Global Financial Crisis: Causes and Effect Essay

The fiscal crisis that began in 2007 spread and ga in that respectd intensity in 2008, contempt the efforts of central commits and regulators to consistore calm. By early 2009, the financial system and the global thriftiness appe bed to be locked in a descending spiral, and the primary focus of policy became the prevention of a prolonged downturn on the order of the Great Depression. The volume and variety of negative financial sweets, and the seeming impotence of policy responses, has raised new questions ab portray up the origins of financial c build ups and the market mechanisms by which they are contained or propagated.Just as the frugal impact of financial market failures in the 1930s remains an active academic subject, it is likely that the causes of the real crisis anyow for be debated for decades to come. Financial Crisis The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the nineteenth and early 20th centuries, umpteen financial crises were associated with asserting panics, and many recedings coincided with these panics.Other situations that are often called financial crises capture stock market crashes and the bursting of new(prenominal) financial bubbles, currency crises, and sovereign defaults. Major causes of Financial Crisis Imprudent owe Lending Against a backdrop of abundant credit, depressive disorder affaire rates, and rising field of operations prices, change standards were relaxed to the depict that many people were able to buy houses they couldnt afford. When prices began to fall and loans started going crowing, there was a pure(a) shock to the financial system.Housing Bubble With its easy money policies, the Federal Reserve allowed lodging prices to rise to unsustainable levels. The crisis was triggered by the bubble bursting, as it was bound to do. Global Imbalances Global financial flows spend a penny been characterized in modern years by an unsustainable pattern some countries ( china, Japan, and Germany) guide large surpluses ein truth year, while separates run deficits. The U. S. outdoor(a) deficits construct been mirrored by internal deficits in the household and administration empyreans.U. S. borrowing cannot continue indefinitely the resolventing stress underlies current financial disruptions. Securitization Securitization fostered the originate-to-distri furthere model, which reduced lenders incentives to be prudent, especially in the face of vast investor direct for subprime loans packaged as AAA bonds. Ownership of owe-backed securities was widely dispersed, causing repercussions throughout the global system when subprime loans went bad in 2007.Lack of Transparency and Accountability in Mortgage Finance Throughout the trapping pay value chain, many participants contri stilled to the creation of bad mortgages and the selling of bad securities, apparently feel ing secure that they would not be held accountable for their actions. A lender could sell exotic mortgages to mob-owners, apparently without fear of repercussions if those mortgages failed. Similarly, a bargainer could sell toxic securities to investors, apparently without fear of personal responsibility if those contracts failed.And so it was for brokers, realtors, individuals in rating agencies, and opposite market participants, each maximizing his or her own gain and passing problems on down the origination until the system itself collapsed. Because of the lack of participant accountability, the originate-to distribute model of mortgage finance, with its at a time great promise of managing risk, became itself a massive generator of risk. Rating Agencies The credit rating agencies gave AAA ratings to numerous issues of subprime mortgage-backed securities, many of which were subsequently downgraded to toss status.Critics cite poor frugal models, conflicts of interest, and l ack of resultant roleive regulation as reasons for the rating agencies failure. An new(prenominal) ingredient is the markets unreasonable reliance on ratings, which has been reinforced by numerous laws and regulations that use ratings as a criterion for permissible investments or as a factor in required jacket levels. Mark-to-market Accounting FASB standards require institutions to report the fair (or current market) value of securities they hold.Critics of the rule argue that these forces banks to recognize losings based on fire sale prices that prevail in distressed markets, prices believed to be under long-term fundamental values. Those losings undermine market confidence and exacerbate banking system problems. Some propose suspending mark-to-market EESA requires a study of its impact. Deregulatory Legislation Laws such as the Gramm-Leach-Bliley Act (GLBA) and the Commodity Futures Modernization Act (CFMA) permitted financial institutions to plunge in unregulated barba rian transactions on a vast scale.The laws were driven by an excessive faith in the robustness of market discipline, or self-regulation. Shadow Banking System Risky financial activities once confined to regulated banks (use of leverage, borrowing ill-judged-term to lend long, etc. ) migrated outside the explicit politics rubber eraser net provided by deposit insurance and safety and soundness regulation. Mortgage lending, in particular, moved out of banks into unregulated institutions. This unsupervised risk-taking amounted to a financial house of cards.Non-Bank Runs As institutions outside the banking system built up financial positions built on borrowing short and lending long, they became vulnerable to liquidity risk in the form of non-bank runs. That is, they could fail if markets lost confidence and refused to extend or roll over short-term credit, as happened to Bear Stearns and others. Government-Mandated Subprime Lending Federal mandates to help low-income borrowers (e. g . , the Community Reinvestment Act (CRA) and Fannie Mae and Freddie Macs affordable housing goals) forced banks to engage in imprudent mortgage lending.Excessive Leverage In the post-2000 period of low interest rates and abundant capital, fixed income yields were low. To compensate, many investors used borrowed funds to boost the return on their capital. Excessive leverage magnified the impact of the housing downturn, and deleveraging caused the interbank credit market to tighten. Financial Crisis & U. S frugality In 2008, the United States experienced a major financial crisis which led to the most serious box since the Second World War. Both the financial crisis and the downturn in the U. S. economy spread to many inappropriate nations, resulting in a global economic crisis.On kinsfolk 15, 2008, Lehman Brothers, one of the largest investment banks in the world, failed. over the next few months, the US stock market plumped, liquidity dried up, successful companies laid bump off employees by the thousands, and for the first time there was no longer any doubt a recession was upon the American people. Eleven months after the fall of Lehman Brothers, the U. S. remains in a state of limbo. Proposals for stimulus packages and other bailout plans have provided some relief, but it seems the most effective remedy thus far has been time.The facts are that nigh 6% of all mortgage loans in United States are in default. Historically, defaults were less than one-third of that, i. e. , from 0. 25% to 2%. A huge portion of the change magnitude mortgage loan defaults are what are referred to as sub-prime loans. Most of the sub-prime loans have been made to borrowers with poor credit ratings, no down payment on the home financed, and/or no verification of income or assets (Alt-As). Close to 25% of sub-prime and Alt-As loans are in default.These loans increased dramatically as a 9/30/99 New York Times article explained, In a move that could help increase homeownership rates among minorities and low income consumers, the Fannie Mae Corp. is easing the credit requirements on loans that it allow for purchase from banks and other lenders. To allow Fannie Mae to make more loans, President Clinton excessively reduced Fannie Maes nurse requirement to 2. 5%. That means it could purchase and/or guarantee $97. 50 in mortgages for every $2. 50 it had in beauteousness to cover possible bad debts. If more than 2. % of the loans go bad, the taxpayers (us) have to pay for them.That is what this bailout is all intimately. It is not the politics paying the banks for the bad loans, it is us Principally Senate Democrats demanded that Fannie Mae & Freddie Mac (FM&FM) buy more of these risky loans to help the poor. Since the mortgages purchased and guaranteed by FM&FM are backed by the U. S. government, the loans were re-sold mainly to investment banks which in turn bundled most of them, taking a hefty fee, and sold the mortgages to investors all over the wor ld as virtually risk free.As long as the Federal Reserve (another government created agency) kept interest rates artificially low, periodic mortgage payments were low and housing prices went up. Many home owners got home equity loans to pay their first mortgages and credit card debt. Unfortunately home prices peaked in the winter of 2005-06 and the house of cards started to crumble. People could no longer increase their mortgage debt to pay previous debts. Now, we taxpayers are universe told we have to bail out the banks and everyone in the world who bought these highly risky loans.The politicians in Congress (mostly Democrats) do not want you to know they caused the mess. In the 2006 elections, the Democrats took control of the House and Senate. There are atomic reactor of videos on the Internet showing many Democrats including Senate Banking Committee Chairman Democrat Christopher Dodd and House Banking Committee Chairman Barney Frank, answerable with overseeing FM&FM, assurin g us that there were no problems with FM&FM right up to their collapse.not surprisingly, virtually all the investment banks that are in smother and being bailed out are run by financial supporters of Obama and other Democrats. Secretary of the Treasury Paulsen was head of Goldman Sachs. The new head of the $700 jillion bailout is likewise from Goldman Sachs. This is like letting the fox be in charge of hen house security. It was announced that our government will infuse capital into the troubled banks. This gives whoever is in power of our government the ability to force the like kind of abuses that have caused this massive banking crisis in the first place.Barack Obama has received more campaign donations that any other politician in the past three years from Fannie Mae and Wall Street. FM&FC have been virtually underground piggy banks of campaign contributions for Democrats for the past 10 years. Yes, a token amount went to some Republicans. And there is plenty of blame to go around in this financial crisis, but the reason it happened was 100% caused by a Democrat run government that forced a liberal policy initiated by President Clinton and reforms primarily blocked by Democrats. One would never know this by watching the news or reading newspapers.Until the majority of our citizens understand whom (government liberals) and what (liberalism/socialism) caused this mess, we will allow our elected officials, through massive inflation, to lower the standard of vivification of those of us who are financially prudent and give our earnings to those who are not prudent. The big acknowledgment for the bailout is that credit markets have frozen up. But it is not true. There is plenty of credit available for beloved credit risks. The only way this can be rectified is to allow the people who made the mistakes to take their losses.It is called taking personal responsibility for ones actions. Already we see that the bailout has had virtually no effect on the mark ets other than to cause huge sell offs because smart investors see that the U. S. is adopting failed liberal socialist policies. Our government is future(a) in the footsteps of Hoover and Roosevelt. We do not need to have another depression, but the government is taking the steps to make it happen. The taxpayer financed bailout should be reversed immediately as it will only make headway more irresponsible fraudulent behavior. Impacts of Financial Crisis on Global EconomyFor the developing world, the rise in food prices as well as the knock-on effects from the financial instability and uncertainty in industrialize nations is having a compounding effect. High fuel costs, soaring commodity prices together with fears of global recession are worrying many developing country analysts. Asia & Financial crisis Countries in Asia are increasely worried around what is happening in the West. A number of nations urged the US to provide meaningful assurances and bailout packages for the US ec onomy, as that would have a knock-on effect of reassuring unconnected investors and helping ease concerns in other parts of the world.India and China are the among the worlds fastest growing nations and after Japan, are the largest economies in Asia. From 2007 to 2008 Indias economy grew by a whopping 9%. Much of it is fueled by its domestic market. However, even that has not been enough to shield it from the effect of the global financial crisis, and it is expected that in data will show that by March 2009 that Indias growth will have speechlessed quickly to 7. 1%. Although this is a very impressive growth figure even in good times, the speed at which it has droppedthe sharp slackeningis what is concerning.China similarly has excessively experienced a sharp slowdown and its growth is expected to slow down to 8% (still a good growth figure in normal conditions). However, China overly has a growing crisis of unrest over job losses. Both have poured billions into recovery packag es. China has also raised concerns about the world relying on mostly one foreign currency reserve, and called for the dollar to be replaced by a world reserve currency run by the IMF. Of course, the US has defended the dollar as a global currency reserve, which is to be expected given it is one of its main sources of global economic dominance.Whether a change like this would actually happen remains to be seen, but it is likely the US and its allies will be very resistant to the idea. Japan, which has suffered its own crisis in the 1990s also faces trouble now. While their banks seem more secure compared to their westerly counterparts, it is very dependent on exports. Japan is so exposed that in January alone, Japans industrial production fell by 10%, the biggest monthly drop since their records began. Japans output for the first 3 months of 2009 plunged at its quickest pace since records began in 1955, mostly payable to falling exports.A rise in industrial output in April was expe cted, but was positively more than initially calculated. However, with high unemployment and general lack of confidence, optimism for recovery has been dampened. In recent years, there has been more interest in Africa from Asian countries such as China. As the financial crisis is luluting the Western nations the hardest, Africa may yet enjoy increased trade for a while. These front hopes for Africa, above, may be short lived, unfortunately.In May 2009, the International Monetary Fund (IMF) warned that Africas economic growth will plummet because of the world economic downturn, predicting growth in sub-Saharan Africa will slow to 1. 5% in 2009, below the rate of population growth (revising downward a March 2009 portent of 3. 25% growth due to the slump in commodity prices and the credit squeeze). Some African countries have already started to cut their health and HIV budgets due to the economic crisis. Their health budgets and resources have been constrained for many years alrea dy, so this crisis makes a bad situation worse.Due to its proximity to the US and its close relationship via the NAFTA and other agreements, Mexico is expected to have one of the lowest growth rates for the region next year at 1. 9%, compared to a downgraded forecast of 3% for the rest of the region. Europe & Financial crisis In Europe, a number of major financial institutions failed. Others needed rescuing. In Iceland, where the economy was very dependent on the finance sector, economic problems have hit them hard. The banking system virtually collapsed and the government had to borrow from the IMF and other neighbors to try and rescue the economy.In the end, public dissatisfaction at the way the government was handling the crisis meant the Iceland government fell. The EU is also considering spending increases and tax cuts said to be worth 200bn over two years. The plan is supposed to help restore consumer and business confidence, shore up employment, getting the banks lending agai n, and promoting green technologies. Russias economy is contracting sharply with many more feared to slide into poverty. One of Russias key exports, oil, was a reason for a recent boom, but falling prices have had a big impact and investors are withdrawing from the country.Africa & Financial crisis Perhaps ironically, Africas by and large weak integration with the rest of the global economy may mean that many African countries will not be affected from the crisis, at least not initially, as suggested by Reuters in September 2008. In recent years, there has been more interest in Africa from Asian countries such as China. As the financial crisis is hitting the Western nations the hardest, Africa may yet enjoy increased trade for a while. These earlier hopes for Africa, above, may be short lived, unfortunately.In May 2009, the International Monetary Fund (IMF) warned that Africas economic growth will plummet because of the world economic downturn, predicting growth in sub-Saharan Afri ca will slow to 1. 5% in 2009, below the rate of population growth (revising downward a March 2009 prediction of 3. 25% growth due to the slump in commodity prices and the credit squeeze) African countries could face increasing pressure for debt repayment, however. As the crisis gets deeper and the international institutions and western banks that have lent money to Africa need to shore up their reserves more, one way could be to demand debt repayment.This could cause further cuts in social serve such as health and education, which have already been reduced due to crises and policies from previous eras. The current crisis The housing bubble started to burst in 2006, and the exacerbate accelerated in 2007 and 2008. Housing prices stopped increasing in 2006, started to decrease in 2007, and have fallen about 25 pct from the peak so far. The decline in prices meant that homeowners could no longer refinance when their mortgage rates were reset, which caused delinquencies and defaults of mortgages to increase sharply, especially among subprime borrowers.From the first butt of 2006 to the third quarter of 2008, the percentage of mortgages in foreclosure tripled, from 1 percent to 3 percent, and the percentage of mortgages in foreclosure or at least thirty days delinquent more than doubled, from 4. 5 percent to 10 percent. These foreclosure and wrong rates are the highest since the Great Depression the previous peak for the delinquency rate was 6. 8 percent in 1984 and 2002. And the worst is yet to come. The American dream of owning your own home is turning into an American incubus for megs of families.Early estimates of the total number of foreclosures that will result from this crisis in the years to come ranged from 3 million to 8 million. So far (as of January 2009), there have already been almost 3 million mortgage foreclosures. Another 1 million mortgages are ninety days delinquent and another 2 million were thirty days delinquent. Therefore, a total of a bout 6 million mortgages either have already been foreclosed, are in foreclosure, or are close to foreclosure. Six million mortgages are about 12 percent of all the mortgages in the United States.The situation could get a lot worse in the months ahead, due to the worsening recession and lost jobs and income, unless the government adopts stronger policies to reduce foreclosures. Defaults and foreclosures on mortgages mean losses for lenders. Estimates of losses on mortgages keep increasing, and many are now predicting losses of $1 trillion or more. In improver to losses on mortgages, there will also be losses on other types of loans, due to the weakness of the economy, in the months ahead consumer loans (credit cards, etc. ), commercial real estate, corporate junk bonds, and other types of loans (e. g. redit default swaps).Estimates of losses on these other types of loans range up to another trillion dollars. Therefore, total losses for the financial sector as a whole could be as hi gh as $2 trillion. It is further estimated that banks will suffer about half of the total losses of the financial sector. The rest of the losses will be borne by non-bank financial institutions (hedge funds, pension funds, etc. ). Therefore, dividing the total losses for the financial sector as a whole in the previous paragraph by two, the losses for the banking sector could be as high as $1 trillion.Since the total bank capital in the U.S. is approximately $1. 5 trillion, losses of this magnitude would wipe out two-thirds of the total capital in U. S. banks * This would obviously be a arch blow, not just to the banks, but also to the U. S. economy as a whole. The blow to the rest of the economy would happen because the rest of the economy is dependent on banks for loansbusinesses for investment loans, and households for mortgages and consumer loans. Bank losses result in a reduction in bank capital, which in turn requires a reduction in bank lending (a credit crunch), in order to maintain acceptable loan to capital ratios. presume a loan to capital ratio of 101 (this conservative assumption was made in a recent study by Goldman Sachs), every $100 billion loss and reduction of bank capital would normally result in a $1 trillion reduction in bank lending and corresponding reductions in business investment and consumer spending. According to this rule of thumb, even the low estimate of bank losses of $1 trillion would result in a reduction of bank lending of $10 trillion This would be a severe blow to the economy and would cause a severe recession.Bank losses may be offset to some extent by recapitalization, i. e. by new capital being invested in banks from other sources. If bank capital can be at least partially restored, then the reduction in bank lending does not have to be so significant and traumatic. So far, banks have lost about $500 billion and have raised about $400 billion in new capital, most of it coming from sovereign wealth funds financed by the g overnments of Asian and Middle Eastern countries. So ironically, U. S. banks may be saved (in part) by increasing foreign ownership. U. S. bankers are now figuratively on their knees before these foreign investors offering discounted prices and pleading or help.It is also an important indication of the decline of U. S. economic hegemony as a result of this crisis. However, it is becoming more ticklish for banks to raise new capital from foreign investors, because their prior investments have already suffered significant losses. In addition to the credit crunch, consumer spending will be further depressed in the months ahead due to the following factors decreasing household wealth the end of mortgage equity withdrawals and declining jobs and incomes. All in all, it is shaping up to be a very severe recession.