The Reasons for the Financial Crisis - Essay Example

?Critically evaluate the reasons for the recent global financial crisis Introduction The Global Financial Crisis which took place during 2007 once again shook the financial system of the world by subjecting it to utmost criticality after the event of the Great Depression during the 1930s. Global Financial Crisis of 2007 had its beginning in United States of America with the crash of the home loan or credit market during July 2007. This credit crunch which happened in United States during 2007 rapidly spread to other global economies thus jeopardizing the global financial system. Investments Banks in United States received a huge blow of the financial crisis for which they gradually disappeared from the financial scenario of the country (Kenc & Dibooglu, 2010, p. 3). The crisis of the mortgage market during 2007 rendered a huge impact on countering a decline in the value of the market price of large securities and other financial instruments held by the financial organizations of the world. Credit Crunch which happened in the American markets created a global turmoil by declining the value of debt instruments all over the world by restricting credit both on personalized and on organized levels. Thus the contagious effect of the financial credit crunch of America took the form of global financial crisis by ripping off the stability of the financial institutions on an international scale (Longstaff, 2010, p.436; Aronson, 2010, p. 276). Reasons for the Global Financial Crisis The main reason which is attributed to causing the event of global financial crisis in the global scenario is the effect of contagion. Contagion effect has been identified to generate similar shocks of financial breakdown in one economic system to other financial systems operating throughout the world mainly through three ways. In the first manner the potency of economic breakdown in one financial market is spread to other world economies through the information network. This information obtained can hugely affect the working of the economic system of the other countries largely jeopardizing them. Secondly the event of contagion also gains ground by disturbing the liquidity position of the financial assets of the other global economies. A strike imposed on the availability of financial liquidity through the system of credit in one economy also renders potential impact by curbing the amount of liquidity in other economies of the world. In the third case the contagious effect of the financial crisis in any developed region like America also weakens the desire and potency of other economies to enhance the risk portfolio in their financial system (Longstaff, 2010, p.438). Along with the above reasons there were several other causes like the selfish outlook of the micro factors of the financial system like the groups of investors, creditors, banks and other financial institutions. These economic groups were busy considering avenues to get the best of the financial system by drifting the financial and economic policies of the government in their favor. The impacts rendered by these systems led to the growth of credit generation in the economy of United States until it led to the final demise. Further the social policy outlines taken by the government of United States to help render huge credits to the poor people of the country to construct houses also led to the happening of the credit crunch. Huge amount of credit ushered in the economy with low amount of interest also led the banks to gain the advantage of such. The financial system of granting credit in America was managed by different agencies that used to set policies and regulations detrimental to the economic system of the country. These agencies were themselves not successful in rightly satisfying the responsibilities entrusted on them and mainly wanted to avail the favor of the intricacies of the government regulations pertaining to credit (Wignall & Atkinson, 2009, pp. 2, 5, 8; McNally, 2009, p. 36, 38). The opening up of the economic system owing to the effects of mass globalization also led to the happening of the global financial crisis. Through the system of open markets large amount of funds from the developed nations became continually pumped into the developing or emerging economies which helped in their developmental activities. Financial organizations operating in the developed countries through the creation of the open markets also wanted to extend their control on the financial position of the emerging economies. Thus the developing economies which were gradually developing their consumption and life style patterns owing to the influence of the financial help of the developed nations became the victims of the financial downturn. Credit crunch which happened in the United States affected the economic and financial system of both the developed and developing nations through the process of contagion (Schmukler & Zoido, n.d.; Banoob, 2009. p. 244). The role of the contagion in affecting the financial system of the world gained impetus with the disturbance of the European economic system due to credit crunch in the United States. European financial organizations were badly affected owing to the disruption of the credit and financial system of United States. These European financial organizations which rendered loan to the developing and emerging economies thus transmitted the economic disturbance along a worldwide base causing economic and social disruptions. Impact of the financial crisis in the United States caused huge decline in the values of assets along with several construction properties. Further the closing down of several banks rendering loans to the public with the rise in huge levels of unemployment in the several economies caused the growth of the global financial crisis. Governments of different countries in a bid to save the economies from the impact of the falling industries and markets started initiating covers for some sectors and also started gaining ascension over many financial institutions. Further the system of credit generation by these banks and financial institutions were highly restricted for which the people of the developing economies largely suffered (Moshirian, 2010, p.503; McNally, 2009, p. 36, 38; Goldstein & Pauzner, 2004, p. 171). In United States the banks operating to fund loans in the subprime market generally focus on rendering of loans to the people who would not be able to repay that in due time. However these banks through such motive aimed to gain a profit on the mortgaged property of their clients in the event of rise in the market value due to availability of high credit. These financial institutions however in the event of depreciation in the value of the property markets counter huge loss. Hence the banks in their drive to gain a good amount of profit while rendering loans to the public were trying to appreciate the value of the housing properties. This act of the financial institutions of the developed countries significantly helped in the affecting the financial position of the economic systems (Niinimaki, 2008, p.514; Aalbers, 2009, p.36; Frank & Hesse, 2009, p. 5). The event of the global financial crisis set forth the happening of some bizarre incidents along the global economic scale. More specifically the collapse of big financial firms like Lehman Brothers during 2008 sent ripples of fear along the several economies trading with United States. The impact of the fear affected the operation of the banks that ceased operations among themselves in the field of lending activities. Owing to the ceasing of operations between themselves in regards to lending schemes the amount of risk premium attached to such greatly increased from zero to around five percent. Again for corporate lending purposes the amount of risk associated with such lending operations rose to around 6 percent. Credit facilities imparted in both the corporate and trading field largely affected also had significant impacts on the manufacturing operations of the several countries. Demand for the production of investment related commodities became largely affected owing to the regime of low credit rendering operations. The above impacts led to the significant reduction of economic operations in the developing and developed economies intensifying the global financial crisis. This pattern of economic slowdown reflected much greater significance with the rolling of time during 2009 leading to a global recession. Trade and economic activities around the world largely dropped due to the fall in the collaboration processes of the financial institutions of the different economies. Oil and Petroleum Exporting Countries stated that global trading figures in volumes reduced by around 13 percent owing to the impacts of the global recession. Decline in trade, economic and manufacturing activities further intensified the problem of unemployment and poverty in the developing countries. Governments of different nations started resorting to take protective measures against such positions to revive the declining markets (McKibbin & Stoeckel, 2009, p.1; Nanto, 2009, p.4). Conclusion The financial crisis which started in the United States owing to crash of the credit markets gradually developed into a financial crisis on a global scale owing to the deficiency caused in properly managing such. Huge amounts of loan generated to the general people by the United States government to build in houses had very low interest rates. This led to the increase in the value of the real estate commodities. Banks and other financial institutions that catered to the rendering of loans to the people got interested in bargaining over the prices of real estate products. Thus the ceasing of the loan amount generated by the banks led to the crunch of the credit system which in turn largely affected the trading and investment activities on a global sphere causing the emergence of the global financial crisis. References 1. Kenc, T. & S. Dibooglu. (2010). The 2007-2009 financial crisis, global imbalances and capital flows: Implications for reform, Economic Systems. Vol. 34. pp. 3-21. 2. Longstaff, F. (2010), The subprime credit crisis and contagion in financial markets, Journal of Financial Economics, Vol. 97, pp.436-450. 3. Aronson, B. (2010), The Financial Crisis One Year Later: Proceedings of a Panel Discussion on Lessons of the Financial Crisis and Implications for Regulatory Reform, Creighton Law Review, Vol. 43, No. 2, pp. 275-322. 4. Wignall, A. & P. Atkinson (2009), Origins of the financial crisis and requirements for reform, Journal for Asian Economics, Vol. 30, pp.1-13. 5. Schmukler, S. & Zoido, P. (n.d.). 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