Global Financial Crisis in Context - Essay Example

Running Head: Global Financial Crisis in Context Year of Study/Semester; Submitted: Background of the Recent Global Financial Crisis There is the general consensus across the globe that the 2007-2010 global financial crisis (GFC) is the worst to have hit the world economies ever since the famous Great Depression during the 1030s. To some this crisis has grown to be known as the Great Recession of the time. One of the notable effects of the recent global financial crisis was brought to the fore in terms of failure by the world’s key businesses, significant decline in the wealth among consumers, as well as massive financial commitments by the various governments. In the overall, the aforementioned effects culminated into significant reduction in the economic activities amongst nations. The said financial crisis has its cradle in the bursting of America’s housing bubble. In particular, this housing bubble experienced its peak during the 2005- 2006 period. Immediately afterwards, there was a general increase in the Adjustable Rate Mortgages (ARM) and subprime default rates. As it is put forward by Taylor and Akila, (2009), a resultant increase in incentives of loans for example, simple easy terms as well as long-term trend of increasing prices of housing. As a result, borrowers had been motivated to take difficult mortgages with the hope of being able to quickly refinance them at favorable terms. However, with the increasing interest rates, prices of housing began to drop although moderately during the 2006-2007 period in several parts of the United States of America. Consequently, refinancing became much more difficult. This provided the much needed impetus to the increase in foreclosures and defaults due to the expiry of the simple initial terms. As it was anticipated, this led to the decline in the price of houses which in turn resulted to an increase in the Adjustable Rate Mortgage interest. Against this backdrop, the United States Federal government through the Federal Reserve opted to lower interest rate up to 1 percent whose primary objective was to stimulate the nation’s economy. At the same time, this move resulted to increase in the flow of foreign investment or money into America from the rapid-growing nations of Asia in addition to those producing oil. As it stated by, Shiller, (2008), it is this combination of increase in the flow of money and easy credit that culminated into the housing bubble in America. Perhaps it is worth noting that this framework made it easier for individuals to obtain loans; such as mortgage, auto and credit card which in turn culminated into consumers accumulating an unprecedented and massive debit load. Owing to the credit and housing boom, financial agreements known as Collateralized Debt Obligations (CDO) and Mortgage-Backed Securities (MBS), that traditionally derived value from housing prices and mortgage payments greatly increased. Hence, investors and institutions from all over the world opted to invest in America’s housing market. However, with the steady and unprecedented decline in the prices of houses, global financial organizations having borrowed heavily to invest in the subprime MBS witnessed massive losses. On a positive rejoinder, Martin, Eric and Rhonda, (2008), note that the falling housing prices led to homes worth being less than these loans. Therefore, this provided the financial incentive amongst investors and consumers for the foreclosure in the long-run. A closer look into the genesis of the global financial crisis reveals that the present-day foreclosure began during late 2006 and has continued to erode the strength of banking institutions while at the same time draining consumers’ wealth. This has therefore led to an increase in the losses and defaults on the other types of loans as well due to the expansion of this crisis from this housing industry to the other sectors of the economy as it is noted by Taylor and Akila, (2009). According to Shiller, (2008), as the credit and housing bubbles built, several factors contributed to the expansion of financial institutions as well as their fragility. First, the policymakers failed to recognize the vital role that is played by hedge funds and investment banks known as the shadow banking system. In a nutshell, these financial institutions had grown to become commercial or depository banks that were actually providing credit to the nation’s economy yet they were not subjected to similar regulations. Also, they had assumed considerable debt burdens occasioned by their provision of loans. The federal government on the other hand decided to bail out major financial institutions in addition to its implementation of the economic stimulus programs and thus assuming extra financial commitments according to Ravallion, (2008). In the overall, the global financial crisis led to the slowing down of economic activity due to losses from the major financial institutions leading to the economy of America and other advanced nations collapsing. Impact of GFC on developing Nations That the recent global financial crisis negatively impacted on the developing nations is a fact. A particular area of concern among economists is the fact that although these developing nations contributed nothing into the said crisis, they have been hard hit by its effects. Indeed, it is clear that the developing nations are still experiencing losses occasioned by this crisis. Furthermore, these loses shall be compounded with time due to its impact on their respective domestic economies. According to a survey conducted by Action Aid in 2009, developing nations such as Ghana experienced significant reductions in revenues from the diaspora due massive job losses of its citizens. At the same time, those that had managed to retain their jobs were forced to contend with reduced wage pays and thus spent less within Ghana. The same scenario was replicated in nations such as India, Mali and South Africa according to the survey. The other way through which the developing nations were affected by the GFC was captured in terms of reduced foreign investments leading to massive job losses as well as it was the case with South Africa and India. According to Lin, (2008), these industrializing nations such as India and Nigeria witnessed significant decline in government revenues through taxes, aid and borrowing. This therefore had a negative impact on the spending ability of these nations in which case the poorest households that are usually dependent on social spending such as social and health protection. On the other hand, the recent financial crisis led to a recession within the advanced or rich nations which in turn compounded its impacts upon them. According to a Lin, (2008), this recession led to significant reductions in the exports by the developing nations. As it was projected by the World Bank, these industrializing nations witnessed a drop from 9.3 to 4.1 percent last year (Amadeo, 2010). According to the report by Action Aid, (2009), developing nations incurred losses from their revenues from export trade. Nigeria for instance, witnessed a 25 percent fall in its export revenue during the 2007-2009 period according this report. The role of International Development Organizations during the GFC One of the major players during the global financial crisis was the World Bank which was created in 1944. By this time, it was primarily concerned with lending to European nations which had been destroyed during the war in order to assist them rebuild. In particular, it developed from the International Bank for Reconstruction and Development (IBRD), and was mainly composed of engineers as its staff in addition to being based in Washington, D.C. It later expanded to become a group of five closely associated development organizations charged with the responsibility of reducing worldwide poverty. In line with its mandate, the World Bank played a very crucial role during this financial crisis in terms of lending to both the developing and developed nations across the globe (Amadeo, 2010). The other international development organization that was quite active during the recent global financial crisis is Action Aid. A look into its history reveals that it was established in 1972 as an exclusive British based charity whose main responsibility was to deliver direct benefits to the individual children who were sponsored. Several years later, it evolved to become a group of European based charities, ActionAid Alliance. However, unlike the World Bank, this organization provided the much needed financial support to various developing nations with particular focus on programmes aimed at ensuring social protection of the vulnerable persons in these nations (http://www.actionaid.org.uk/). Impact of GFC on China and Kenya China being one the most rapidly industrializing nations of the present-time 21st Century was undoubtedly hard hit by the GFC. One of the ways through which China was adversely affected was in terms of losses in export revenue due to the recession in the advanced nations. To add to that, China also witnessed decline in government revenues from aid, taxes as well as borrowing. To its aid, the World Bank provided loans to enable it to overcome its difficulties with respect to financing in addition to employment according to Action Aid report, (2009). Kenya on the other hand was adversely hit in terms of reduced government spending due to the financial difficulties according to Masha, (2009). As a result, the government experienced difficulties in providing basic social services to its citizens. This was compounded by the food and water crisis that had been occasioned by drought. In addition, the country was still reeling from the effects of its 2007 post election violence that saw about 250,000 persons displaced within the country. To its aid, Action Aid through its various and community programmes provided financial and humanitarian support to Kenya during this period up to date (Lafarque, 2009). The Global Financial Outlook for 2010 There is the general consensus among economic experts that contrary to the gloom and doom during 2009, 2010 appears to be reasonably bright economically according to Oliver, (2009). However, it is imperative to note that the aftershocks of the recent global financial crisis such as retrained bank lending and high unemployment are bound to linger throughout the year. That notwithstanding, there are signs of the labor markets improving and thus providing imputes to the growth of a self-sustaining economy. It is expected that 2010 shall witness a global growth of 4 percent up from 0.8 percent witnessed last year with the private sector largely taking over. This is bound to encourage stronger economic growth within the emerging markets and economies. Hence, China’s export revenues are expected to increase as well as investments within the country. It is also expected that the there shall be significant improvement in the unemployment rate within the country. With the growth in the emerging countries, it is projected that the Kenyan government shall be able to increase its spending on social needs due to improvement in its export trade and increased revenue (Oliver, 2009). References List Amadeo, K, The Purpose of the World Bank. Retrieved on January 7, 2010 from; (http://useconomy.about.com/od/internationalorganizations/p/World_Bank.htm) Action Aid, (2009), Where Does it Hurt? The Impact of the Financial Crisis on Developing Countries. Retrieved on January 7, 2010 from; (http://www.actionaid.org.uk/doc_lib/where_does_it_hurt_final.pdf) Action Aid Profile. Retrieved on January 7, 2010 from; (http://www.actionaid.org.uk/) Lafarque, J. (2009).The General Elections in Kenya, 2007. Nairobi. African Books Collective. Lin, J.Y. The World Bank, (2008), The Impact of Financial Crisis on Developing Countries. Korea Institute of Development; Retrieved on January 7, 2010 from; (http://crisistalk.worldbank.org/files/Oct_31_JustinLin_KDI_remarks.pdf) Martin, Eric and Rhonda Schaffler. 2008. "Roubini Sees Worst Recession in 40 Years, Stock Drop (Update3)." October 14 ed. Bloomberg.com Masha, I. (2009). The Global Financial Crisis and Adjustment to Shocks in Kenya, Tanzania and Uganda: A Balance Sheet Analysis Perspective. International Monetary Fund publications. Oliver Shane, (2009), Financial outlook for 2010. SmartCompany.com. Retrieved on January 7, 2010 from; (http://money.ninemsn.com.au/article.aspx?id=983463) Ravallion, Martin. 2008. "Bailing out the Worlds Poorest." Washington, DC: World Bank Shiller, R.J (2008). The Subprime solution: How today’s global financial crisis happened, and what to do about it. Princeton University. Taylor, and Akila, W. (2009). Principles of Economics: Global Financial Crisis Edition. New York. South- Western Pub. Read More