It has rightly been said many newspapers all over the world. If US sneeze, the whole world catches cold. During the latter half of the 20th century the United States was the world's leading economic power. US status of being the most powerful nation and London's status as a leading financial centre have come under threat. This essay explores a wide and deep research taken in order to explain and highlight the MAIN causes of the global financial crisis based on the factors discussed in the lecture and from other sources. The essay also proposes recommendations for the UK government in order to reduce dangers of another crisis.
The financial crisis as being defined by Gerald F. Davis (2009), pp. 27 - 44 as the worst global economic down turn since the Great Depression in the 1930s. Advanced economies are either in recession or in a deep recession and the emerging markets is facing a sharp economic slowdown.
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It has been a topic of great discussion and debate in order understand what exactly happened and who can be blamed for the global financial crisis. The essay presents an analysis done by different authors and reasons given by them and concludes the main causes/roots of the crisis.
The Great depression
According to Booth 2009, pg: 52. The financial crisis 2006-2009 has roots going back to the great depression of 1930s where credit was tight and mortgages were hard to sell. Therefore, government had to step in forming many regulation and laws in order to revive the markets. One of which was the Glass-Steagall Act which prohibited any one institution from acting as any combination of aninvestment bank, acommercial bank, and/or aninsurance company. Wikipedia, TheGramm-Leach-Bliley Act (GLBA), also known as theFinancial Services Modernization Act of 1999 is anactof the106th United States Congress(1999-2001) which repealed part of theGlass-Steagall Act of 1933 also known as Banking Act of 1933, opening up the market amongbankingcompanies,securitiescompanies and insurancecompanies. Booth 2009 argues that the majority of problems that occurred centred mostly on the pure-play investment banks likeLehman Brothers, the huge banks born out of the revocation of Glass-Steagall, especiallyCitigroup, and the insurance companies that were allowed to deal in securities, like theAmerican International Group, would not have run into trouble had the law still been in place. Cyrus Sanati New York times November, 2009.
Changes in Fiscal & Monetary policies
Many authors including Milne (Pg: 37, 2009), believe that the real cause was due the changes in Monetary policies in the early 2000s where the US Federal Reserve was accused of having encouraged unsustainable credit boom in the years 2002-07, when the interest rates were kept at very low levels.
According to Faber (Pg: 13-19, 2009), Alan Greenspan, the chairmen of US Federal Reserve from august 1987 to February 2006. The beginning of the 2001 the interest rates were 6 percent when Greenspan and his Fed governors saw a slowdown in the economy due to the puncturing of the 'dot com' stock market boom in 2000, the emergence of accounting scandals or Enron and WorldCom and started to lower the interest rates. Due to seven separate cuts in interest rates had fallen to 3.5 percent by August 2001 and then came the devastating 9/11 which became a global issue, Greenspan aggressively reduced the interest rates. In space of 3 months, interest rates were half. Borrowing cost had plummeted to levels not seen in 50 years and it continued till early 2007 due to a series of bomb attacks on London's transport network in London on 7th July, 2005. Booth, et. Al (2009) and BBC (2005) GRAPH FROM PAGE 17: FABER 2009
According to Rowley pg: 26-31, 2009, and Faber 2009, pg: 13-19. Easy money fuelled a house price bubble, low interest rates and a surge in personnel indebtedness. Therefore, money was almost free if you could borrow it which created debt bubble. An interest rate is the price of debt. Therefore, low interest rates led to widespread surge in the indebtedness throughout the US economy. The Rise in consumer debt as shown in figure below reflects the response of consumers to the low interest rates. In October 2008 consumer debt stood at $2.58 trillion. As the credit terms tightened, following the financial crisis of September 2008, the leveraged impact on household consumption was very sharp.
Always on Time
Marked to Standard
The rise in the home mortgage debt reflects both a response at low interest rate and a house price bubble. A bank is a place that will lend you money if you can prove that you don't need it. ~Bob Hope Quotegarden.com A large number of unscrupulous realtors encouraged their clients to write liar contracts in which borrowers were encouraged to overstate their income and net wealth to qualify for higher mortgages. The Excess of the housing bubble thus reflected a mixture of private market and government agencies failure that ultimately needed government and its independent agencies to bailout the undeserving. For e.g., the world's largest insurance company, AIG which had ventured unwisely and extensively into financial markets, was bailed out by the Bush administration on the dubious ground that “it's too big to fail”. Rowley (2009)
I had a cheque returned earlier. “Insufficient Funds” Mine or the banks?- Pyers Symon, Worcester Bbc JOKES. Shadow banking system has been blamedfor aggravating thesubprime mortgage crisisand helping to transform it into a globalcredit crunch. According to Davidson (Pg: 17,2009) theshadow banking systemor theshadow financial systemconsists of non-bank financial institutions that play an increasingly critical role in lending businesses the money necessary to operate.
CHANGES IN LABOUR MARKET:
According to Manson (2009), it was the low-wage economies that fuelled the high-risk finance. In the intervening decades, high-wage manufacturing jobs were replaced by lower-paying service jobs for instance- the most popular job in Michigan was to work in the restaurant or a fast food joint. 155,000 people across the state started earning their living this way. Second in job league table was 150,000 shop assistants and then came 108,000 cashiers. Not one these occupations pay more than $10 an hour. Therefore due to low earnings Michigan workers have been earning a wage that would lift a family of four. Now the question arises if the wages were fallen, who is buying the Ford cars, Sony televisions, Nike shoes etc. as we can't have mass consumption if we do not have high paying jobs? Therefore, the money comes from credit. Credit cards, short term payday loans, zero percent car finance, self certified mortgages etc. Thus lending money to people who had no possible to return on time was again a bad decision.
Failure to Manage the U.S. Trade Deficit:
The housing bubble was fuelled by cheap credit and low interest rates. One reason for the cheap credit was an influx of capital into the United States from China. China's capital surplus was the mirror image of the U.S. trade deficit. U.S. corporations were sending lots of dollars to China in exchange for the cheap stuff sold to U.S. consumers and thus government's failure to manage the US trade deficit was also a major cause in the crisis.
Shareholder value has come to mean essentially share price. The role of the corporation as a repository of long-term value was discarded - the corporation was just a vehicle for appreciating share value. This was accomplished by constantly seeking ways to 'unlock' value. The principle agent problem between shareholders and management of US financial institutions also played a central role in generating the 2008 financial crisis. Specifically it is charged that short-term personal wealth extraction on the part of management and traders exploited the rational ignorance of the individual shareholders and imposed long term damage to not only the shareholders and bond holders of the institutions but also to the broader US economy. Rowley and Smith (2009) The implications / impact of the financial crisis were huge. “Today, there are three kinds of people: the have's, the have-not's, and the have-not-paid-for-what-they-have's”.
George W. Bush's administration increased the size of the real per capita debt, it can be seen from the figure above, that deficits increased less under younger president Bush than they had during Regan administration. These deficits were also an automatic result of recession and partly the side effect of the war of terror after 9/11. In February 2009, the total US federal debt was $12.35 trillion. Of this around $6.45 was held by the public and $5.9 trillion in the form of intra-governmental holdings. The per capita burden of debt roughly tripled from 1980 to 2008. Rowley and Smith (2009, 26, 27)
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From 2004-07, the top five U.S. investment banks each significantly increased their financial leverage (see diagram), which increased their vulnerability to a financial shock. These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007.Lehman Brotherswas liquidated,Bear StearnsandMerrill Lynchwere sold at fire-sale prices, andGoldman SachsandMorgan Stanley became commercial banks, subjecting themselves to more stringent regulation. With the exception of Lehman, these companies required or received government support [wikipedia]
Thisrecessioncan be explained by the fact that, Americans tends to spends more than to save. According to the analysis of the Organization for Economic Co-operation and Development (OECD),the UnitedStatesranked the lowest saving country in the world with a percentage of 0.4 compared to that of United Kingdom 2.9 percent, Japan 3.1 percent, Italy 6.8 percent, Germany 10.9 percent, France 12.7 percent, China 24 percent and India being the highest with a percentage rate of 28.
STEPS TAKEN BY UK GOVERNMENT
Now, it is time to fight back the recession, the two recent meeting of the world leaders G20 and G7 has played an important role in organising and deciding common measures to put down new economic measures to overcome the crisis.
In April 2009, the world witnessed the G20 summit in London, hosted by Gordon Brown officially known as “the London summit”. The summit included leaders from 22 nations including Barak Obama.
The G20 was set up after the Asian crisis in the 1990s led world leaders to conclude that there ought to be a forum for economic debate including a wider range of countries. It had its first meeting in 1999. It does not have a permanent staff and the chairmanship rotates every year. Britain is in the chair for 2009.
I believe apart from all these steps by government, people should realise where they went wrong and try not to repeat their mistakes in the future. The last decades have been marked by a combination of low savings rates and high debt levels, especially in the US and UK. The time has come to rebuild the savings culture - to reject the credit card in favour of the piggy bank, and it is also for the Government to cultivate an environment that encourages this. This should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.
SMEs are an important part of developed and developing economies as they play an important role in creating jobs, innovation, supporting stability, macroeconomic growth and act as a growth engine. In OECD countries, SMEs represent 95 percent of all enterprises, accounting for two thirds of employment and being the main source of new job creation. As such, SMEs in many countries around the world are the major source of economic recovery and assist the return to sustainable growth. In fact, some of the most innovative and fastest growing companies were started during recessions such as Wal-Mart (1962), Starbucks (1971), Microsoft (1975) and Virgin Atlantic (1982).
Summary in short
I believe it will be unfair to blame just one person for the global crisis. According to Rowley and Smith (2009), it is not too difficult to explain the stylized facts of the past decade in terms of in terms of basic economic intuition, such as scarcity and that people respond to incentives. In the late, 1990s government spending was retrained and the economy boomed. In 2000s, government spending started rising and since resources are scare, private investment fell. With less private investment, economic growth became less robust and created fewer jobs. Easy money from the Federal Reserve and capital inflow from abroad buoyed the economy temporarily, fuelling a surge of debt and a housing price bubble in the process. When housing prices started to fall, mortgage debt went bad, bringing down the financial industry with it the burden of government grew and the economy paid the price.
But still, I believe the main cause of the global financial crisis was GREED as no one would tempt an alcoholic by putting one in charge of a liquor store and neither would anyone put a fox in charge of a henhouse. So why are greedy bankers being allowed to rewrite banking regulations to enrich themselves while leveraging taxpayers, destroying trillions of dollars of hard-earned savings and sinking us into a potential depression?
When written in Chinese the word “crisis” is composed of two characters - one represents danger and the other represents opportunity. ~John F. Kennedy, address, 12 April 1959
According to Davidson Pg: 21, 2009, Islamic banking is the squeaky clean alternative to conventional banking, although it is not yet widely used. The concept of Islamic banking lays on the principle that money cannot be used to make more money. On this basis no interest is charged and therefore, lenders must share in the risk and profits of the enterprise and wealth creation should aim at improving the society as a whole.
World financial leadership is moving eastwards, away from the US and UK, towards China (and, probably in future, India). The decline of British banks and the rise of Chinese banks are the biggest trend in the finance sector. Five years ago, of the world's 12 biggest banks six were US, three were UK, one was Swiss, one Japanese and one French. Now, of the 12 biggest banks, five are American, three are Chinese, one is British, one Spanish, one French and one Australian. This crisis is a symptom of the shift in the way the world economy is organized.