Causes and effects of the Global Financial Crisis
Question:
Discuss About The Global Financial On Youth Labour Markets?
The present report highlights on the cause and effect of GFC (global financial crisis) on several countries that occurred during the year 2008 and 2009. This paper also aims to provide an overview about the examples of financial crisis events, identification of proposed reforms and possibility of its occurrence in future. The GFC also referred to as financial crisis occurred during the year 2008 and 2009 has been considered as worst crisis since occurrence of great the depression event in the year 1929. It is one of the economic catastrophes, which adversely affected most of the nations in the globe. The GFC began in the last quarter of the year 2007 with the housing bubble in US and this in turn led to subprime mortgage crisis, collapse of several investment banks including Lehman Brothers (Berkmen et al. 2012). However, the persons staying in this nation had huge fear of getting their money back and thus demanded their money from these financial institutions and investment banks. As a result, these banks adopted several measures in order to meet the demand of these people, which in turn led to liquidation of the holdings of financial asset by the banks. This event mainly worsened due to crash as well as high instability of the stock market. This crisis was then followed by downturn in economy of several countries, which is also termed as Great recession. The policymakers of some of the countries also changed their monetary as well as fiscal policies for restricting huge downfall of their global financial system (Frankel and Saravelos 2012). However, some developed nations succeeded by adopting these policies while other developing economies and emerging markets failed to adopt these. This study also elucidates on the effect of GFC on Pakistan and other economies. The possibility of occurrence of this event is also analyzed in this report.
The GFC is believed to have started in the year 2007 mainly due to three underlying causes that includes- deregulation of the financial industry, mismanagement of risk in business and interest rate level. The crumple of real estate boom in this country also triggered to as the important cause of the GFC (Jarsulic 2012). This boom was usually developed on the borrowed money. However, the lenders of this nation were highly geared and hence decline in value of real estate pushed them into insolvency. In addition, these banks then strategized to engage in hedge funding along with the derivatives, thereby demanded high mortgage rate for supporting sale of profitable derivatives. The four fundamental reasons that caused GFC are given as under –
Impact of Global Financial Crisis on Pakistan and other economies
Housing bubble growth- The housing bubble increased by around 124% in the US during the period 1998-2006. The individuals who had raised their wealth were spending huge amount on increasing stocks. This increase in stock wealth led to consumption boom to purchase better residence as they sought in buying new stock on housing. This rise in demand impacted on triggering housing bubble as the supply of residence became relatively fixed (Barakova, Calem and Wachter 2014). This caused several residence owners to refinance at low interest rate or finance their spending by taking the mortgages. However, this larger amount of money sought high yields with respect to that provided by the treasury bonds. This money was then connected to the mortgage market by the investment banks. In 2003, the supply of mortgage exhausted, which in turn reduced lending standards. During the GFC, the prices of residence again decreased by 20%, thereby the borrowers faced huge difficulty in refinancing high payments relative to rate of interest. Thus, the housing prices decreased by their 30% from the year 2007 to the end of 2008.
Predatory lending- This signifies to as the practice of unscrupulous lending that tempt the borrowers to shift into insecure loans for some bad purposes. The banks in this nation gave loans to numerous borrowers for their illegal business practices. As a result, this caused GFC in this nation.
Deregulation- Recent study reflects that the bank regulation that relied in the Bassel accords encouraged unconventional practices of business, which in turn armored into GFC. The US president in the year 1999 had signed the law, which repealed provisions of Glass Steagull Act and this in turn prohibited the financial organization from holding other institutions. However, this repeal eliminated division between the investment banks and other depository banks. This led to GFC.
Subprime mortgage crisis- The crises in subprime mortgage was basically triggered by decrease in residence prices after this housing bubble. As a result, it led to securities devaluation and mortgage delinquencies. The two basic reasons for this crisis were increase in residence speculation and subprime lending. Easier conditions of credit contributed to rise in total amount of subprime lending during this period (Dell’Ariccia, Igan and Laeven 2012). The housing bubble that led to this crisis was mainly financed with collateralized debt obligations (CDO) and mortgage backed securities (MBS) that offered higher rate of interest than the government securities. Moreover, there were several other causes of these crisis- bad residence policies, risky mortgage product, trade imbalance, adoption of improper government regulation and inability of the house owners to make their payments (Shiller 2012).
Impact of Global Financial Crisis on Australia
Collapse of the Lehman Brothers- One of the investment bank Lehman Brothers was filed for bankruptcy during this period. With a total of $619 billion debt and $639 billion total assets, this bank collapsed since their assets exceeded with regards to bankrupt giants. This event also contributed to attrition of total of $10 trillion in market capitalization from the equity market. However, the stock procedure of this bank declined sharply owing to this credit crisis and hedge funds failure. During this GFC period, this bank also removed 2500 jobs relating to mortgage and also closed some of their units. In 2007, their total stock again rebounded since the equity market reached to new height as well as their fixed assets prices took rebound. Hence, this huge leverage and credit crisis led to collapse in the market.
The Pakistan economy was adversely influenced by the GFC and the direct victims were the financial institutions especially the commercial banks. These banks withstood worst affect of GFC due to their credit policies as well as reforms in banking for the last two decades. But the State Bank of Pakistan remained resilient as well as strong despite huge pressures that emanated from bad macroeconomic environment during this period 2007-2008 (Ali and Ghauri 2013). In the long run, this economy was greatly affected owing to decline in foreign direct investment (FDI), remittances, exports and development aid. In addition, budgetary and trade, shortage of energy, increasing food inflation, twin deficit and increase in stock markets. Furthermore, size of these remittances that this nation receives from West mot only affected their businesses but also the people’s job prospects. According to the World Bank data, this GFC also led to political instability and also added to downward pressures on their financial markets. As a result, the Pakistan government lowered their target for the inflation rate as well as GDP growth rate (Chaudhary and Abbas 2017). It is also seen from the historical evidences that the exports of this country hit severely owing to this recession. However, in order to avert this GFC, this nation formed nation’s group known as “Friends of Pakistan” for attaining financial help. Some countries did not came out to help this country and so they asked IMF ( International Monetary Fund) to provide them funds for overcoming this crisis. However, the GDP growth rate of this economy declined during this period.
The effect of GFC on Australia was considerably low in comparison with the other developed countries. This country recorded better GDP growth rate and low inflation as well as unemployment rate. The financial system of this country became highly resilient and the commercial banks had continued to gain huge profit and also did not need any injection of capital from the Australian government (Bryant 2012). The obvious effect of GFC that it had on their Australian households was huge decline in prices of equity, which in turn declined their wealth by 10% in 2009. Additionally, this country’s dollar depreciated rapidly owing to intensification of GFC. Around the Lehman bankruptcy period, the foreign exchange market conditions were basically illiquid, which promoted that the RBA (Reserve bank of Australia) to intervene in this market.
Impact of Global Financial Crisis on UK
The effect of GFC on the UK economy was larger than other nations owing to some particular factors. The productivity in UK declined sharply during this recessionary phase owing to credit crunch in financial market. Moreover, there was sharp decline in lending between the commercial banks (Junankar 2013). The unemployment rate in UK increased as the people employed in its financial industry were fired from the job. In addition, this crisis also led to decline in retail sales and this in turn led to decline in productivity of the nation (Martin and Gollan 2012). Overall, the GDP growth rate of this country fell by around 1.5% during the last quarter of the year 2008.
Few proposed reforms that had occurred during this recessionary period includes-
- Implementation of Basel III capital requirement, which involves countercyclical capital protect and surcharge for the financial institution.
- Improvement in the framework of securitization
- Adoption of principles regarding compensation practices in order to avoid risk taking incentives
- This nation also reached to an agreement for implementing the liquidity standards, which includes – LCR ( the liquidity coverage).
- Agreement in some of the principles on different types of financial transactions in US , which includes- GAAP ( Generally accepted principles), IFRS( International Financial reporting standards) etc.
- The policymakers also proposed to close data gaps such as starting of consolidated data gathering especially on the bilateral counterpart, banks credit risk etc.
There might be possibility of occurrence of this financial crisis in future according to the concept of “business cycle”. Business cycle signifies the economic cycle in which there has been upward as well as downward movement in GDP growth rate for longer term. These variations mainly involves shift between the phase of economic growth (expansion) and relative stagnation (recession) over certain period of time. There are basically five stages of the business cycle including- expansion, peak, contraction, trough and recovery (Gabisch and Lorenz 2013). In the expansionary stage, the economic growth of the country increase at higher rate and this situation continues till it reaches peak. In peak stage, the business cycle growth rate reaches its highest level, which the economic factors do not increase further. After this stage, there has been gradual decline in economic factors, which leads to recession stage. At this recession stage, all the economic factors including prices, investment starts to decline. This then enters to trough stage in which the activities of the economy decline below the target level. After the economy reaches the minimum level, the economic growth starts to increase at higher rate. This completes the business cycle (Iacoviello and Pavan 2013). However, at present the US economy is in expansionary phase and hence this can be assumed after few years the economy will reach peak stage and then it will again move to recessionary stage.
Conclusion
The financial crisis affected most of the developed countries positively as well as negatively. The negative impact of the GFC reflected collapse in financial industry, decrease in GDP growth rate, decline in productivity etc. On the other hand, positive impact of GFC were redrafting of financial rules and regulations including IMF (International Monetary Fund), WTO (World Trade organization), absence of the bigger financial organization in several nations. However, the government of several countries implemented proper fiscal as well as monetary policies in order to improve their economic health.
References
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Barakova, I., Calem, P.S. and Wachter, S.M., 2014. Borrowing constraints during the housing bubble. Journal of Housing Economics, 24, pp.4-20.
Berkmen, S.P., Gelos, G., Rennhack, R. and Walsh, J.P., 2012. The global financial crisis: Explaining cross-country differences in the output impact. Journal of International Money and Finance, 31(1), pp.42-59.
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Bryant, L., 2012. An assessment of development funding for new housing post GFC in Queensland, Australia. International Journal of Housing Markets and Analysis, 5(2), pp.118-133.
Chaudhary, G.M. and Abbas, Z., 2017. Global financial crisis and its impact on efficiency and performance of commercial banks in Pakistan. Journal of Business Studies Quarterly, 8(4), p.15.
Dell’Ariccia, G., Igan, D. and Laeven, L.U., 2012. Credit booms and lending standards: Evidence from the subprime mortgage market. Journal of Money, Credit and Banking, 44(2?3), pp.367-384.
Frankel, J. and Saravelos, G., 2012. Can leading indicators assess country vulnerability? Evidence from the 2008–09 global financial crisis. Journal of International Economics, 87(2), pp.216-231.
Gabisch, G. and Lorenz, H.W., 2013. Business cycle theory: a survey of methods and concepts. Springer Science & Business Media.
Iacoviello, M. and Pavan, M., 2013. Housing and debt over the life cycle and over the business cycle. Journal of Monetary Economics, 60(2), pp.221-238.
Jarsulic, M., 2012. Anatomy of a financial crisis: A real estate bubble, runaway credit markets, and regulatory failure. Palgrave Macmillan.
Junankar, P.N., 2014. The impact of the global financial crisis on youth labour markets. Browser Download This Paper.
Martin, G. and Gollan, P.J., 2012. Corporate governance and strategic human resources management in the UK financial services sector: the case of the RBS. The International Journal of Human Resource Management, 23(16), pp.3295-3314.
Moulton, S., 2014. Did affordable housing mandates cause the subprime mortgage crisis?. Journal of Housing Economics, 24, pp.21-38.
Shiller, R.J., 2012. The subprime solution: how today’s global financial crisis happened, and what to do about it. Princeton University Press.
Yoshino, N. and Taghizadeh–Hesary, F., 2014. Monetary policy and oil price fluctuations following the subprime mortgage crisis. International Journal of Monetary Economics and Finance, 7(3), pp.157-174.
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