Global Financial Crisis: Causes and Effect Essay

The pecuniary crisis that began in 2007 shell out and garner intensity in 2008, despite the efforts of central swans and regulators to restore calm. By archaean 2009, the pecuniary dust and the global sparing appe bed to be locked in a descending spiral, and the primary focus of policy became the pr regulartion of a drawn-out fellturn on the order of the Great Depression. The volume and variety of prejudicial fiscal watchword, and the becharmming impotence of policy responses, has raised refreshed questions al some the origins of financial c climb ons and the foodstuff mechanisms by which they ar contained or propagated.Just as the scotch impact of financial market failures in the 1930s frame an active academic subject, it is ilkly that the arouses of the current crisis give be debated for decades to come. fiscal Crisis The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a bear-s ized part of their value. In the 19th and early 20th centuries, m any(prenominal) financial crises were associated with banking panics, and many street corners coincided with these panics.Other situations that be often called financial crises include stock(a) market crashes and the bursting of different financial bubbles, bills crises, and sovereign defaults. Major causes of monetary Crisis Imprudent owe alter Against a backdrop of grand credence, depleted liaison place, and rising base prices, lending standards were relaxed to the point that many wad were able to buy houses they couldnt afford. When prices began to fall and loans started going unfavourable, thither was a severe shock to the financial system.lodging Bubble With its easy bullion policies, the Federal Reserve allowed hold 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 wipe out been characterized in late(a) years by an unsustainable pattern some countries (China, japan, and Germany) rank large surpluses either year, while otherwises run deficits. The U. S. external deficits urinate been mirrored by ingrained deficits in the household and government vault of heavens.U. S. borrowing stoolnot continue indefinitely the resulting accent mark underlies current financial disruptions. Securitization Securitization fostered the originate-to-distribute model, which reduced lenders incentives to be prudent, especially in the strikingness of vast investor demand for subprime loans packaged as AAA bonds. Ownership of mortgage-backed securities was astray dispersed, causing repercussions throughout the global system when subprime loans went bad in 2007.neediness of Transp arncy and Accountability in Mortgage Finance Throughout the house finance value chain, many participants contributed to the creation of bad mortgages and the selling of bad securities, apparently feeling se cure that they would not be held accountable for their actions. A lender could sell exotic mortgages to home-owners, apparently without fear of repercussions if those mortgages failed. Similarly, a monger 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 evaluation agencies, and other market participants, each maximizing his or her own gain and passing problems on down the line until the system itself collapsed. Because of the lack of participant accountability, the originate-to distribute model of mortgage finance, with its once plumping(p) promise of managing risk, became itself a massive generator of risk. Rating Agencies The acknowledgement rating agencies gave AAA ratings to numerous issues of subprime mortgage-backed securities, many of which were subsequently downgraded to junk status.Critics cite miserable economic models, conflicts of interest, and lack of effective regulation as backgrounds for the rating agencies failure. some other factor is the markets excessive reliance on ratings, which has been strengthen by numerous laws and regulations that use ratings as a criterion for allowable enthronization fundss or as a factor in required corking levels. Mark-to-market Accounting FASB standards require institutions to report the fair (or current market) value of securities they hold.Critics of the find oneself argue that these forces banks to recognize losings based on fire cut-rate sale prices that prevail in distressed markets, prices believed to be below long-term primeval values. Those losses undermine market confidence and exacerbate banking system problems. almost propose suspending mark-to-market EESA requires a study of its impact. Deregulatory Legislation Laws such as the Gramm-Leach-Bliley exercise (GLBA) and the Commodity Futures Modernization Act (CFMA) permitted financial institutions to engage in unre gulated risky transactions on a vast scale.The laws were driven by an excessive faith in the robustness of market discipline, or self-regulation. iniquity Banking System Risky financial activities once confined to regulated banks (use of leverage, borrowing short-term to lend long, etc. ) migrated outside the explicit government guard 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 gameboards.Non-Bank Runs As institutions outside the banking system built up financial positions built on borrowing short and lending long, they became vulnerable to liquid state risk in the form of non-bank runs. That is, they could fail if markets lost confidence and refused to live on or roll over short-term credit, as authorizeed to Bear Stearns and others. Government-Mandated Subprime Lending Federal mandates to assist low-inco me borrowers (e. g. , the Community Reinvestment Act (CRA) and Fannie Mae and Freddie Macs low-priced housing goals) agonistic banks to engage in imprudent mortgage lending. high-spirited Leverage In the post-2000 period of low interest rates and abundant peachy, 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 preservation In 2008, the United States go through a major financial crisis which led to the most serious recession since the hour World War. Both the financial crisis and the downturn in the U. S. economy spread to many hostile nations, resulting in a global economic crisis.On September 15, 2008, Lehman Brothers, one of the largest investment banks in the knowledge base, failed. Over the next some months, the US stock market plummeted, liquidity dr ied up, successful companies dictated off employees by the thousands, and for the first time at that place was no prolonged any doubt a recession was upon the American people. Eleven months by and by the fall of Lehman Brothers, the U. S. remains in a state of limbo. Proposals for stimulus packages and other bailout plans be possessed of provided some relief, but it seems the most effective remedy frankincense far has been time.The facts are that approximately 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 commodious portion of the increase 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 will barter for from banks and other lenders. To allow Fannie Mae to make more loans, President Clinton withal reduced Fannie Maes reserve requirement to 2. 5%. That means it could purchase and/or guarantee $97. 50 in mortgages for e precise $2. 50 it had in equity 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 or so. It is not the government paying the banks for the bad loans, it is us Principally Senate populists 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- exchange primarily to investment banks which in turn bundled most of th em, taking a hefty fee, and sold the mortgages to investors all over the foundation as almost risk free.As long as the Federal Reserve ( other government created agency) kept interest rates artificially low, monthly mortgage payments were low and housing prices went up. many another(prenominal)(prenominal) home owners got home equity loans to pay their first mortgages and credit card debt. Unfortunately home prices bloominged in the winter of 2005-06 and the house of separate started to crumble. People could no longer increase their mortgage debt to pay previous debts. Now, we taxpayers are creation told we have to bail out the banks and e realone in the world who bought these highly risky loans.The politicians in Congress (mostly Democrats) do not fatality you to know they caused the mess. In the 2006 elections, the Democrats took control of the House and Senate. on that point are jalopy of videos on the Internet showing many Democrats including Senate Banking Committee Ch airman Democrat Christopher Dodd and House Banking Committee Chairman Barney Frank, responsible with overseeing FM&FM, assuring us that there were no problems with FM&FM right up to their collapse. non surprisingly, virtually all the investment banks that are in trouble and being bailed out are run by financial supporters of Obama and other Democrats. secretaire of the Treasury Paulsen was head of Goldman Sachs. The new head of the $700 million bailout is too 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 same 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 historical three years from Fannie Mae and circumvent Street. FM&FC have been virtually private piggy banks of campaign c ontributions for Democrats for the past 10 years. Yes, a token amount went to some Re nationalans. And there is band 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 stop 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 living of those of us who are financially prudent and give our earnings to those who are not prudent. The big excuse for the bailout is that credit markets have frozen up. But it is not true. There is plenty of credit available for good credit risks. The only focus this can be rectified is to allow the people who made the mis fool aways to take their losses.It is called ta king personal responsibility for ones actions. Already we see that the bailout has had virtually no effect on the markets other than to cause huge sell offs because smart investors see that the U. S. is adopting failed liberal socialist policies. Our government is side by side(p) 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 transposed immediately as it will only encourage more overbearing 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 industrialized nations is having a compounding effect. senior high fuel costs, soaring commodity prices to requireher with fears of global recession are worrying many developing country analysts. Asia & Financial crisis Countries in Asia are change magnitudely wor ried around what is happening in the West. A bod of nations urged the US to provide meaningful assurances and bailout packages for the US economy, as that would have a knock-on effect of reassuring foreign investors and helping ease concerns in other parts of the world.India and China are the among the worlds fastest ontogeny 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 judge that in data will show that by March 2009 that Indias harvest-festival will have slowed quickly to 7. 1%. Although this is a very impressive crop figure even in good times, the further at which it has droppedthe sharp slowdownis what is concerning.China similarly has as well as experienced a sharp slowdown and its growth is expected to slow down to 8% (still a good growth figure in convening conditions). However, China also has a growing crisis of unrest over byplay losses. Both have poured billions into recovery packages. China has also raised concerns astir(predicate) the world relying on mostly one foreign currency reserve, and called for the one dollar bill 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. magical spell 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 ou tput for the first 3 months of 2009 plunged at its quickest footprint since records began in 1955, mostly overdue to go exports.A rise in industrial output in April was expected, but was positively more than ab initio estimated. 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 hitting the Western nations the hardest, Africa whitethorn in time enjoy increased trade for a while. These before hopes for Africa, above, may be short lived, unfortunately.In May 2009, the International fiscal 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 race growth (revising downward a March 2009 prediction of 3. 25% growth due to the slump in commodity prices and the credit squeeze). Some African countries have already started to cut their wellness and HIV budgets due to the economic crisis. Their health budgets and resources have been constrained for many years already, so this crisis makes a bad situation worse.Due to its proximity to the US and its close alliance 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 reckon of 3% for the rest of the region. Europe & Financial crisis In Europe, a come up of major financial institutions failed. Others needed rescuing. In Iceland, where the economy was very dependent on the finance heavens, 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 i ncreases and tax cuts said to be worth 200bn over both years. The plan is supposed to help restore consumer and business confidence, put down up employment, getting the banks lending again, 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 mayhap ironically, Africas generally 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, unfortu nately.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 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 services 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 reject accelerated in 2007 and 2008. Housing prices stopped increasing in 2006, started to decrease in 2007, and have locomot e about 25 percent 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 quarter 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 delinquency 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 nightmare for millions of families.Early estimates of the total number of foreclosures that will result from this crisis in the years to come kitchen ranged from 3 million to 8 million. So far (as o f January 2009), there have already been almost 3 million mortgage foreclosures. another(prenominal) 1 million mortgages are ninety days delinquent and another 2 million were thirty days delinquent. Therefore, a total of about 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 addition 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, bodied junk bon ds, 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 high 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 severe ravage, 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 lessening in bank capital, which in turn requires a reduction in bank lending (a credit crunch), in order to maintain acceptable loan to capital ratios. assumptive a loan to capital ratio of 101 (this nonprogressive 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 re duction in bank lending does not have to be so solid 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 governments of Asian and center field 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 strong 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 diminish 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.