Capital Markets and New Markets Bubble and Banking Crisis - Essay Example

CAPITAL MARKETS HAVE LED TO CREATION OF “NEW MARKETS” BUBBLE AND BANKING CRISIS By Location Capital Markets have Led to Creation of “New Markets” Bubble and Banking Crisis Introduction Capital markets refer to the markets for purchasing and selling commodities such as debt and equity instruments. Capital markets enable the movement of these debt and equities, commodities from capital suppliers such as organizational investors and large retail investors to the capital buyers such as government institutions, business owners, and individuals. Capital markets pose many benefits to the growth of many countries’ economic status, although they have some injurious impacts (Stiglitz & Ocampo 2008, p. 32). This is because capital markets provide business and large company owners with capital, which is a vital component for enabling economic growth and development. This essay aids, to discuss the view that capital markets created the conditions that led to the “new economy” bubble and the banking crisis. Difference between old and new economy firm Old economy firms were or are large, well established firms that operate in a form of traditional sector. Old economy firms have small investment and less involved in the current technology era (Torre & Schmukler 2007, p. 88). These old economy firms were the ones, which dominated the entire economic activities before the introduction of the dotcom epoch. The current dotcom era ushered in the economy back in the 1990s, leading to the creation of new and high-growth firms hence improving the economic status of many countries “bubble” and causing banking crisis internationally. Old economy firms usually exhibit low volatility and suffer continuous dividends as they continue to participate in mature firm sectors, which tend not to provide potential investments for companies (United Nations Conference On Trade And Development 2009, p. 90). In contrast, new economy firms operate in advance technology industry sectors and the highly competing and successful firms have the opportunity of building value at a higher growth rate. Good examples of these new economy firms include primary firms, whose operations involve commerce and technology-based services such as Intel, Google, eBay, and Cisco. These new economy firms typically operate in environments, which are extremely different from of the old economy firms and have more volatile stocks (Stiglitz & Ocampo 2008, p. 30). New economy firms do not necessarily pay dividends since they opt to reinvest their profits into new businesses or expansion. Old and new economy firms not only differ in terms of their activities, but also they differ in the way markets value them. New economy firms tend to have strong volatility valuations since their modes of operation are not much stable as in the case of old economy firms and they are found in current industries. On the other side, old economy firms’ valuation base on less robust economic growth rate and business models. This results from less variance in expectations of analysts and estimations of accurate earnings. In general, during analysis of new economy firms, analysts place much focus on expectations of growth and earnings estimates for several years (Raines & Leathers 2007, p. 50). Because of the strong impacts, which new economy firms has due to future earnings estimates, they tend to be overvalued than old economy firms. The “new economy” bubble dotcom of 1990s led to the growth of new economy firms with limitless potentials. These forms of economy firms continue to have more volatile than the old economy firms. Additionally, new economy firms often experience higher P/E rates because there are expectations that they will grow at a faster rate in coming decades than the old economy firms (Raines & Leathers 2007, p. 51). Technological advancement With no doubt, capital markets have enabled the world to experience overwhelming advancement in technology and firms production for the previous centuries. This technology and productivity progress has resulted in enormous economic and personal wealth growth. According to many researches, the current most industrialized countries are 20 times better than they were hundred years ago due to capital markets (Raines & Leathers 2007, p. 53). The shift from old economy firms to new economy firms was highly influenced by technological advancements. For instance, the most successful adopters of the current technologies were earlier the old economic firms such as Argos, Tesco, Jon Lewis, among many other advanced companies. Although these companies faced challenges to compete in the new digital era due to financial crisis, capital markets enabled them to overcome these barriers and they are currently ranked the most progressing companies (Paganetto 2005, p. 65). Despite the capital restrictions applied to these companies due to requirements of earning 12% to 15% ROCE (post tax), these old economy companies tried to cope with the new advancement. The capital markets provided money to many new economy companies, which had less earnings as well as uncertain prospects. Due to technological advancement, computational costs have decreased rapidly. Following technological improvement, there broad availability of information, hence improving transparency (Institute for Social and Cultural Communications 2009 p. 34). As technology has advanced, lending institutions have no opportunity to overcharge borrowers for intermediary services. Often, lenders and borrowers are now able to interact directly via social media networks (Mathieson & Schinasi 2007, p. 87). This is advantageous since lenders are now able to earn extra and borrowers incur less expenses since there are no middlemen charges incurred. Capital markets improve capital and risk allocation Capital market development has engendered two major economic benefits, which has highly led to the creation of “new economy” bubble and banking crisis. Firstly, capital markets have improved allocation of capital (Eatwell & Taylor 2007, p. 45). Since corporate equity and debt prices are highly affected by demand and supply changes, many industries and companies have highly benefited from capital markets. These price changes encourage or discourage firms’ capital inflows. The ability of firms in their infant stages of growth to accrue funds to the capital markets allowed these firms to develop very rapidly (Perez 2007, p. 71). This fast growth in turn enabled dissemination of technology development in the entire economy, hence fastening the growth and development of “new economy” bubble (Raines & Leathers 2007, p. 56). Furthermore, by increasing returns due to persuasion of new ideas, new modes of conducting business activities, and technologies, the capital markets ease entrepreneurial as well as other risk taking business activities. Secondly, another reason supporting the view that capital markets led to the creation of “new economy” bubble and banking crisis is that they helped distribute risks more efficiently (Perez 2007, p. 75). The advancement of capital markets has played a vital role of the risk - transfer process. Therefore, capital markets ensured/ensures that capital is allocated to profitable uses and the riskier business activities, which have high payoffs, are as well funded hence ensuring growth of new economy firms. Higher returns on capital For instance, returns on capital is always much higher in developing countries such as the UK and US than in other countries. The gap in capital returns remains to be particularly wide. For instance, in the year 2003, had a higher return on capital compared to other countries (Grahl 2009, p. 45). The fact that investors were able to earn higher capital returns, this strongly supports that capital markets led to the creation of ‘new economy” bubble and banking crisis due to efficient capital allocation. Inflows of capital in countries Capital markets led to the growth of new economy and banking crisis due to the willingness of investors from foreign countries to persistently supply other countries with capital (Obstfeld & Taylor 2005, p. 98). This is evidence that capital markets influenced the creation of the banking crisis and new economy due to the availability of capital and risk reduction. Old economies were now able to shift to new economy firms. For instance, due to capital markets, the US dollar is currently 11% more than its value back in 1990s supporting the view that capital markets led to the creation of ‘new economy” bubble and banking crisis. More stable banking system The rapid growth of capital markets over the past decades seems to have changed the banking status of many countries to a more stable system (Cline 2005, p. 11). Although there is evidence of sharp adjustments in the prices of financial assets in the past years due to the financial crisis in some countries such as Russian, Asia, and Argentina, the rate of banking failures seems to have decreased rapidly over the past periods hence leading to the banking crisis. Researches show that during the years 2001 to 2003 a total of 16 banks in the US failed (Cumming, Dai & Johan 2013, p. 15). On contrary, in the years 1990-1992, a total of 412 commercial banks had failed due to introduction of capital markets (International Monetary Fund 2008, p. 35). One of the vital elements that have assisted in protecting banks against loss of credit is derivative obligations. These elements allow many banks to protect the risk of organizations’ bankruptcy. This protection enables banks to continue lending capital to developing firms. At the same time, banks are now able to limit their credit exposure to borrowers and diversify the exposure of these credits across firms and geographically (Cline 2005, p. 14). This decline in banking failure is substantiation that derivatives have highly assisted in the distribution of risk at a broader rate throughout the global economy. Greater supply of equity capital to new market Capital markets ensured availability of equity capital to start-up firms and private business, hence influencing the creation of “new economy” bubble and banking crisis. For instance, the United States markets were noteworthy to provide equity capitals to companies’ owners. The introduction of capital markets led to progress and growth of new economy firm since there was availability of equity capitals (Choudhry 2010, p. 67). Currently, the provision of equity capital in the United States takes place in two stages. Good examples of some of the firms, which have highly developed due to capital markets, include Amazon or Ford. During the initial stage, investors and venture capitalists make individual equity investments. Later on when these firms progress and have successful records, they are taken publicly and equity capital is provided publicly through IPO (Initial Public Offering) process (Brenner 2003 p. 51). These two financing stages seem to be self-reinforcing. The existence of this dynamic IPO process encourages venture capital investments due to its provision of a viable exit strategy by which capitalists are able to monetize their investment values (Choudhry 2010, p. 76). As a result, capital markets enables new entrepreneurs to obtain capital easily, hence influencing growth and development of “new economy” bubble markets. This easy availability of capital for new entrepreneurs facilitates growth and development of new economy firms. A good example of these new firms is technology companies, which are rapidly growing and becoming essentials firm in the international economy (Brenner 2003, p. 54). IPO existence also helps to facilitate innovation and risk taking throughout the global economy. A study conducted by Pricewaterhouse stated that the United States dominate international venture capital and investments (Beddies, George, Schipke & Sheridan 2004, p. 31). In general, capital markets have led to the advancement of technology firms, which rapidly growing at a faster rate and becoming more important in the current global economy. Technological firms such Google has also improved the quality of services and products as well as information accuracy (Blenman, Black & Kane 2010, p. 67). These firms have also improved banking services across the world and made all banking transactions real-time processing. Banking and capital markets Although banking operations in most countries such as the UK are more stable, the landscape emerging from banking crisis brings new formidable challenges. With high debts and new economic development, which seem to be sluggish in the coming years brings a lot of banking crises in today’s banking sector (Blenman, Black & Kane 2010, p. 67). These banking crises have currently brought severe challenges to existing and new investors and entrepreneurs. However, the current multi-disciplinary teams of banking and capital markets have the knowledge and enough experience, enabling them to assist investors and entrepreneurs overcome these long term and complex challenges (Beddies, George, Schipke & Sheridan 2004, p. 34). The difference between the bursting of the bubble is that the investors absorbed the new economic losses, whereas the bank losses led to State intervention. These teams are currently thinking about these complex and long term issues faced by investors and entrepreneurs. Although capital markets and banking teams do not have all the solutions for these challenges, they do have competent expertise to help investors and entrepreneurs navigate through these challenges (Adams 2009, P. 45). Additionally, the accelerating shift of economic powers from already developed to the currently emerging economies is rapidly changing the industry of banking across the world. This is evidence that, capital markets have led to the creation of ‘new economy’ bubble and banking crisis across the globe. Conclusion In conclusion, capital markets have led to the creation of “new economy” bubble and banking crisis. Capital markets have influenced many old economy firms to shift to new economy firms since there is availability of equity capital. Capital markets have also led to the rapid growth and development of technology firms, which are highly essential in today’s global economies. Capital markets have also caused banking crisis across the world, although the capital markets and banking teams are trying to come up with solutions by helping investors and entrepreneurs to overcome these complex and long term challenges. Bibliography Adams, C 2009, International capital markets: developments, prospects, and key policy issues. Washington, DC, Internat. Monetary Fund. Beddies, C., George, S. 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