, because the economic crisis of 2008, for example is attributed to factors that may not be applicable in, say the year 2020 (Nanto 2009). Principles on the other hand can be changed from time to time in response to changes in economic circumstances – a factor that promotes flexibility which prevents undesirable economic phenomenon. Judging from the cause of 2008 crisis, it is clear that Australian financial institutions should at all times endeavor to eliminate conflict of interest in matters dealing with loans and interests rates. In addition to avoiding conflict of interest the financial institutions of Australian should endeavor to avoid predatory lending. Predatory lending refers to unscrupulous lending which in most cases refers to lending which is based on unsafe securities from loans which increase the rate of defaulting. Even the predatory lending is avoided, over leveraging should be avoided because of inflationary occurrences and defaulting rates which, in the event that the insurance firms are not reliable, may cause solvency problems which are directly connected to the liquidity status of the financial institution (Savona et al 2011). Related to this lesson is the reality that the Australian financial institutions should avoid easy lending, that is lending at low interest rates to investors, especially those in the real estate industry, as this may lead to worthiness assets which may make it difficult for the borrowers or mortgagees to repay the loans. Among the primary causes of 2008 global crisis was increased debt due to overleveraging by the financial institutions. Therefore, the Australian financial institutions should device their strategies and policies in such a way that overleveraging does not occur because, by the 2008 crisis, increased debt can be a cause of financial crisis (Dudley 2009). However, this should extend to other actors, including those that appear in the financial scene periodically such as the hedge funds. In essence what this means is that the financial institutions should seek to address the weaknesses in the previous crises while considering the contemporary conditions of the market. Contemporary economists argue that the financial institutions and banks should work with the market as it evolves. Time is different and a large historical survey is only important to a particular extent. From the foregoing it is clear that the Australian financial institutions and banks should learn that overregulation is as dangerous as a situation where there is no regulation. Essentially, therefore, the Australian financial institutions should seek to device strategies and policies of strengthening the capacity of the central bank to provide liquidity in times of financial strain to the commercial banks and non- banking financial institutions. Speaking of policies, it is worth mentioning that, following the effects of globalization, wrong policies can be borrowed from other countries. As such, the banking and non-banking institutions should seek to establish those policies applicable to their financial circumstances for purposes of relevancy and consistency (Dolezalek 2012). Additionally, the financial institutions should work in collaboration with the credit rating agencies to ensure the borrower credit worthiness is properly assessed prior to the issuance of the loan or credit. Apparently, the issuance of easy loans is among the primary causes of high demand for currency – a factor likely to lead to demand pull inflation which will contribute to a financial or economic crisis The banking institutions and the non – banking entities should work in collaboration with the insurance firms in ensuring the transparency and full disclosure of the borrowers for purposes of stability. For the financial institutions of Australia to work towards a common goal there is need for the adoption of similar accounting standards. The differences in accounting standards are a likely cause for financial crisis because the banks and other financial institutions offer different terms to the borrowers at a certain time. The adoption of similar accounting standards will likely introduce consistency which will in turn boost the validity of predictability in the financial sector (Dudley 2009). Social activism is one among the primary factors of ensuring that all the stakeholders of the financial sector are involved in policy making and financial planning of financial institutions. Through social activism the financial institutions of Australia will ensure that other stakeholders of the financial sector are involved in preventing the potential financial crisis. It is through such social activism that the general public or the borrowers will be informed about the dangers of easy lending. Additionally, it is a lesson to the financial institutions of Australia that championing for shock absorbers at the national level is important (Schwartzman 2008). While other economists argue that shock absorbers at the financial level are insufficient deep governance of economic policies is exceptionally important I minimizing the chances of economic crisis through imported inflation. Additionally, national level policies are supposed to uphold price stability – a factor whose absence contributed to the rise of the United States’ housing bubble. Strengthening the capacity of the central bank to provide liquidity commercial banks and give a response to the economic shocks is exceptionally important in an economy because the central bank is the key determinant of the economic or financial capabilities of the commercial banks. What this means is that the commercial bank, being the lender of last resort should be in a position to affect the manner in which the financial banks operate as far as interest rates and lending are concerned. From the causes of the 2008 financial crisis it is important that the banks and other financial institutions of Australian should practice self restrain alongside social activism in ensuring deeper governance of economic policies and strategies (Mackenzie 2012). Conclusion In conclusion it is clear to see that the Australian economy, much like the New Zealand economy, was not affected to a great extent by the global economic crisis of 2008. However, towards the end of the crisis, the Australian economy was at the verge of suffering economic difficulties because of the notable issuance of extra notes amounting to about 5 billion dollars which translated to approximately 12% increase in the normal issuance rate. From the findings of the research, the lessons from the financial institutions of Australia include; the adoption of similar accounting standards which will eliminate inconsistency in the issuance of loans and interest rates. Secondly, the financial institutions of Australia ought to adopt full transparency to the regulatory bodies for purposes of planning and prediction. Speaking of transparency, full disclosure ought to be practiced by the borrowers where the credit rating agencies are concerned. Thirdly, the financial institutions of Australia ought to adopt a principle based system instead of the conventional rules based system. Conflict of interest should be recognized as one potential cause of the economic crisis. Additionally, the financial institutions of Australia should learn to practice self restrain in as far as taking risks is concerned. Speaking of risks, the financial and banking institutions of Australia should prioritize social activism in reducing chances of a potential financial crisis. Summarily, it is evident that the financial crisis of 2008 was caused by easy loans and recklessness in prediction and credit rating, especially in the real estate sector. The research gives valid lessons to the financial institutions of Australia. Reference List Dolezalek, H. (2012). The Global Financial Crisis. Edina, Minn, Abdo Pub.  Dudley, W. C. (2009, July 03). Lessons learned from the financial crisis. Federal Reserve Bank of New York, Retrieved from http://www.newyorkfed.org/newsevents/speeches/2009/dud090702.html Grant , S. (2012, May 03). Grant Spencer: Prudential lessons from the global financial crisis Financial Institutions of NZ 2012 Remuneration Forum, Retrieved from http://www.bis.org/review/r120503e.pdf MacKenzie, D. (2012, Aug 2012). Valuable lessons from global financial crisis. Otago Daily Times, Retrieved from http://www.odt.co.nz/news/business/221109/valuable-lessons-global-financial-crisis Mitchell, N. (2012, Aug 09). Lessons from the global financial crisis. Reserve Bank of New Zealand, Retrieved from http://www.rbnz.govt.nz/news/2012/4884922.html Mosley , L. & Singer, A. D. (2012, July 11). The global financial crisis: Lessons and opportunities for international political economy. Retrieved from http://web.mit.edu/dasinger/www/Publications Website/Publication PDFs/singer_global_financial_crisis_lessons_opportunities_intl_polt_econ.pdf Nanto, D. K. (2009). The Global Financial Crisis: Analysis And Policy Implications. Darby, Pa, Diane Publishing. Obstfeld, M., Cho, D., & Mason, A. (2012). Global Economic Crisis Impacts, Transmission And Recovery. Cheltenham, Edward Elgar.  Rhode, L. (2011, April 11). Lessons from the last financial crisis and the future role of institutional investors. Financial Market Trends, 2011(1), Retrieved from http://www.oecd.org/finance/financial-markets/48615723.pdf Savona, P., Kirton, J. J., & Oldani, C. (2011). Global Financial Crisis: Global Impact And Solutions. Farnham, Surrey, Ashgate. Schwarzman, S. (2008, Nov 04). Some lessons of the financial crisis. The Wall Street Journal, Retrieved from http://online.wsj.com/article/SB122576100620095567.html Read More