Stock Market Crash of 2008 - Research Paper Example

• Stock Market Crash
• INTRODUCTION

The stock market crash of 2008indicated its weeklong decline in the financial performances of renowned companies, concerning their share price fluctuations. Following this incident, Dow Jones’ business dropped to around 18.1%. Notably, a certain degree of similarities was observed between the causes of the 2008 stock market crash with the downturns of1929 and 1987. The entire duration of the crash, since its beginning on October 6th to the next 7days is marked as the ‘black week’. During this period, Dow Jones Industrial Standard failed miserably with a simultaneous fall of around 20% in S&P 500. As a consequence, the market witnessed a second decline in the same month. The key reason for the crisis situation in the financial sector was evident mainly due to a high amount of bank lending to people neglecting the creditworthiness of the investors apparently that ultimately resulted to loss of credit capabilities of the financial institutions, giving rise to the economic bubble (Money-Zine, “The stock market crash of 2008”).

New York Stock Exchange (NYSE) and NASDAQ were the first entities to face the shock and be affected by the market crash. Both these entities are renowned as the indexes, which are used for the trading of a substantial proportion of the equities worldwide. NYSE and NASDAQ operate separately in an independent manner, as their working procedure differs substantially. NYSE functions as an auction market, whereas, NASDAQ is identified as a dealer’s market (Angel, “Market Mechanics: An Educator’s Guide to U.S. Stock Markets”). To be noted in this context, NYSE was established in the year 1792, which currently follows a traditional mode of conduct to trade in financial instruments. On the contrary, founded in the year 1971, NASDAQ has a modernized approached in place, based on advanced technologies which increases its time as well as cost efficiencies to deal with traders from around the world. At often instances, these two entities are observed to compete with each other in terms of their listings and investor benefits (Weinberg, “NYSE vs. NASDAQ”). Being functional in the same industry and in the same stock market however makes them equally vulnerable to stock market crashes as was witnessed in 2008.

Thesis statement. This paper examines the stock market crash scenario that took place in 2008-2009 affecting the financial stability of Wall Street and thereby, affecting the trading process of the NYSE and NASDAQ. The following discussion also elaborates on the causes of the downturn to gain an in-sight to the entire occurrence.

• DISCUSSION

Reasons of the Stock Market Crash in 2008. The stock market crash began with the failure of the US banking as well as financial sector on September 2008. Debt crisis throughout Europe and the US economy evidently fuelled the crisis situation of 2008. The failures of banking sector affected the stock market as well. During September 2008, the US lost its stock market value by around 21%, which was reflected as similar to the occurrence of Black Monday, which was witnessed during the financial crisis of 1987, when the stock market value decreased by around 22.6%. The primitive causes of the crash of 2008 were further noted as linked with the subprime credit disaster observed in the US economy. Companies were lending with bad credit ratings irrespective of the fact that borrowers might have to struggle to pay back the loan. This drawback and the compromised transparency increased the risks for bankruptcy issues and weakened the economy. The US banks were out to these things and had ultimately warped because they were lending more money to the market, which led to shortage of funds in banks and in turn resulted in the financial bubble. As a consequence, it further increased the value of non-performing assets of the US bank, which led to the collapse of the banking sector. The shareholders also became skeptic doubtful of the return prospects on their investments considering that the banks were at risk of liquidation. This ignited a trend in the market to sell-out shares, which ultimately decreased share prices further. This effect in the stock market led to the fall of various companies causing the recession within the economy (Money-Zine, “The stock market crash of 2008”).

• Aftermath: Recession and Responses

The common responses of financial crisis in the US as well as the UK emphasized financial support needed by the banks. Analysis also debated to point out the loopholes in the banking sector and how it could be rectified within the short run. It undoubtedly demanded billions of funds to reinitiate functioning of the banks and ensure monetary flow within the economy. The financial companies reacted to the occurrence by limiting stock temporarily in order to retain liquid cash that could be used to strengthen the market. The interest rates were also slashed to encourage formation of new businesses and encourage people to invest to boost the operations of the stock market again. However, the responses failed to overlap the fact that the US was going through another great recession of its history (Money-Zine, “The stock market crash of 2008”).

• Credit Market Collapsed

In 2008, the fall of the credit market was wrapped as the Subprime Mortgage Industry thrived. Borrowers with the poor credit ratings were reflected as having access to loan amounts that they could hardly afford to repay. The credit market problem started when the housing price fluctuated and began to fall in the year 2007, which is often denoted as the housing bubble of 2008, as the homeowners suddenly identified themselves in the situation of high un-repayable loans (Money-Zine, “The stock market crash of 2008”)

• Financial Instability

After the crisis was identified, there was a chronic unrest and reshuffle observed within the market. For instance, the Bank of America overtook the functions of Merrill Lynch with around $50 billion, following the second occurrence of volatility that evident in the stock market in 2008. Furthermore, the financial deterioration was reported to have caused mainly because of the growing anxiety among investors, as they grew concerns regarding the banks as well as lenders’ ability to manage the decline as well as exposure of Subprime Loan Market and Credit Default Swaps. Overall, these fluctuations in the market resulted in the financial instability (Money-Zine, “The stock market crash of 2008”).

American International Group (AIG) was also identified to befall in the trap of liquidity crisis with continuous decline in the price of shares during September 2008. Notably, AIG lost around 95% of its value of shares, which intensified the crisis situation. Financial details of AIG reveals about a loss of around $13.2 billion during the period, which apparently illustrates the influence of market fluctuations on its business stability (Money-Zine, “The stock market crash of 2008”).

• The Trading Process of NYSE and NASDAQ

NYSE is among the largest stock exchanges in terms of trading volumes. It operates in the US stock market following the traditional physical dealership mode of functioning, where the floor dealers, known as the floor brokers, complete transactions based on auctions. On the other hand, as affirmed earlier NASDAQ, operates on the basis of Telecommunications Network using advanced technologies and the advantages of virtual trading globally. In case of NYSE, it takes hours to complete the trading transactions, whereas the shareholders engaged in NASDAQ, have to deal through an electronic system that processes the deals immediately. NYSE deals with companies which are principally based on traditional methods and present a history of consistency in their business practices that in turn leverages their credit rating. American Express, IBM, Toyota, Microsoft, and Coca-Cola among others are some of the companies engaged with NYSE to trade their stocks. On the contrary, NASDAQ offers a trading platform through the High-Tech Market. Nevertheless, a comparative analysis drawn after the crisis situation revealed that the companies trading stocks through NASDAQ reflected a greater degree of volatility along with a growth oriented nature. Although this implied better returns for the investors, it lacks transparency and stability, which was also argued as a possible cause to the 2008 crash. Comparatively, NYSE offered the benefits of greater transparency and reliability through a consistent flow of funds and better credit ratings (Burke, “NASDAQ vs New York Stock Exchange”).

• The Financial Crisis of 2008-2009

In 2008, the world financial system faced many challenges that led to the crisis. The housing bubble that started taking shape in 2007 with rising home prices in the US lastly turned into the downfall of the financial sector. The investment-banking industry, insurance industry, the mortgage lenders and commercial banks had to face massive disruptions in their functioning owing to the fund shortage in the market. The crisis began with the mortgage dealers issuing credit facilities to borrower neglecting their credit rating which increased debt risks by a large extent within the market. Apparently, the insurance industry was on the Credit Default Swaps during the financial crisis. Simultaneously, the price of the homes started increasing, as each of the marketers aimed greater profits, which worsened the scenario. Mortgage holders were entitled to lend money with the high home equity using their income sources. By 2008, it gradually became clearer that the price of the property had decreased in various regions, which was rising since 2006 (Haveman, “The Financial Crisis of 2008: Year in Review 2008”).

The US economy had to suffer largely from various economic issues during the 2008-09 crisis. The shocks experienced by the US in the period, included rise in the housing prices as well as in the commodity prices as the rate of oil mounted. Furthermore, with the augmented economic dependency at the international level, global trade partners of the US also had to face the aftermath of the crisis, leading to a deteriorating situation in the world economy. During the crisis, the operations of many financial institutions were intervened, as the economic firms were found to be interlinked into a complex web of loans, insurance contacts and securities that also increased problems in the world economy (Jones, “The Global Financial Crisis: Overview”). For instance, the incident of Lehman Brothers was one of the most apparent shock results that reflected the beginning of the worldwide collapse of the banking sector. The US government, at the time of financial crisis, planned to fund $700 billion to save the banking sector and to deal with the crisis, which however could not be passed under supposition and counter-arguments by the US congress that spending such a huge amount of funds into the security may further weaken the economy in the long run. In the need of greater safety in return, in 2008, investors started to invest in gold, bonds and currency rather than other financial instruments. It was only in 2009 that the US President offered federal spending of around $1 trillion, emphasizing the situational needs (Justine, “Global Financial Crisis – What caused it and how the world responded”).

• FINRA and Regulation after the Crisis

Financial Industry Regulatory Authority (FINRA) is an independent regulator that was formed for the safety purposes after the crisis. In order to maintain transparency within the banking and the financial sector overall, this organization is provided with the responsibility and authority to enforce actions and penalties against traders who lacked adequate transparency in their processes. The regulatory body is also held responsible for controlling the operations of brokerage firms as well as exchange markets. Based on the investigations conducted post crisis, FINRA charged fines amounting to $68 million in more than 1541 cases on the grounds of violating the provision of authority and $28 million in 1073 cases for regulatory breach (Justine, “Global Financial Crisis – What caused it and how the world responded”).

• The Regulations in the US 2008

In the post crisis scenario, the treasury secretary declared that the federal government may take up billions of dollars in account of losses that was experienced by Citigroup. Citigroup was on the edge to collapse in the situation and if the federal government would have not allowed one of the largest banks to collapse, it could have imposed a furthermore serious impact on the world financial institutions. The financial crisis that occurred in 2008 had many causes. This crisis explored mainly due to a fall in the housing industry because of the marketers’ non-compliance to the credit rating policies. In addition, failure of governmental provisions to become accustomed to reforms in the lending industry also heaped the crises scenario. The prime cause of financial crisis was considered as the failure of the lenders and the regulatory bodies to forecast and control the Sub-Prime Market, which reflected from mortgage loan policies. A subprime mortgage has huge rate of interest, which changes according to the course of the loans in future (Federal Bureaucracy, “Regulation Failure and the Financial Crisis of 2008”).

The mortgage brokers, working with the conservative lenders, sold properties at a higher percentage of subprime loans. In addition, many of these mortgage brokers also engaged in raising electorate inside the mortgage industry that was unregulated and hence, augmented market risks in the situation. The failure to mortgage sufficiently regulated the mortgage brokers without the affiliation from any particular bank or licensed credit providing agencies. Many of these mortgage brokers were also found to be engaged in lending funds for many banks that in turn contributed to the housing bubble. During the 1990s, unregulated changes within the mortgage industry had resulted in unraveling lenders from the consequences of the measure. Lenders and brokers believed that they will never strike and will have to deal with the situation of bad debts in future. Another prime cause, which had affected the rules and regulations in the US, was the failure to accurately identify and regulate the Mortgage Backed Securities. Traditionally, people used to lend money from banks for arraigning funds to purchase assets in lieu of debts that guaranteed protection to the borrowers as well as ensured return of the loaned amount. However, through the reforms in the banking provisions, the banks took mortgages, traded it with the group of others, and sold them to the investors in order to attain higher profits. These forms of packed mortgages are known as Mortgage Backed Securities (MBSs). The federal government also played a crucial role in the entire scenario by relaxing its lending policies, which encouraged flow of funds within the market at higher risks (Federal Bureaucracy, “Regulation Failure and the Financial Crisis of 2008”).

• The Role of the SEC

The Security and Exchange Commission (SEC) role is to act as a governing authority over the operation of the US stock market. The Commission is also accountable for defensive the effective markets, maintaining fair-trading environment fair, investors protection and orderly making easier the capital formation. The SEC has the responsibility for supervising the securities, which include the securities exchange, dealers, mutual fund and the other securities. The commission is also liable for supervising of the inspections of the brokers, as well as securities firms. The SEC consists of the various commissions, which is appointed by the president (Wallechinsky, “Securities and Exchange Commission”). In the US, mainly the SEC, a national government agency, regulates the public capital markets. The law empowers the SEC to prescribe the form and the contents filled with the commissions. The SEC supervises about 30000 registrants including around 12000 Public Companies, 11300 Investment Advisers, 600 Transfer Agencies, and 4600 Mutual Funds along with 5500 broker dealers in the year 2008. In the year 2007, July, the SEC voted generally to publish a release for the public point of view on whether to allow the US issuers, which include the investment companies to arrange for a financial statement using the IFRSs. In 2008 during the period of financial crisis in the US SEC printed for the remark its future prospects for the probable use of the financial statements equipped in according with the IFRS by the US issuers (Deloitte, “US Securities and Exchange Commission SEC”).

• Sarbanes-Oxley Act

Considering the scenario of financial crisis, the Sarbanes-Oxley Act was heavily criticized. The investors suffered huge losses during the period of financial crisis. In addition, millions of people had lost employment and homes during this period. Statistically, approx $11 trillion in household wealth was misplaced during the period of financial crisis reported by the Financial Crisis Inquiry Commission. The application was very dangerous for insider control of the Citi groups and the valuation process related to Subprime Mortgage Bonds. The financial crisis of 2008 raised many questions regarding the Sarbanes-Oxley reforms that introduced in the year 2002 and failed to bring improvement to the independence and minimize the crisis issues. The working group of Sarbanes-Oxley from the scenario of financial crisis learned a lesson and strongly recommended adaptation of PCAOB and inclined to conduct in-depth study into the role played by the auditors in the event of financial crisis (PCAOB, 3-4).

Sarbanes-Oxley was considered responsible of the financial crisis and the great recession of 2008-2009 from which the US economy need improve the condition. The financial crisis of 2008-2009 was partially a regulatory failure that evident within the scenario. The Sarbanes Oxley during the time of financial crisis used to warn the companies for the overleveraged. However, the investors as well as the company used to pay no attention to the information, and is not a failure to adopt Sarbanes Oxley act but the instead of the human beings greediness. There are number of reasons for which the US financial sectors have to face with the situation of financial crisis in 2008-2009. Sarbanes Oxley no doubt had mitigated the force of the financial crisis in US in 2008-2009, which would have been worse. The Sarbanes Oxley has affected the major financial part of the global financial crisis that has occurred in 2008-2009 (Sweeney, “Sarbanes Oxley”).

• CONCLUSION

Based on the discussion it can be affirmed that in 2008, the US along with various economy experienced the worst financial crisis since the great depression in 1929-30. The refuse of the actual financial system was coordinating the fall down of the financial market up. Additionally, after occurring of the financial shock and economic loss on 2009, it was considered the most difficult time to not only the US economy but also the global economy. Many of the observers reflected that the turmoil in the world financial market eventually been responsible for economic downturn in the most of the economies. The worldwide market has struggled in financial crisis period. The global financial crisis has started from 2008 October. The investors have reached a loss threshold and the subprime mortgage was the serious problem for the global financial crisis. The reason is the lenders were lending money to those borrowers also who do not the capability to refund the borrowed fund. The stock market was fallen on October 2008, which was similar to the crisis that occurred before in 1929 and 1987. The stocks were also volatile in the wall street of United States of America and the US government and regulatory authorities taken many rescue plans after the worldwide financial crisis. This crisis was worst crisis that has happened and impacted the economic condition over the last 75 years. The financial market has been seen collapsed and the regulatory framework has failed to curb the widespread abuses and the corruptions.

• Works Cited
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Deloitte. US Securities and Exchange Commission (SEC). 2016. Web. 22 Apr. 2016.

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Justine, Davies. Global Financial Crisis – What caused it and how the world responded. Canstar, 2014. Web. 22 Apr. 2016.

• Money-Zine. The stock market crash of 2008. 2016. Web. 22 April. 2016.

PCAOB. “The Sarbanes Oxley Act.” Public Company Accounting Oversight Board (2011): 2-3. Print.

Shmoop University, Regulation Failure and the Financial Crisis of 2008. Federal Bureaucracy. 2016. Web. 22 Apr. 2016.

Wallechinsky, David. Securities and Exchange Commission. Allgov. 2015. Web. 22 Apr. 2016.

Weinberg, Ari. NYSE vs. NASDAQ. Forbes. 2008. Web. 22 Apr. 2016.