The Global Financial Crisis - Essay Example

Table of Contents Page I. Abstract……………………………………………………………………………… 2 II. Introduction………………………………………………………………………….. 3 III. United States of America regulatory response to economic crisis……………………4 IV. Factors that led to the current US financial crisis……………………………………. 4 a. New regulatory reforms………………………………………………………. 5 b. US 2008 Actions……………………………………………………………... 7 c. Housing and Economic Recovery Act………………………………………...8 d. Barack Obama’s action………………………………………………………. 9 V. United Kingdom regulatory response to economic crisis……………………………10 a. UK financial crisis overview……………………………………………….. 10 b. UK rescue Package…………………………………………………………..12 c. Assistance to British banks Act……………………………………………...12 d. The Financial Services Authority Acts……………………………………...14 e. Asset Protection Scheme…………………………………………………….14 VI. Conclusion…………………………………………………………………………. 14 VII. References…………………………………………………………………………... 16 Abstract The current global crisis began in 2007 and spread in 2008. It had varying impacts on the financial systems of various countries depending on the initial stability of the system and its exposure to the credit derivatives that accelerated the crisis. A combination of several factors led to the current US financial crisis including imprudent mortgage lending, deregulatory legislation, and rating agencies among many others. The global micro policies and poor regulatory framework at local and regional levels played significant roles. On the international level, policies regulating liquidity led to excess leverage. There are similarities in the regulatory responses that have been given by different nations to the current financial crisis. The responses mainly touch on improved liquidity, management of risks, and lowering leverages. Enhanced insurance on investment and banking sector are other key response. The effects were severe in the developed countries like United States. In this regard, different countries reacted to the crisis identifying the opportunities and the associated challenges. The countries in the OECD advocated for a joint effort to have international standardization of regulatory policies. The main concerns are stimulation of demand in a given economy, improving liquidity, preventing foreclosures of mortgages and improving access to financing by for the SMEs and giant investors. There is a focus in risk reduction through investment in insurance. Introduction The current global crisis began in 2007, in some countries, and deepened in 2008.1 Some of the factors that may contribute to financial crisis include application of similar operational strategies by players in the market, changes in the banking business, excessive leverage, changes in regulations and corporate governance, and failure of government policies on the financial sector.2 Government policies regulate the financial sector within in a country and the operations with a global business partner. The failures in some of these policies could have contributed greatly to the current situation. To fix the situation and mitigate for future crises, various governments have enacted some monetary policies. The current global financial crisis had other related problems like food crisis especially to the developing countries as was, and continues to be, witnessed in the horn of Africa.3 The financial reforms to manage the crisis must then focus on the other financial instruments controlling the economy of the country. The problem that has been encountered in the management of the crisis is that economists and the policymakers do not have a proper understanding of the relationship of various components of economic policy and regulation. It is important to understand the interaction between monetary and macro-prudential policies in enabling financial stability. Designing a successful macro-prudential policy requires the government to understand the risks of the new financial instruments it is putting in place.Focusing on the monetary policy is insufficient in the management and mitigation of financial crises. This paper focuses on the regulatory responses that have been given by four different countries in relation to the current global financial crisis. It focuses on the regulatory responses in the UK, the United States, France, and Germany. United States of America regulatory response to economic crisis In the US, the current financial crisis began in 2007 and deepened in 2008 even though attempts were made by the Central Bank to restore financial stability.4 Various views have been given by economists and financial analysts concerning the causes of the current crisis. Factors that led to the current US financial crisis The last Congress created the Financial Crisis Inquiry Commission to investigate the factors that led to the crisis in an attempt to develop solution. Members of the commission differed on their views and several factors were raised. In one line of argument, it was observed that the government made an unnecessary intervention into the housing market through Fannie Mae and Freddie Mac.5 The move led to an inflation of housing bubble that culminated into the crisis. The other argument, supported by the majority of the members of the commission, is that large banking institutions serving their interests took control of the financial and political system in Washington to their advantage.6 The greedy banks manipulated the operations of large real estate and mortgage investors increasing the risks in the global financial system. The third argument brings together different factors. Here, it is pointed out that the economic forces on the global scene as well as the failure of the US government to develop good policies and ensure proper supervision contributed to the current situation.7 The last observation had been partly supported earlier by some financial analysts. It had been earlier pointed out that the crisis occurred due to the ‘distortions and incentives created by past policy actions’.8 A combination of several factors are also cited by 9 including imprudent mortgage lending, deregulatory legislation, and rating agencies among many others as the key factors. New regulatory reforms While the discussions continue, the US Congress has shown commitment to prudential regulatory reforms in commercial banking, securities and insurance sector, and the investment banking industry.10 However, the intervention has not been smooth since the development of these regulatory policies by the US has to conflict with the interests and policies of other governments across the globe. The US had experienced economic crises before the 2008 crisis. In the response to these crises, the regulatory agencies focused on liquidity issues, demand stimulation, and prevention of foreclosures of mortgages.11 The other response that was given to the earlier crisis involved legislation that would see increased demand and prevent mortgage foreclosure.12 Nonetheless, in as much as there were several other regulatory agencies, much of the task at this time was limited to the Federal Reserve. After the September 2008, other regulatory institutions like the US Treasury joined hands with the Federal Reserve to develop the Emergency Economic Stabilization Act 2008.13 The then president appealed to the Congress on the need to pass the proposal, which would see the government invest $700bn in purchasing the “toxic” illiquid assets, in order to revive the credit market. An institution was to be eligible to the program if it were regulated at the federal level.14 The implementation of the program began in the President Bush era and continued into the President Obama era. Before the termination of President Bush’s term, about $350bn had been invested towards the scheme.15 To improve on the equity stakes, the US Treasury injected funds into different financial institutions. Under the scheme (Failing Institutions), the US treasury in conjunction with the Fed gave out several bailouts to AIG, a giant insurance company.16 It was noted that the insurance company provided insurance cover to more than 100000 clients employing over 100 million Americans.17 Its collapse would be a financial downturn. The Treasury also awarded loans to other giants in the automobile industry like General Motors. The other response was that the Federal Reserve and US Treasury declined to bail out Lehman Brothers, an investment bank, with a shift towards Bear Stearns. The move was aimed at illustrating to the other banking institutions that they were at par and ‘that no bank was too big to fail’.18 The Federal Reserve continued with the earlier approach of lowering interest rates to increase liquidity and stimulate lending. In response to the predicament, the Securities and Exchange Commission (SEC) suspended the short selling of financial institutions.19 This saw Fed raise fines for unprotected sale of the (financial) institutions. Another important response was the development of the comprehensive Homeowners Affordability and Stability Plan to enable homeowners who are at risk of foreclosure to refinance their mortgages.20 The Congress also passed the $787bn American Recovery and Reinvestment Act 2009 to revive demand in the US economy.21 US 2008 Actions In March 2008 the US Treasury released its Blueprint for Financial Regulatory Reform, which advocated for the strengthening of US financial regulation.22 Through the reduction of transaction costs negotiation and clarification of agency accountability, the consolidation of regulatory agencies aimed at promoting cooperation among the international regulatory agencies. The House Banking Committee chair, Barney Frank then announced the committee’s focus on developing some universal regulator before focusing on the several federal and state agencies later on. The US proposed G-20 group in a November 2008 Summit in Washington that would focus on better prudential policies, tough regulations, improved risk management and increased supervision of the financial institutions in the country.23 During the 2008 final quarter, the U.S central banks purchased the government debt, which had reached the margin of 2.5 trillion United States Dollars. In addition to the aforementioned counter actions, it purchased the assets of the private banks, which were experiencing various financial troubles. It has been established that such liquidity injection within the credit market is one of the largest ones historically. Besides, within the world history, it remains to be the biggest monetary policy action. While still attempting to salvage the country from the financial crisis, the US government increased the national banking systems’ capital by 1.5 trillion24. The government made this accomplishment by purchasing the preferred stock, which had been newly issued by the principal banks. Housing and Economic Recovery Act The 2008 Housing and Economic Recovery Act was one of the Acts, which were introduced in order to combat the financial crisis phenomenon. This specific Act comprises of six different major Acts formulated with the intention of restoring confidence within the country’s mortgage industry. There are various specifications, which were outlined within the Act. In the first place, around 3000 billion USD would be provided as mortgages’ insurance so as to assist approximately 4000,000 homeowners. Secondly, the Act led to the establishment of a new regulator. The already existing two authorities, that is, OFHEO (Office of Federal Housing Enterprise Oversight) along with the FHFB (Federal Housing Finance Board) would be merged to have only one authority, which would be termed as the Federal Housing Finance Agency. The newly formed body was endowed with extra powers, as well as, authority, which were greater than those of its two predecessors25. The new agency was given the mandate to supervise the GSEs, which stands for, Government Sponsored enterprises, which were fourteen housing projects. The supervision of the Feral Home Loan banks which are around twelve in number. The mortgages purchasing rate value by the GSE’s would escalate in accordance to the freshly brought up Act. Additionally, the mortgage disclosures were enhanced after the implementation of the Act. A 8000 billion USD increase within the ceiling of the national debt was introduced so as to enable the Treasury to assist what are considered as secondary housing market along with the earlier mentioned 14 GSEs, in the event that the need arises. On top of this, the Act clearly specifies that the foreclosed properties would be refurbished and bought by the local governmental agencies in partnership with the business community. Either way, by making use of foreclosure risks, mortgages refinancing loans will be available to the genuine owners. Barack Obama’s action In the course of the month of June 2009 Barack Obama, who is the U.S President along with other key advisers brought up several other regulatory proposals.26 The proposals actually address issues such as consumer protection, bank capital requirements or financial cushions, executive pay, expanded shadow banking system regulation and derivatives along with enhanced Federal Reserve authority to wind-down vital institutions in a systematic and secure procedure. Banks’ activities within propriety trading were imposed with restrictions by the extra regulations brought up by the President. Moreover, during May 2010, the regulatory reform bill was passed by the United States’ Senate27. There are also various Acts, which were introduced by the Senate in order to resolve the emerging financial crisis. The other Act, which was introduced by the Obama administration with the aim of combating the financial crisis, was the Dood-Fran Wall Street Reform and Consumer Protection Act28. This Act is basically concerned with bringing about reforms within the financial sector. It was actually implemented within the July of 2010 after garnering a lot of support from the democrats. The Act is considered to have brought about effective financial regulation within the U.S. On top of bring about various regard the banks’ along with insurance companies’ capital investment; the Act also introduces novel regulation regarding hedge funds along with private equity funds. Moreover, the Act altered the accredited investor’s definition. It also requires all public companies to produce reports illustrating the CEO to junior employee salary ratios along with any other relevant compensation data. Besides, the Act enforces regulations encouraging the equitable credit access by all consumers. It also offers incentives so as to encourage banking among citizens who are either low or medium income earners. There are other objectives, which led to the enactment of this legislation. One of the objectives was to improve the accountability along with transparency of the United States’ financial system so as to ensure that the country was financially stable29. The Act was also aimed at protecting the taxpayers by bring to an end bailouts. Furthermore, upon its successful implementation, the Act would offer consumers protection from abusive financial practices, which aggravate the emergence of financial crisis. Through the Act, an effective warning system was established which could aid in determining the country’s economic stability. In addition, corporate governance along with executive compensation rules is also featured within the Act30. In fact, the Act has effectively sealed most of the major loopholes, which are thought to have brought about the economic recession experienced in the course of 2008. United Kingdom regulatory response to economic crisis UK financial crisis overview The UK felt the effect of the financial crisis within a very short period. In 2007, the GDP growth rate +3% and the growth rate declined drastically to -1.5% by the end of the first quarter in 2008.31 The country recorded rising unemployment rates, decreased consumer spending and increased budget deficits. The budget deficits rose to ₤43bn in 2008 and ₤70bn in 2009.32 According to the Financial Services Authority chair, the crisis developed out of interplay between macroeconomic imbalances and the developments in the financial markets intensified in the last decade or so.33 The global imbalances could be attributed to the high saving rates in China and other countries that led to large current account surpluses in these oil-producing countries. The net effect was immense credit extension in the developed nations like UK and US.34 35 It also led to convolution in securitization market. To manage the crisis, certain areas needed to be reexamined including the deposit insurance mechanism, bank solvency regimes, liquidity risk management, and boundaries regulation. Increased sector analysis by the regulators could prove sufficient.36 The Central Banks and other regulators need to work together to amalgamate the analysis of macroeconomic and macro-prudential policies.37 In response to the financial crisis, the UK treasury sought information from various stakeholders like actuaries and economists. Her Majesty’s Treasury, the United Kingdom’s economic and finance department responsible for regulatory policies consulted the Actuarial Profession on the appropriate mechanisms of reforming the financial markets in the country.38 In response, the Actuarial Profession advised that strict regulations would be pricey for the clients and policyholders making firms to shy away from the UK market. The agency also advised that it would be unnecessary in the subsequent periods to put further changes to prudential regulation for the insurance companies in the UK.39 UK rescue Package The United Kingdom responded to the financial crisis by developing a bank rescue package. The rescue package was valued at 500 billion Great Britain Pounds. The package was actually announced by the government in the month of October 200840. The reason behind the implementation of the rescue package was the major falls, which had been experienced within the country’s stock market. In addition, the British banks stability had become questionable. The plan was targeted at restoring confidence within the market and assist in the stabilization of the country’s banking system. This bailout was actually similar to the 2008 Emergency Economic Stabilization Act introduced within the United States at around the same period. The plan provided for the establishment of various funding sources. In accordance to the plan, the Special Liquidity Scheme of the Bank of England would offer short-term loans of approximately 200 billion Great Britain Pounds. Assistance to British banks Act In the second place, the rescue plan outlined the manner in which the United Kingdom government would offer assistance to British banks in accomplishing their objective of increasing their market capitalization by establishing the Bank Recapitalization Fund41. Every bank would receive at least 25 billion Great Britain Pounds and have the right to request for additional 25 billion Greta Britain Pounds if the need arises. The banking corporations willing to take part in the government sponsored lending within UK would enjoy a bank rolling allowance of loan guarantees amounting to almost 250b GDP (GDP-Great Britain Pounds). Actually, the banking operations would regain confidence according to Alistair ideas. Alistair Darling was at the financial crisis time, the U.K‘s Exchequer Chancellor. The Exchequer Chancellor further explained that in the event that the proposal was successfully implemented, the British banks would get a stronger funding footing. The United Kingdom’s government also decided to undertake capital investment to combat the emerging 2008 financial crisis. The percentage of the stake to be acquired in any bank would be agreed on with the management of the specific bank. Banking corporations seeking to be considered for the alleged rescue packages are expected to observe stringently to the restrictions regarding executive remuneration along with dividends’ disbursement. Homeowners along with business enterprises were also supposed to enjoy on a fair ground, the credit facilities from the benefitting banks. The long term motives of the ruling authorities’ suggestions could be appropriately focused on. For instance, it could easily established that all the expenses which could be incurred by the Obama administration in putting the aforementioned program in full operation would be compensated by the selling the shares in the event that the shares market becomes conducive. The benefitting banks had a high likelihood of having their novel shares hitches been underwritten. The plan can be considered to have been characterized by partial nationalization. On the other hand, the banks would be permitted to participate in the plan in accordance to their needs. The Financial Services Authority Acts After examining the past trend and the failed approaches, FSA made some resolutions. There was need for a new capital adequacy approach and effective risk management approach.42 The Treasury increased the levels of bank capitals. Secondly, the country adopted new approaches to liquidity. FSA understood the need to have internationally recognized system that would enhance standardized regulation of liquidity. The other approach that was proposed and adopted is the removal of shadow banking system with strict requirements on disclosure.43 Just like the other approaches, this was aimed at reducing risks to restore financial stability.44 The UK also participates in G-20 meetings with a focus on improving transparency, openness, and disclosure among the financial institutions. Another significant response was the Asset Protection Scheme developed in 2009. The scheme by UK government was aimed at reducing potential losses and risks to the financial institutions in an effort to stabilize the financial system of the country.45 A number of banking institutions like the Royal Bank of Scotland agreed to participate in the scheme. Conclusion Different factors contributed to the current financial crisis. The global micro policies and poor regulatory framework at local and regional levels played important roles. On the global level, policies regulating liquidity led to excess leverage. There are similarities in the regulatory responses that have been given by different countries to the current financial crisis. The responses mainly touch on enhance liquidity, management of risks, and lowering leverages. Improved insurance on investment and banking sector are other key response. The governments are mainly concerned with promoting access to finances and getting the financial institutions to penetrate into other financial markets. References Actual Profession.(2009). Actuarial Profession response to the HM Treasury Consultation on Reforming Financial Markets.Retrieved from http://kan.actuaries.org.uk/sites/all/files/documents/pdf/AP_HMT_FinancialMarkets_20090928_resp.pdf Blundell-Wignall, A., Atkinson, P., and Lee, S. (2008). The Current Financial Crisis: Causes and Policy Issues. 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Policy Responses to the Economic Crisis: Investing in Innovation for Long-Term Growth. Retrieved from http://www.oecd.org/dataoecd/59/45/42983414.pdf Reid, M. (2009).UK Response to the Global Financial Crisis. Retrieved from http://gre.academia.edu/MJReid/Papers/252220/UK_Response_to_the_Global_Financial_Crisis Savona, P., Kirton, J., & Oldani, C. (2011). Global Financial Crisis: Global Impact And Solutions. Farnham, Surrey: Ashgate. Singer, D. (2008). The Global Financial Crisis and U.S. Leadership. Retrieved from http://www.alternet.org/economy/104358/the_global_financial_crisis_and_u.s._leadership/ Squire Sanders. (2009). US and Global Regulatory Responses to the Financial Crisis. Retrieved from http://www.squiresanders.com/us_and_global_regulatory_responses_to_the_financial_crisis/ Tamirisa, N. (2011). International Capital Flows: What Actually Happened In 2010? 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