Causes of the GFC
Over the past few years, the world has gone through various financial shock that have shaken the complete global financial system. Financial crisis is mainly referred to a variety of the situation in which some of the financial assets loses a major part of their nominal value suddenly. It is the sudden disturbance that generates a considerable loss of the value in the assets or institutions. It is referred to the particular extreme shock in the country’s financial system that leads to the financial system’s disruption (Alvarez 2015).
The financial crisis occurs as an outcome of the severe fluctuations of price in the financial markets, such as equity markets or foreign exchange, or as an outcome of the blockage or problems in the financial systems, and it creates huge problem in the economies. It indicates a deterioration in the entire financial markets, and where the moral hazard issues and adverse selection worsens, and the financial market do not permit funds transition to the most productive areas of investment. The financial crises include currency crisis, banking crisis, speculative bubble and burst, stock market crash, and debt crisis (Attig et al. 2015). Hence, this paper aims to discuss about the possible causes and events of the GFC, and analysis will be done on the chances of the GFC to be repeated again in the future.
The 2007-2008 financial crisis is also referred as the GFC, which is considered by various economists as the nastiest financial crisis after the Great Depression of 1930s. The crisis started in 2007 with the crisis in the US subprime mortgage market, which developed into the full-blown international banking crisis with the corporate failure of the well-known investment bank- Lehman Brothers in 2008. During the GFC 2008, a fall in the housing market of the US was the main catalysts for the financial crisis that blowout from the US to the other parts of the countries across the world through the connections in the GFC (Lane and Milesi-Ferretti 2017). There were various banks all across the world, which incurred huge losses and depend upon the government aid to avoid bankruptcy. There were millions of the people who lost their jobs, since the major developed and advanced economies experiences severe recessions. The retrieval from this crisis was quite sluggish compared to the previous recessions, which were not related to the financial crisis (Claessens and Van Horen 2015).
Causes
The GFS has caused massive upheavals all across the world. For all the financial crisis, there were a range of the factors, which indicates the possible causes of the GFC and its severity level. Some of the main causes of the GFC are listed below:
Excessive taking of risk in the favorable macroeconomic setting: Prior to the GFC, the economic situations in the US and the other nations were quite favorable, as well as the economic growth was stable and strong, the rates of inflation, interest rates, and the unemployment rates were comparatively low; as an outcome of which prices of house grew strongly. The banks and the other creditors were quite willing to provide large amount of the risky loans (Choe and Ki 2018).
Impact of the GFC
Increased borrowing by the investors and banks: The banks and the other investors, who were in the US and other nations borrowed high funds to expand their overall lending and have purchased the MBS products. Further, borrowing funds to purchase asset magnifies the likely income and also magnifies the likely losses. Consequently, when the prices of houses fall, the banks and investors incurred huge losses. They become highly reliant in the creditors.
Regulation and the policy mistakes: The MBS products and the subprime lending’s regulations were quite lax, particularly there was not enough regulation of the financial institutions that created as well as sold opaque and complex MBS to the investors. This increased the cases of fraudulent activities (Zhang and Broadstock 2020).
Impacts
Fall in the US house prices, and missed repayments by the borrowers: The main catalysts for the occurrence of the GFC were falling prices of the US houses and increased number of the borrowers who were not able to repay their loan (Dijkstra, Garcilazo and McCann 2015).
Stresses in the Entire Financial System: The stress in the financial systems clearly emerged around the middle of the 2007, after the investors and lenders started incurring large losses.
Spillovers to the other nations: The interconnectedness of the US banks in the other nations provided a medium for the issues in the housing market of the US to spill over to the economies and financial systems in the other nations (Koser 2016).
Failure of the financial entities and panic in the financial markets: Following the corporate failure of the US- Lehman Brothers, the financial stresses increased, which triggered huge panic in the financial markets on global scale. The investors started pulling out their money from the banks and the investment funds, which made the financial markets dysfunctional (Jin and An 2016).
There are various other examples of the events of financial crisis, which have had huge impact on the overall global financial markets, such as the Great Depression in 1932, the International Debt Crisis in 1982, the Latin American Debt Crisis in 1994 to 2002, the European sovereign debt crisis in 2008, and many more. Further, the most recent financial crisis has been due to the covid-19 impact that has affected the economy of almost every nation (Wang et al. 2021).
There was huge impact of the GFC in the three different nations’ economies, which are the US, Australia, and the UK. The financial crisis has led to the global recession that resulted into severe downturn. The impact of the GFC on the US economy has already been discussed in the previous sections. Further, the GFC has highly impacted the UK economy. The financial crisis has intensified impact of the crisis on the e UK’s economy. For instance, fall in the revenue had led to the redundancies when entities such as MFI and Woolworths went bust. Further, the overall merchandise trade of Australia reduced by 11.6% in 2009 that was affected by the GFC. This was the 1st fall in the exports after 1964-1965. The exports reduced by the amount of $27.4 billion to the amount of $196.9 billion from its highest peak in the 2008 of $224.3 bn. Apart from these nations, there were various other nations that were highly affected due to the GFC (Claessens, Kose and Terrones 2014).
Examples of Other Financial Crises
Policies and Reforms
The main response of policy to the financial crisis has come from the central banks until September 2008 that reduced the rates of interest to encourage the economic activity that slowed down in the 2007 end. However, the response of the policy ramped up after Lehman Brothers’ collapse and fall in the global growth. The central banks lessened the rates of interest rapidly to quite low levels; used quantitative easing; and lent huge fund to the banks and the other financial institutions, and the assets that could not be purchased in the financial markets. The governments further increased their overall expenditure to drive demand and aid the employment all through the economy; purchased the stakes of ownership in some banks and the other financial entities to avoid bankruptcies, which could have worsened panic in the financial markets; and guarantees bank bonds and deposits to shore up the confidence level in the financial entities (Tosun, Wetzel and Zapryanova 2014). In the response towards the financial crisis, the regulators reinforced their oversight of the banks and the other financial institutions. Some other proposed reforms that have eventuated after the GFC were “the Consumer Protection Act”, and “the Dodd-Frank Wall Street Reform”. Further, Basel III liquidity and capital standards were implemented by various nations across the globe (Taskinsoy 2019).
Ever since 1930s, the worst financial crisis is the global financial crisis of 2007-2008. But this essentially does not mean that such financial crisis does not occur in the future. The continuing covid-19 pandemic is the biggest example of the same, because after the GFC, this pandemic has shaken the global economy and resulted in creating huge recession. The history in itself gives a huge indication of further occurrence of the financial crises with the stronger banking system that would not be identical to the previous one. The damages of such crises are long-lasting. In more extreme situation, the prevention of financial crisis will require more swift and forceful measures by the central banks, international governments, and the governments, along with the ability of innovation and adaptation. It is important to enhance the policies in the normal period for being prepared enough to fight with the next crisis (Thakor 2015).
Ten years ago, the financial system was more vulnerable compared to the present financial system. The governments across the world have made huge investments to save the financial institutions and banks from any further failures. At present, the bank’s capital and leverage ratios are quite stronger and the global banks are also quite big to fail. The banks are ensuring that they are having enough resources to sustain in goods and bad times. They are now less complex and carrying out the tough stress tests on annual basis that comprises wide range of the scenarios. This will help in fighting against the further crisis. Further, fiscal policy and unconventional monetary policy are the most important tools to prevent crisis (Baruník and K?ehlík 2018).
If stability of banks is again threatened due to the recession, there are quite limited resources available in the law for being rescued from the situation. The financial regulatory transformations call for the bail-ins of the owners and lenders. However, the main issue is that the new financial systems continue to be underfunded as well as untested. The choices of the public financial resources of a country and its policy may be much more reserved compared to what was in the past. Therefore, each nation should be prepared enough to restrict any vulnerabilities and they should be careful enough to sustain the growth rate.
GFC’s Impact on the US, UK, and Australia Economies
There is also huge significance of multi-lateral preparedness and action. The global financial institution- IMF has played significant role in responding towards crises over the years and helped in keeping the world’s economy on track. Further, it is important for the IMF’s evolution process to continue its research, analytical, and lending activities, so as to support the global growth and maintain financial stability. A new multilateralism is committed to enhance the lives of the citizens all across the globe and ensure that the advantages of the globalization and the technology are broadly shared. This will help in preventing the occurrence of any more crises further and will help in successfully responding to any further recession. It is the most practical way of getting over the destructions caused by the financial crises in the financial institutions, and help in creating sustainable, shared and prosperous future (Bernanke 2018).
Conclusion and Recommendations
Therefore, this paper concludes that the unexpected financial crisis can occur any time without giving any prior notices, as the past financial crises has already proved it. The financial crises have occurred over time in various different sizes, forms, and shapes across the globe that posed major challenges for the economy of the countries. The GFC led recession depicted the limitations of the policy measures in dealing with any further financial downfall. This necessitated to have discussion on the ability of the macroeconomics and the financial sector’s policies in avoiding the costs that arises from such events. While various valuable lessons can be learned from the GFC and its resolution and prevention, still there are some nations, which are far beyond the adoption of best practices to respond to the financial crisis. Further, it has been analyzed that there are high chances of the occurrence of the future financial crisis. This necessitates the requirement of making the overall financial system strong enough to deal with such crises.
Hence, with the right financial preparations and right strategies, once can turn a likely tragedy into just a setback. It is recommended that the financial institutions and banks should have sufficient financial resources to deal with the good and the worst period, and they must assess the risks associated with the financial system on a continuous basis. Moreover, there must be immediate and comprehensive response of the policy. It requires for the radical changes in the financial sector and fiscal policies, as well as demands high coordination in the global financial measures and policies. Lastly, the central banks should examine the overall risks with the help of various tools and techniques so as to continue to maintain a stable financial system.
References
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