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The global financial crisis, word itself suggests it is all about one of the biggest crisis that took over in the later part of 20th century and hit the economy of whole world in one or the other way. Financial crisis are a kind of recurring phenomena that can have a significant impact on the economy. Below is a small introduction on classification of financial crisis, its causes on second part and later discussion about the steps that UK government could take to reduce or avoid the danger of another crisis.
In general, global financial crisis can be classified in several ways depending on how a person defines a financial crisis as, just for an example, an US monetary economist, Anna J. Schwartz, argued about financial crisis that it should involve a run on monetary base or else it could be difficult to get an clear idea about distinguishing between the real crisis and the pseudo crisis. Apart from that, financial crisis could involve currency crisis or bank crisis or both of them occurring at the same time. (Liberals and Democrats, 2008)
Now, about the recent crisis that took place, it was very severe and many sided such that the implications of which can hardly be underplayed. It can be said on the basis that they are found at macro as well as at micro level. (Liberals and Democrats, 2008)
And as mentioned earlier about the different types of classifications to view a crisis, here, using the analytical classification, one could identify a few and important structural factors and cyclical factors as the roots of current financial crisis. Structural factors are those which help in creating the favourable conditions to generate a crisis where as cyclical factors are those which help in triggering them. (Liberals and Democrats, 2008)
Talking about the causes of global financial crisis as per above factors, it all started from the US, which was being considered as world's leading economic power in the later part of 20th century. And the first thing that came into the picture was the worst recession in housing sector in the history of US. US home(Housing sector prises by) prices fallen between 20% and 30% from their peak, because of that nearly about 10 million of home owners were with negative equity and got defaulted. Home builders got bankrupted; joining the club of small ones who already gone bankrupt and leading to another fall in stock prices which has rallied irrationally in recent past. (Roubini, 2008)
Second major feature was losses for the financial system which were not just from subprime mortgages but spread to near prime and prime mortgages as well. This happened mainly because of the financial infrastructure was like no down-payment, no proof of income, jobs and assets as well, teaser rates, interest rate only, negative amortization, etc. took place throughout the spectrum of mortgages. And the main reason behind this whole scenario was the toxic features and reckless structure of the nearly 60% of mortgage origination since 2005 through 2007. Moreover because of securitization, the securitized waste spread all the way from banks to the capital market funds, including their investors in the US and abroad, thereby it made the presence of the credit crunch globally. (Roubini, 2008)
Another issue that triggered the financial crisis was increase in the number of student loans, credit cards, auto loans, etc. but side by side the numbers of defaults were also increasing. The numbers of these loans were high and so the numbers of defaults were getting higher in this sector which added losses to banks as well as other financial institutions too and lead to more severe form of credit crunch. (Liberals and Democrats, 2008)
Next point we could add here is the "shadow financial system" which is composed of the non-bank financial institutions, as all of these are subject to market risk, credit risk and liquidity risk as their assets are illiquid and of longer term compare to their short term liquid liabilities. And one problem with these institutions is, unlike the banks, they cannot be rescued by the central banks directly. (Roubini, 2008)
Adding on to the above points, one matter of concern could be the lost or reduced transparency of the market which can be even called as more opaque market. It is because of the increase in the use of securitization that has spread out risks across borders, which in turn leads to systemic risks because, in the synthetic products, the origination and distribution was meant to decrease the individual risks due to spreading and diversification, but in case of opaque market, there is a clash between micro and macro rationality, the latter becoming more fragile. (Liberals and Democrats, 2008)
Few more causes to be considered could be, over reliability on the market self regulatory systems, the compensation scheme that exists in the financial industry had encouraged high percentage of risk taking. Economy overdriven by more consumption, as in case of excessive savings or investing in developing countries like china, India, etc. Even one more cause could be the low credit risk that was spread across all instruments and was totally unreasonable. (Liberals and Democrats, 2008)
After the discussion of various major n minor causes of the global crisis, now the question remains is what steps to be taken to avoid the risk of further future crisis! Well, to begin with the first step, that is all about banking sector which played a major role in the current global financial crisis. The issues to be addressed are such as taking care of the mortgages as to check on real value of property or assets rather than relying on perceptions of increase in the prices of such assets in the future. Moreover the standards of subprime mortgages should be checked on a regular basis so as to avoid the case of default in longer term. (Mohan, 2009)
Another step could be taken is to have a regular check on prime and near prime mortgages as well and all the verification proof of incomes, jobs should be considered, if at all a factor of certain amount of down payment is reintroduced, automatically it will easy to be on safer sides for banks. Securitization is also one of the biggest factors that led to crisis, as there are certain evidences which suggest bank lending channels becoming less effective could be due to securitization and so it is advisable to keep watch on linkage between banks and the stance of monetary policy. Another step could be bringing the awareness among the youth culture and throw a light on the issue of savings matter rather than relying on credit card which in long run led to bad debt as per the figure in recent past shows that there are approximately 13 million adults having savings or investments, If at all this issue is considered by UK government on priority basis, in coming years there are possibilities to have a nice savings culture by 2020. (ACCA, 2009)
Talking about the recession, data shows that one in every five it sector jobs lost in uk was replaced by a person who is self employed now so that helps in making a structure of growing economies as small business are the growth engines of the economies for whole world. If the government considers the approach of "think small first", there are chances to boost or grow economy and here it should be allowed if the business is complying with all the legal requirements and is of proper vision. If we consider the matter of "reduced transparency", policies towards it should be made strict in a way to make such market players being more transparent about their activities because they do have a significant impact on overall financial system. (ACCA, 2009)
Improving the current supervisory as well as regulatory framework could have a major role to play in minimising the crisis conditions, developing the EU wide system that takes care of each operating market participants and carry out the required regulatory framework along with coordinating them would be an added advantage to the UK, furthermore, the compensation packages for managers to achieve incentives are at times risky and good for short term but on a long run its not feasible, a revised compensation scheme should be prepared so that risk factors could be measured before proceeding. (Liberals and Democrats, 2008)
And last but not the least step is more emphasis should be given to the performance of corporate governance and to understand about it rather than the regulatory performance of it. A set of ten corporate governance and risk management has been published by ACCA which should be observed in order to achieve better corporate governance. (ACCA, 2009)
ACCA (2009), 'Nine Steps to Financial Stability in 2020', The Association of Chartered Certified Accountants, December 2009, pp.1-8
Liberals and Democrats (2008), 'The International Financial Crisis: Its Causes and What to Do About It?'. Liberals and Democrats Workshop, 27 February 2008, pp. 1-59.
Mohan R. (2009), 'Global Financial Crisis- Causes, Impact, Policy Responses and Lessons', (Online) Available:http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/IIBISSApril212009.pdf(Accessed on 21 February 2010)
Roubini, N. (2008), 'Rising Risk of a Systemic Financial Meltdown: The 12 Steps to Financial Disaster', (Online) Available: http://www.marketoracle.co.uk/article3677.html (Accessed on: 24th February 2010)