Financial Markets and Institutions - Essay Example

?Financial Markets and s Table of Contents Financial Markets and s Part Warnings about the financial crisis 3 Part 2: Parties culpable for the “crime” 5 Effect on Germany 6 Part 3: US financial crisis responsible for failure of financial institutions around the world 7 Reference List 9 Part 1: Warnings about the financial crisis The financial crisis of 2008-2009 has affected and deformed the financial system of the United States and Euro zone countries and also many other countries in the world. Both developed and developing countries have faced the severity of the consequences of this crisis. While the crisis had taken shape, economists, politicians and researchers were concerned about the causes that triggered a crisis of such a dimension. Although it was quite late and the crisis was already in full swing, researchers claim that prior signs were visible about the occurrence of the crisis. A number of investors had seen these signs as warnings for the development of the crisis situation. Based on these signs, some of the investors had predicted that the tremendous growth of the US economy was a temporary phenomenon and the US economy was ultimately going to collapse (Connolly and Wall, 2011). Several researches have been conducted since then, and are being continued still now, regarding the causes and the warnings of the crisis. Several leaders belonging to different countries have predicted the inevitable collapse of the economy of United States. However, some of the leaders made legitimate and confident forewords about the critical elements within the economy’s financial structure and the extent of dire consequences that the economy was going to face in the near future (McDonnell and Burgess, 2013). Several logical analyses were made on the facts and data that were collected from the-then economic and financial condition of the economy. A considerably large fraction of investors, including buyers of private homes, received credible warnings about the occurrence of a housing bubble. According to some researchers and market observers, the root to this crisis lied in the policies and regulations developed by the Federal Reserve. Additionally, many of the investors ignored these messages received and did not make any changes in their course of action. Banks were also bound by the need to meet the credit needs of local investors. This policy forced the “banks to make subprime loans” (Gramm and Solon, 2013). Bank authorities transferred this pressure to the banking personnel and regulators to make more loans of the subprime category. The banks performance was measured on the basis of the loans that they were able to extend to the investors (Wang, Ali, and Al-Akra, 2013). In this process, the issue of credibility of the investors was ignored. The quota to provide affordable housing loans was fixed at 30 percent in the year 1993 (Gramm and Solon, 2013). This was made during the era of President Bill Clinton of the USA. Within three years this quota was increased to 40 percent. The quota further increased within a few years and reached the target of 50 percent by 2000. At that point of time, the administration of President George W. Bush took control of the American economy. Under his control the affordable housing loan goals were increased further. Documents from that period of time reveal that “these quotas were promoting irresponsible policy” (Gramm and Solon, 2013). The risks involved in these subprime loans were severely high as due to lack of credibility check a large proportion of the borrowers would be found to be defaulters. According to some sources, researchers claim that as high as 28 million high risk loans were provided to borrowers. Although the safety enforcement laws advised the banks to reduce high loans, there existed conflicting regulations regarding the promotion of affordable housing loans. Thus, the safety and soundness measures were ineffective in restraining the pattern of loan giving, conflicting laws regarding providing housing credit facilities to as many borrowers who demand home loans. This shows that there were all channels that gave shape to a massive situation of financial breakdown. The economic growth exhibited by the US economy during the 1990s was the result of wealth bubbles that were destined to burst in the near future. All these factors laid several vivid warnings regarding the occurrence of the financial crisis. After making extensive studies researchers have claimed that the government regulators are the main culprits of phenomenon. The private sector financial institutions succumbed to the threat of the making subprime loans to a significantly large extent (Uppal and Mangla, 2013). Part 2: Parties culpable for the “crime” The rule of Clinton was carried over by the Republican succeeding president of the country, George W. Bush. Both the Democratic Party policies and the Republican Party regimes were found to be supporting the home ownership credit extension policy. According to Wallison (2009), the major policy change that is expected to be effective in this situation and capable of controlling the fall of the US economy, is adopt more stringent “regulation of the financial system within the economy” (Wallison, 2009). A higher level prescription would lead to termination of the government policies that are distorting the mortgage lending activities. Apart from the government, the individual investors are also held responsible for the occurrence of the financial breakdown. This is because there is evidence that there were some distinct warnings that were visible to the investors. However, many of them ignored these signs and did not seriously consider the probability of occurrence of a financial crisis (Gunnigle, Lavelle and Monaghan, 2013). Hence, the proportion of bad loans continued to increase and the economy further moved into a situation of bad irrecoverable debt. Thirdly, many banks were engaged in various types of fraudulent practices. The bank professionals were packed with credit rating agencies to gain high ratings for their own organizations in order to gain confidence of more investors. Financial institutions, such Lehman Brothers, Bear Sterns and Goldman Brothers misrepresented their financial statements to their stakeholders even when they faced credit crunch (Bennett and Kottasz, 2012). During the same period, the Euro zone faced a financial crisis. Some of the countries were affected to such an extent that their financial structures were redefined after the crisis. Few other countries have been affected by a lesser range. The result of bankruptcy filing by the Lehman Brothers in September 2008 has brought the greatest effect on the Euro zone crisis (Deissinger and Hellwig, 2005). This failure identifies one of the greatest failures of financial institution in the history of two decades of world banking. The financial crisis arising as a result of housing bubble in the US, led to a decline in credit facilities all over the globe, thereby causing the global trade to take a down turn (Merrouche and Nier, 2010). The effect of this global trade down turn was felt on the GDP growth in almost all economies around the world, in varying degrees of effectiveness. In this paper, the context of Germany has been investigated with reference to the economic down turn of the Euro zone. Effect on Germany The economy of Germany is highly dependent on its export sector. Hence, any developments in the world economy affect the export sector of Germany largely, thereby affecting the functioning of the entire economy. Germany experienced a quick contraction of its economy beginning at the second half of 2008. The manufacturing sector of Germany is mostly export oriented. It contributes the lion’s share in the country’s GDP. Hence, in the latter part of 2008, the economy faced a rapid contraction (Reavis, 2012). However, the economy showed immediate signs of recovery. By the second quarter of 2009, the country showed strong signs of coming out of recession (Dullien, et al., 2010). This happed with the unfaltering crisis management by the German government. Employment was maintained at a stable level even during recession and GDP growth showed increasing trend towards the end of 2009. Several healing activities by the government included stabilization measures for the banking sector, activities to remove toxic assets from the society and rebuilding trust among the economic agents on the financial structure of the economy (Allen and Carletti, 2009). As the part of stabilization measure, the government injected capital into the economy for every 3 percent of the GDP and made purchases of assets providing a guarantee of maximum of EUR 400 billion (accounting for almost 116 percent of the GDP). Additionally, the government made an introduction of the “bad bank scheme” (Orendt, 2010). The risky assets were termed as toxic and were removed from the balance sheets of banks. This helped to rebuild trust of the customers on the liquidity of the banks. The government also provided support to the small domestic banks against the larger banks that operated internationally, in order to push up their market performance and re-establish the faith of domestic customers on these institutions. Furthermore, with the gradual recovery of the developing world the export sector of the country recovers fast, which casts positive effects on the economic growth of the country (Orendt, 2010). Part 3: US financial crisis responsible for failure of financial institutions around the world The origin of the US financial crisis can be traced back to the era of Bill the 42nd president of the country. Clinton was the US president during the period between 1993 and 2001. This was the period when the baby boomers generation had entered adulthood. Now the population of the country had increased tremendously and alongside level of economic activities was also increasing. During Clinton’s regime the government made the rule that the local credit needs would have to be fully satisfied. An article published in the New York Times has critically blamed the government regulation, which encouraged the banks and financial institutions to make more subprime loans and engage into more risky financial transactions (Wallison, 2009). This regime continued even during the rule of President Bush. Bush had made excessive promotions of the ownership of private home, although the banks were increasingly running bad debts. The banking system became submersed in junk mortgagees. This led the banks through continuous loses thereby puling the economy further downwards. Secondly, the government policies made during this period, particularly, “the Community Reinvestment Act and Fannie Mae and Freddie Mac” (Wallison, 2009) are responsible for the distortion that was brought about in the financial structure of the economy. The turmoil in the US financial markets was not far from the German economy. The breakdown of the financial system of the US affected the German economy with lightening speed. Not only were the financial institutions of the country affected by the US credit crunch, but also the common people of the country suffered from lack of credit and loss of confidence on the liquidity of the banks (McKibbin and Stoeckel, 2009). International companies operating in Germany as well as their domestic companies have been adversely affected due to the failures of US based financial institutions and their bail outs. This is because apart from private companies, some of the big investors also bought securities of the financial institutions, such as, Lehman brothers. However, the position of the German economy in the world market, itself acted as a protector of the economy during times of crisis. Since the economy faces high level of demand from the customers from all around the world, the country was immune to the credit crisis to a large extent. Some of the banks that were affected by the crisis were Deutsche Bank, Bayerische LB, HSH Nordbank and LBBW. LBBW’s exposure outside Europe was 29.9 percent in 2006, after which if failed badly. The credit exposure of some of these banks was terminated and has not increased since the crisis period. Some of the financial institutions were rescued by the government by providing bail outs, while the others failed and were occupied by other banks or financial institutions. Reference List Allen, F. and Carletti, R., 2009. The Global Financial Crisis: Causes and Consequences. [pdf] BM Available at [Accessed 23 November 2013]. Bennett, R. and Kottasz, R., 2012. Public attitudes towards the UK banking industry following the global financial crisis. International Journal of Bank Marketing, 30 (2), pp. 128 - 147 Connolly, C. and Wall, T., 2011. The global financial crisis and UK PPPs. International Journal of Public Sector Management. 24 (6), pp. 533 - 542. Deissinger, T. and Hellwig, S., 2005. Apprenticeships in Germany: Modernising the Dual System. Education + Training, 47 (4/5), 312 - 324. Dullien, S., Kotte, D. J., Marquez, A. and Priewe, J., 2010. The Financial and Economic Crisis of 2008-2009 and Developing Countries. [pdf] United Nations Available at [Accessed 23 November 2013]. Gramm, P. and Solon, M., 2013. The Clinton-Era Roots of the Financial Crisis. [online] Available at: < http://online.wsj.com/news/articles/SB10001424127887323477604579000571334113350 > [Accessed 23 November 2013]. Gunnigle, P., Lavelle, J. and Monaghan, S., 2013. Weathering the storm? Multinational companies and human resource management through the global financial crisis. International Journal of Manpower, 34 (3), pp. 214 - 231. McDonnell, A. and Burgess, J., 2013. The impact of the global financial crisis on managing employees. International Journal of Manpower, 34 (3), pp. 184 - 197. McKibbin, W. J. and Stoeckel, A., 2009. The Global Financial Crisis: Causes and Consequences. [pdf] Lowy Institute Available at [Accessed 23 November 2013]. Merrouche, O. and Nier, E. 2010. What Caused The Global Financial Crisis? Evidence On The Drivers Of Financial Imbalances 1999–2007. [pdf] IMF Available at [Accessed 23 November 2013]. Orendt, M., 2010. Consequences of the Financial Crisis on Europe. [online] Available at: < http://www.bilgesam.org/en/index.php?option=com_content&view=article&id=234:consequences-of-the-financial-crisis-on-europe&catid=70:ab-analizler&Itemid=131 > [Accessed 23 November 2013]. Reavis, C., 2012. The Global Financial Crisis of 2008: The Role Of Greed, Fear, And Oligarchs. [pdf] MIT Available at [Accessed 23 November 2013]. Uppal, J. Y. and Mangla, I. U., 2013. Extreme loss risk in financial turbulence – evidence from the global financial crisis. Managerial Finance, 39 (7), pp. 653 - 666. Wallison, P. J., 2009. The True Origins of This Financial Crisis. [online] Available at: < http://spectator.org/articles/42211/true-origins-financial-crisis > [Accessed 23 November 2013]. Wang, Z., Ali, Z. M. and Al-Akra, M., 2013. Value relevance of voluntary disclosure and the global financial crisis: Evidence from China. Managerial Auditing Journal, 28 (5), pp. 444 - 468. Read More