The Causes of the Financial Crisis and the Overhauling of Regulatory Framework - Essay Example

?Introduction As a function of the economic events and precedent which has been set over the past several years, this brief analysis paper will seek to identify a further level of understanding with regards to why some of this crash came about, some preventative measures for ensuring that such a crash does not occur again, and ultimately whether or not it is the belief of this author whether or not such proscriptions for change are ultimately effective. As a means of analyzing each and every one of these determinants, it will be possible for the reader to come to a more full and complete understanding of the means by which the financial and banking crisis occurred in the first place as well as seeking to understand whether or not the current regulatory framework is in and of itself sufficient to provide a firewall against any further shocks to the market. Likewise, following an analysis of all of these factors, the discussion will also be briefly concentric upon the future outlook that the global economy has to look forward to; based upon the realities that have been discussed and presented within the piece. Reasons for the crisis The financial crisis of 2007/2008 was predicated by the banks which had leveraged bad debt in order to create more debt for their clients. Ultimately, this can understood as a situation in which certain types of outstanding credits that eh bank had in the form of loans to various entities or stock market derivatives were falsely identified as suitable contingents upon which further money could be “created” and/or loaned within the financial system. By constraining the amount of capital that could be raised/borrowed from investors and by striking at the underlying stock values of these financial institutions, the means whereby the banks could continue to loan and borrow were fundamentally reduced. By attacking the very mechanism whereby a bank can operate and hope to engage with consumers and turn a profit, the financial crisis was able to disable a number of banks and financial institutions; both large and small. However, as the crisis bore down on these banks and other entities within the economy, it was soon understood that the levels of debt and exposure to bad debt that the banks had on their books were ultimately untenable (FAHLENBRACH et al, 2012). Firstly, with regards to the banking and economic meltdown that occurred between 2007/2008, this must be understood as a global crisis. Although it began in the United States as a result of the subprime mortgage crisis, it rapidly spread globally and has affected every extant economy in the world; slowing growth, diminishing export strength, and devaluing a litany of world currencies in the process. Figure 1.0 denotes the issue of debt to GDP within major world economies. Figure 1.0 Preventative Steps: As a function of the breakdown in regulatory mechanisms capable of dealing with the size of the crash of 2007-2008, many of the largest and most effective regulations have been international in scope. But a few of these global regulations include the Basel III International Framework as well as further EU regulations concerning Markets in Financial Instruments Directives (MiFID). Ultimately, these further regulations, in tandem with existing regulations on the banking sector seek to integrate a set baseline of rules with regards to the standards underlying capital liquidity within the market. Due to the fact that the ultimate issue that the banking system was faced with during the crash was concentric around liquidity, most of the further regulations that have been passed with regards to seeking to provide a remedy to any further exhibitions of the same problem have been concentric upon speaking to the underlying weakness of the liquidity requirements that existed prior to the crash of 2007/2008. In seeking to identify the overall effectiveness of the current regulations, it can be said that they have kept the world from experiencing any further shocks similar to the ones that precipitated the events of 2007/2008; however, very little more can be said (Edgar, 2009). Moreover, lending back to the prior discussion that was had with regards to whether action or inaction would have provided the best utility to the system, much the same can be said with regards to the current level of regulation the defines the financial/banking system. Although the current system has not experienced any other massive shocks, this in and of itself is not sufficient to validate the current level of regulatory constraints. Future regulation for the banks Although the level to which future regulation may take place is merely guesswork, it is the belief of this student that the extent to which banks will be allowed to make speculative entries into other markets will be constrained to certain levels. Naturally, it only exhibits good business practices for a bank not to leverage any particular investment to an imbalanced degree. Likewise, the level and extent to which large multinational banks will be able to engage in business as usual without further levels of government meddling will more than likely soon be reduced (Williams & Martinez, 2012). Due to the precedent that has been set, the governments of the world have now taken responsibility for many of the missteps and poor management/planning that large financial institutions and banks have made. As a function of this, the governments have become deeply involved in this process and will seek to have a more active voice in dictating further financial policy and actions of such large players within the future (McGarvey, 2009). This only stands to reason as it is the governments that will ultimately be responsible for any further missteps that the banking industry makes. Conclusion: As a function of the preceding research on how the entire economic system came to find itself in such dire straits following the global economic meltdown of 2007/2008 as well as the manner in which existing regulatory framework was unable to control the process and finally the use and misuse of the stimuli money with regards to the outlandish bonuses that were paid to many top ranking bank officials, it is the belief of this author that any further bailouts or interference on the part of the government within the banking system may be foolish. Although the ramifications of inaction are strong, the fact of the matter is that a dangerous precedent has now been set whereby the banking system can behave in as reckless a manner as it wishes, knowing that as long as their bank is large enough to be considered “too large to fail” they can always count on being backed by the government, and ultimately the citizen taxpayers within whatever nation they operate. Sadly, even though the information that has thus far been presented represents a very close estimation of what can be done to mitigate the risk of another financial collapse, the greatest threat that continues to exist is with regards to the economic threat of unsustainable debt; a risk that has only grown in the years since the economic collapse. As developed countries and developing countries alike have attempted to spend their way out of this crisis, the level of debt has ballooned; likely creating another bubble with regards to the risk of hyper-inflated and ultimately worthless currencies which will rupture sometime within the near future – creating a far greater economic concern than the issues that have thus far been detailed throughout the course of this brief analysis. Unless a determined approach is engaged in order to ameliorate this debt crisis, it is most likely that the current level of expectation for the surviving the financial crisis of 2007/2008 may indeed be short-lived. References Edgar, RJ 2009, 'The Future of Financial Regulation: Lessons from the Global Financial Crisis', Australian Economic Review, 42, 4, pp. 470-476, Business Source Premier, EBSCOhost, viewed 2 April 2013. FAHLENBRACH, R, PRILMEIER, R, & STULZ, R 2012, 'This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis', Journal Of Finance, 67, 6, pp. 2139-2185, Business Source Premier, EBSCOhost, viewed 2 April 2013. MCGARVEY, R 2009, 'THE PRICE OF NOTHING', Risk Management (00355593), 56, 5, pp. 48-50, Business Source Premier, EBSCOhost, viewed 2 April 2013. Williams, C, & Martinez, C 2012, 'Government Effectiveness, the Global Financial Crisis, and Multinational Enterprise Internationalization', Journal Of International Marketing, 20, 3, pp. 65-78, Business Source Premier, EBSCOhost, viewed 2 April 2013. Read More