Global Financial Crisis
This paper reviews the receding global financial crisis and the bail-out plans that were instituted to avoid the collapse of corporations that governments deemed played a huge role in the national and global economy to be allowed to collapse. In addition, the paper will look at some of the measures that governments use to regulate the market, both in the past and current measures and the potential for these measures to attain their objectives.
A Review of the 2007-2010 Global Financial Crisis
The great financial crisis is finally receding leaving on its wake destroyed economies and corporations and governments wondering what went wrong and why it was allowed to occur. The economists and economy analysis may show that the global financial crisis is over but the effects are still being felt by the common man who still believes that the crisis is still continuing and may continue for a little longer.
To portray the severity of the crisis, some authors have referred to the crisis as a Great Recession and considered the worst since the Great Depression of the 1930s. The crisis has left large financial corporations collapsed or greatly weakened, decline in stock market activities world wide, and banks and other institutions with a huge debt to repay governments for the bail-out plans. In general, the most affected economic sector was the housing sector resulting in foreclosures, evictions, and lack of occupiers.
What were the causes of the 2007-2010 global financial crisis The cause of the crisis has been attributed to the boom of the housing market in the United States which saw a rapid increase in default rates on adjustable rate and sub-prime mortgages. Relying on easy initial terms and favorable long term increase of housing prices, borrowers took up mortgages but repayment proved difficult once the housing prices began to drop early in 2006 coupled with rising interest rates and this led to massive defaulting and foreclosures.
According to the Nobel laureate professor Joseph Stilglitz, the underlying doctrine for the current financial system is flawed and as such it was the reason for global economic crisis. Professor Prabaht Patnaik on the other hand noted that the reason for the global financial crisis was the fundamental defect of the free market system that allows for the market to be dominated by spectators whose main interest is on the short-term asset appreciation and not on the long term asset yields. However, according to a speech by Bernanke (2009), the question on the cause of the global financial crisis does not have a simple answer. He however notes that an inflow of foreign funds coupled with the low interest rates formed the foundation for the crisis by encouraging a debt-fuelled consumption.
What were the most notable effects of the global financial crisis As noted earlier, the crisis affected corporate organizations and governments as well. Starting from its epicenter in the United States, the financial crisis spread to all parts of the world. Mataloni (2010) pointed out that the gross domestic product (GDP) of United States decreased by 6 per annum in the last quarter of 2008 as well as in the first quarter of 2009. In addition, the unemployment rate increased to the highest rate since 1983 to 10.2 in October 2009. Weekly hours also fell to 33, the lowest recorded figure. On a global scale, the GDP in Mexico declined by 21.5, Latvias fell to 18, Japan to 15.2, Germany 14.4, and 9.8 for Euro area with United Kingdom registering 7.4 decline.
Economic slowdowns were experienced in developing countries that had previously shown improved economic growth. Cambodia had a projected zero growth from an impressive 10 prior to the crisis while Kenya was expected to register 3 from 7 in 2007. The decline in economic growth in the developing countries could be due to reduction in trade, rise in commodity prices and fall in investment. Velde (2009) notes that the Middle East had lost up to three trillion dollars to the crisis by 2009 due to a decline in the global demand for oil. Some countries such as Ireland reported a negative growth during the crisis. It was during the global financial crisis that the Celtic Tiger Irelands economic boom came crumbling down and resulting into a mass movement of people that had characterized the country in the earlier years.
In Africa, the global financial crisis presented significant challenges and exposed the weakening of the functioning of the global economy. This called for rapid reforms to the international financial architecture. The crisis presented a setback to Africa since it occurred at a time when the region was making significant progress in economic management and performance and management. It would have been expected that countries with low interbank markets and having several restrictions would not be affected by the global financial crisis nevertheless, such countries were still affected.
Under normal financial market conditions, it is expected that countries that have any restrictions to new financial products and market entry would be shielded from the direct effects of the financial crisis. But this was not the case. This implies that somehow, markets will always be affected by the behavior of market participants and are not overly pegged on attempts by governments to intervene through regulations.
The outcome of the crisis has notably been the largest sharpest drop noted in global economic activity in the modern times. For instance, in 2009 most major developed economies found themselves in a deep recession. In addition there was a dramatic fallout for global trade in terms of both the pattern of trade and trade volume. Along this line, the OECD predicted as dramatic shrink in world volumes, shrinking by 13 percent between 2008 and 2009.
Causes of the crisis
Although global crisis largely emanated from the housing crisis in the United States, it can also be attributed to how international markets operate and how governments intervene to regulate the market behavior. The points highlighted next depict how some issues contributed to the crisis. First, there were real inadequacies in both the financial sector and the real economy. Much responsibility was noted in the financial sector.
Secondly, large Surpluses in China and the undervaluation of currency in Asia led to a global imbalance, which needed and still needs to be corrected. The third point is that the financial crisis broke out in the United States and spread out to other regions around the globe. The reason for this is that there was too much so-called financial evolution that arose from a decision to increase debt if it was practically impossible to raise income. This occurred in violation of Basel II (a regulatory requirement for risk quantification for purposes of capital allocation) and beyond Basel II, fundamentally with mortgage-back securities.
The fourth point is that central banks and ministers of finance in many countries have become too complicit in that they allowed prices to become opaque and thus be set without a clear market mechanism. In connection to this, the fifth point is that rating agencies were responsible, particularly for having given triple-A ratings to assets whose worth could not be determined (it should be noted that triple-A ratings should be reserved for only the safest investments). Finally, the globalization of finance made a significant contribution to the global financial crisis.
Response to the Global Financial Crisis
Different countries and various institutions responded differently towards mitigating the impacts of the crisis. Governments responded by easing fiscal and monetary policies which in turn had their own effects on market activity and financial and trade flows. The downturn in activity caused high unemployment levels, and with it, a political response involved protecting domestic industries through a series of combinations of domestic subsidies as well as border protection. This led to the potential of protectionism rising further. The next section highlights some of the particular cases of intervention.
The United States
The role of the United States Congress in dealing with the financial crisis was multifaceted. The main focus was on how to combat the recession, followed by how to ensure a smooth and efficient functioning of financial markets in order to promote the general well-being of the national while protecting the taxpayer.
Congress, aiming at preventing worsening of the crisis without creating a moral hazard, provided funds and ground rules to facilitate economic stabilization and also offered rescue packages to support collapsing investments. The United States Congress was also active in availing measure to reform the international financial system, and recapitalizing global financial institutions such as the international monetary fund.
The United States applies policy measures that were mainly aimed at containing the financial mess and dealing with the recession. Key legislations implemented include the Troubled Asset Relief Program to support financial institutions and the American Recovery and Reinvestment Act of 2009 that was aimed at providing stimulus to the economy. Numerous bills were also introduced to deal with issues such as establishing commissions to investigate causes of the crisis, offer insight into greater accountability of the Reserve and Treasury lending activity and deal with housing and mortgage problems. Overall, most strategies applied by the United States to avert adverse effects of the crisis focused on bailout schemes and offering incentives to firms on the verge of collapse.
China
The degree of Chinas exposure to the global financial crisis was not as clear as that witnessed in the United States. This is because on one hand, China places a lot of restrictions on capital flows, especially outflows, in part so that it can be able to maintain its managed currency float policy. Such restrictions limit the ability of citizens and numerous forms to invest in their savings internationally, forcing them to invest them to invest in the funds domestically (though banks, real estate, stock markets, as well as business ventures). Hence, the exposure of Chinese private sector enterprises and individual Chinese business people to sub-prime United States mortgages was likely very small.
Nevertheless, Chinese government entities, for instance the State Administration Foreign Exchange, state banks, the China Investment Corporation, and state-owned enterprises may have been more subjected to the troubled United States mortgage securities. If China held any troubled subprime mortgage backed securities, they would most likely be included in the corporate securities class and certain United States equities such as investment companies share funds, hedge funds, money market funds, and pen share funds. All the same, these are a comparatively small share of Chinas overall United States securities holdings.
While Chinas economy could have been much shielded from the impact of the global financial crisis, there are some pointers to show that it was affected, after all. There was a slowdown in the construction industry, with increasing pressure on banks to lower interest rates so as to further stabilize the industry. Further, Chinas main stock market lost nearly two thirds of its value between December 31, 2007 and December 31, 2008. Additionally, Chinas FDI and trade plummeted over a periods of six month between late 2008 and early 2009. Most importantly, 20 million migrant workers in China lost their jobs in 2008 due to the global economic meltdown.
In response to the crisis, the Chinese government took a number of steps including boosting bank lending, applying strategies to increase consumer spending, and increasing income for farmers and poor people in rural areas. A key approach was Chinas stimulus program.
The government announced a two-year four million trillion yuan (an equivalent of 586 billion) stimulus package. The package was meant to finance public transport infrastructure, affordable housing, environmental projects, health and education, technological innovation, and rehabilitation of areas hit by disasters. The stimulus package was also aimed at assisting 10 key industries deemed to be vital to Chinas economy, including shipbuilding, autos, steel, machinery, textiles, information and electronics among others so as to enhance their competitiveness.
African countries
As mentioned earlier, African countries were affected, though to a small extent, by the global financial crisis. The countries took a series of steps to mitigate the impact of the crisis. These included reduction of interest rates to encourage borrowing, recapitalization of financial institutions, raising the level of liquidity to banks and firms, formulating fiscal stimulus packages, changing several trade policies to improve conditions, and applying a host of regulatory reforms. The measures were however different depending on the condition of each country.
For instance, oil-exporting countries had a larger fiscal space to implement counter-cyclical polices since they had accumulated huge foreign during the period of hikes in oil prices. However, the use of stimulus packages was not widespread in these economies. Nevertheless, countries such as Kenya came up with economic recovery plans aimed at pumping emergency funds into their budgets in order to support collapsing firms. Additionally, some countries set up task forces to monitor the financial crisis and offers advice to the government on the best way forward. Countries that took this approach include Rwanda, Democratic Republic of the Congo, Kenya and Nigeria.
Institution Case Study the International Finance Corporation (IFC)
Responding to the financial meltdown, IFC launched broad initiatives to help private investors to cope with the conditions. 30 million was set aside for this initiative to run for three years starting 2009. IFC identified the private sector as a critical area for employment and development in emerging markets, and which therefore needed some incentives to survive the financial meltdown. IFCs strategies aim at easing liquidity constraints on trade, strengthening financial infrastructure and revamping the banking sector, solving problems related to troubled assets, and mobilizing funds from governments and other sources.
Analysis
The development from the case studies is that during the global financial crisis, several industries needed to be supported though bailouts in the form of stimulus packages. In this regard, a point that is amenable to discussion is, Did the industries really need the bailouts The answer is both in the affirmative and in the narrative. Yes because some industries are critical to the economies of countries and their collapse could have serious corollaries. On the other hand, the answer could be No because the bailouts may be inconsequential since many market such as the United States are free market economies in which in trends market operations are determined by market forces. Unlike China where most market operations are regulated, most economies are open to competition in which the most competitive players are successful. Thus, bailouts may only serve as short term help to collapsing industries, their future still remaining uncertain.
Market regulations are effective for establishing rules of the game but there is increasing concern that regulation has become too intrusive and stifling market operations. Firms thus have to be competitive in order to eliminate unnecessary and obsolete regulations. But still there is need for governments to soften the regulations that are too restrictive.
As it was discussed, China is a good example of the nations with too restrictive regulations. Such regulations hinder competitiveness in the local market and make the economy vulnerable in case of any financial uncertainty. In todays market, business outsourcing has become the order of the day and firms are able to use this strategy to avoid direct market regulations in some aspects.
In addition there is need for governments to respect market conditions such as Basel II since these are established standards that determine the effectiveness of economic strategies. It can be noted that that the violation of Basel II was committed by the United States government in its bid to intervene in the local market. Hence, the private sector needs to have its own economic forecasters and analysts to determine market trends and naturally avoid situations in which they would need bailouts.
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