What Leads to Financial Crisis - Essay Example

?Financial Crisis XIAOYU ZHANG ZHIJIAN WANG PART A A1 Introduction Since the beginning of the human civilisation, when man was a caveman the mediumof communication was being discovered in the form of cave paintings. With the gradual development of the human race that reached its peak in the modern age, the medium of communication have even developed and took various forms. It is those cave paintings that were studied by the historian that gave the information about the way of life and its various elements in the undiscovered years of mankind. A study into the history of human civilisation till the present time would reveal that people from every period of time has left their mark with and into certain form which could tell the unadulterated story of that particular time. The history was documented in various forms which later communicated with the succeeding civilisation and revealed the history. With the roll of time various means of communication were discovered and put to use by man. In the present age which is driven by technology, it provides more than one means of communication that makes communication all the more easy and dynamic in nature. Besides, newspapers, magazines, journals, television, the moving pictures are also a means of communication which could be used by the communication for far reaching consequences. One of the many forms of moving pictures use for communication is the documentaries. According to the words of International Documentary Association, a documentary is a form of moving pictures which is non-fictitious in nature and which is primarily used for documenting reality. The audio and visual elements make documentaries even more appealing and add credibility to the document that it features. In the present technology driven age it is one of the most important and popular means of communication with a larger appeal. The feature documentary “Inside Job”, directed by Charles Ferguson documents the slide of the economy through the acknowledged individuals who speak the economic crisis of 2008. It also speaks about the various reasons that contributed to the ultimate downfall of the economy and its impact on the billions of lives and livelihood of the huge number of people. The economic crisis that affected the entire world economy during 2008 and beyond took shape from an economy which was known as one of the most stabilized economies and peaceful land among the world economies. According to Keynes (1936) the smooth flowing world economy was destabilized during the late 2000s and such a scenario was seen in Iceland for the very first time and even in the world. Krugman (2008) explains economic crisis is one the retarding factors that have pulled down the steep growth of the world economy including the subsequent growth of the smaller economies which have gained a new impetus in the growth of their economies. Kothari (2010) defines economic crisis as a collection of varied circumstances that results in the huge loss of the nominal value of their financial assets. He further explains that an organisation or a company has a number of stakeholders who are directly or indirectly related to the organisation or company through a financial relation. An economic crisis turns a company into a dried well of financial resources and a result the stakeholders of the company even suffers through immense lack of financial resources. According to the observations of Kothari (2010) the economic crisis faced by the entire world has turned a disturbingly huge number of people jobless and thus penniless. People all over the world lost their jobs while others bargained for the job in exchange of one of the most meager sum of money. As more and more people turned jobless the chaos and panic regarding being jobless seemed to engulf them over a long time. He further elucidated the different kinds of economic crisis. Firstly it is the banking crisis where the depositors of the respective banks immediately ask for returning their deposited money. The bank faces a crisis over the availability of the funds within a stipulated time period. The second form of economic crises is the stock market crash which clearly suggests that it refers to the drastic decrease of stock prices over the larger section of the stock market that hugely depreciates the amount or value of the stocks resulting in excessive loss for the investors. The third form of economic crisis comes in the form of currency crisis. Currency crisis takes place when there is a sudden devaluation of the currency of a particular economy which normally maintains a fixed exchange rate of its currency. The final kind of economic crisis identified by Kothari (2010) is the recession. The recession is defined as the negative growth of the Gross Domestic Product (GDP) for a period more than two or more quarters. It is considered as one of the most disastrous of all the types of economic crisis. It not only prevents the economy to grow but it even causes negative growth of the economy. In the late 2000s a series of incidents culminated to cause the economic crisis of 2008 that had a havoc impact over the world economies for a longer period of time. Iceland being a stable country which has a high standard of living, abundant natural resources and a lower population of 320,000 during the making of the documentary “Inside Job”. According to AndriMagnason, Writer and Filmmaker, Iceland had the perfect infrastructure of a modern society, clean energy, cultivation of food and others that made it self-sufficient. GylfiZoega, Prof. of Economic, University of Iceland, informed that Iceland had great healthcare and education system, with hardly any crime. Given the number of population, its geographical location, natural resources and the stable condition of the democracy, it is ideal for progression but due to certain factors its economic condition crippled to unwavering lows. The economies of the world are inter-connected with trade and commerce that make them inter-dependent. As a result the toppling of the economic system in Iceland sent rippling effects to every corner of the world. During 2000 the government of Iceland began a huge deregulation which cause havoc damage to the abundance of natural resources that it possessed and it even highly damaged its economy. According to Barnum (1998) de-regulation is allowing more freedom or liberty to certain financial institutions which can de-stabilise the functioning and cripple to downfall of the financial institution. The government of Iceland allowed companies like Alcoa to build their production units on the lands of Iceland and use its abundant naturals geothermal and hydroelectric energy sources (Sornette, 2003). During the same time the Icelandic government even privatized three of its most important banks like Islandsbanki, Kaupping, and Glitnir. In the March of 2000 the country suffered a huge loss of $ 5 trillion when the Internet Stock Bubble burst for promoting the non-promising internet companies (Charles and Kindleberger, 2005). It was a huge blow to the economy. During the same year, when the Banking Industry was dominated by investments banks like Goldman Sachs, Morgan Stanley, Lehman Brothers, and others; financial conglomerates like J P Morgan, Citigroup; securities insurance companies like AIG, MBIA and others; and rating agencies like Moody’s, Fitch and others. The investment banks combined the mortgages with other debts and loans and sold to investors while the rating agencies arbitrarily rated undeserving groups and approved huge loans which the owners could never pay. This culminated a huge sum of unrecovered money that over burdened the economy. According to Langohr and Langohr (2009) credit rating agencies are the companies which assign different ratings to the ability of the debtor for paying back the debts by making interest payment at a particular time. The investment banks bought excessively more than their assets. The arbitrary and unjustified grading of the rating agencies resulted in the rocketing of the number of AAA –rated instruments from a few in the year 2000 to the staggering 4000 in 2006 (Laevenand Fabian, 2008). According to Christopher (2013) AAA is a type of rating grade use to rate the credit bonds in investment. It is basically a bond credit rating. The Collateralized Debt Obligations (CDOs) market collapsed under severe conditions during the late 2000s which left the investment banks with loans of up to hundreds of billions of dollars. As a result of all of the financial institutions crippling down the Great Recession began in 2007 and by 2008 the Bear Stearns went out of cash. Gradually the stalwarts of the financial institutions like the Lehman Brothers, AIG, and others went on to become bankrupted resulting in the economic crisis that gripped the world (Sornette, 2003). According to Bethany and Nocera (2010) Collateralized Debt Obligations (CDOs) is a type of structured asset-backed security. Conclusion Ferguson, documents the economic slide of the economy of Iceland which resulted into the crippling of the economy of the entire world. Owing to the smaller size of the region with a standard number of population it was unlikely for a country like Iceland to experience such a massive blow to the economy but the reasons that lead to the downfall of the balanced economy is a eye-opener to the entire world which could make use of the documentation to prevent such a scenario. The slight de-regulation that triggered a series of inter-linked action which crippled the entire economy and destroyed the developed status of the country could be taken as a warning by other nations that would help the economies from crippling down. PART A A2 (a) Introduction The financial institutions operate in the environment of the society and with the elements of the society. This makes the financial institutions an integral part of the society and being an integral part of the society it is bestowed with quite a few responsibilities for the public. The fact that it is a financial institution also makes more responsible for looking into the self-interest of the institution in terms of generation of revenue so that it can maintain the commitments to its depositors as well as maintain the structure and functioning of the institution itself. It could be said more appropriately that the financial institutions have a blend of public as well as private or self-interest. The financial organisations operating in the country carry certain responsibilities which are at the balancing point of fulfilling the responsibilities towards the public. According to the analysed observations of Hidayat and Alhur (2010) the responsibilities that the financial institutions carry for the public is primarily living up to the expectations of being an institution that can provide the assured sum of interest for their deposited money, grant them loan at a reasonable rate of interest and even create job opportunities that will employ the countrymen and countrywomen as their employers and add to the financial security of the country, make the economy more stabilised. He further explains that being an important part of the society and a business entity it also has roles to play in the form of Corporate Social Responsibility (CSR). He explains that Corporate Social Responsibility (CSR) is the responsibility of the institution towards the society, and the work it does in order to fulfill the same like providing aid for the relief of individuals from natural calamities, organising health camps or even taking initiative in educating the mass about various related aspect of finance. When a financial institution engages in various works that serves the public interest the financial institution draws a more human image for itself in the minds of the public who are also its important stakeholders, because it is these very public whom the financial institutions provide its services. It represents the financial institution as a more socially responsible and so dependable organisation, it is this very image that the financial institution strives to build up for themselves because it will enhance their credibility and increase their value in terms of being more efficient and approachable both for depositing and borrowing money and both of them are business to the financial institution that it functions for. In case the financial institution fails to or does not pay much attention to the need of serving the responsibility to the public the financial institutions stands the grave risk of being abandoned by the depositors and it will lose it s business prospects. So, it could be concluded that adhering to the responsibilities towards the public the financial institutions pave way for the commercial success of the very institution and by not adhering to them it loses the business prospects of the very institution. It is indeed an organisation with commercial interests, the profit is very important for the sustenance of the organisation itself. So in order to maintain a striking balance between the self-interest and serve for public good in the tumultuous situation of the financial crisis the financial institutions need comprehensive policies in terms of interest rates and strict terms for the returning the borrowed money from the bank. Keeping in line with the professional standards and even with the moral standards, the financial institutions developed policies that would aim for long-term growth (Brunnermeier, 2001). The economic crisis in Iceland that toppled the entire world economies taught the lending policies has to become more conservation, has to have a balance and a high consideration about the origin of the money. This would ensure that the financial institutions do not lend money exuberantly that could not be traced down. The later policies that were adopted after economic crisis gripped the economy, concentrated more on the practicality of the borrowing and lending scenario. The financial institutions that still managed to survive and the ones which were saved by the intervention of the International Monetary Fund (IMF), formulated lending and borrowing policies made sure that the borrowers are lent the money and made sure that they strictly adhere to the returning policies and return them on time and in the mean time ensured generation of the financial resources to maintain themselves and recover from the recession. In recent times the financial institutions are stronger than before and offer one of the best financial solutions in the market. Being a financial institution it has a greater role to play in the financial system of the nation. When a nation is at the influential point that could influence the world market, its significance and role intensifies (Fried, 2012). Beck (2011) observes that the financial institutions like the banks plays an important role in building up an economy by encouraging people with minimal income for making small savings. The savings would accumulate to form a larger amount that would enable the individual in strengthening his or her economic condition and make him or her more economically stable. The process works more beneficially for people with larger ownership of wealth, it makes them wealthier. This overall system leads to the formation of a strong economy. The financial institutions also plays an important function in the creation of the infrastructure and assisting individuals and groups in making further development by lending them money at reasonable interest rates that serves the purpose of the both the parties – the banks in generating revenue through the levied interest and of the individual to develop with the aid of the loan. In the aftermath of the economic crisis the financial institutions adopted balanced policies that helped it recover from the crisis and register itself as stronger than before. Conclusion From the above discussion it could be concluded that the financial institutions has an important role to play for the society ignoring which it can harm its long term goals. The financial turmoil in Iceland was primarily created because the financial institutions behave irresponsibly towards the public as well as it ignored the need to operate while striking a balance. The failure in both the cases resulted in the economy that crippled in the chain-wise reaction. A2 (b) Introduction The financial decisions have a direct impact on the economy of a country in a chain wise manner, because the various economic elements are very much interlinked to each other. In a similar way the decision of de-regulation taken by the financial institution of Iceland has a direct impact on the economy with a heavy blow on it and resulted in the downfall of the entire economy of the world. De-regulation provides more freedom and liberty to the financial institution for operating which can be taken on the positive stride and the liberty allowed in the performance can be used to develop or improve the economy of the financial institution by strengthening its policies and attracting more customers to deal with the bank. Such an initiative could have brought in more business. On the other hand the liberty when used arbitrarily could result in the breakdown of the entire economic system which is what has happened with Iceland. A failed de-regulated market gets translated into an failed economy which adds to the worsening of the situation by clogging the avenues of development and even it paralyses the existing developmental process. The allowance to de-regulate a financial institution was an advantage that was misused by Iceland that has cause havoc damage to not only the economy of Iceland but also to the economy of the entire world. When the de-regulation in the financial institutions resulted in financial crisis that toppled the world economy, it led to the creation of distrust of the public over the financial institutions. The breakdown of the entire financial system and disturbance of the economy all over the world was caused due to the failure of these giant financial institutions (Brunnermeier, 2001). It led to such an economic crisis that made companies curtail their number of employees as a result numerous people lost their jobs, this added to the financial woes because it shattered the base of the economic foundation of the world economic system. Due to globalisation the nations and their economic system are very well connected and inter-dependent on grounds more than one. As a result failure of the economic system of a nation would affect the economic system of other nations as well and in a similar fashion. The high fallout of the economic system and the development of the financial crisis led to the depletion of public trust over these financial institutions which were trusted as the stalwarts of the economic stability (Fried, 2012). The financial crisis developed largely due to the de-regulation of the financial institutions. So, in order to restore the normalcy of the economic system the institutions need to impose self-regulation in a more organised and practical way that would work to secure public faith and apathy in the financial institutions. The financial institutions need to impose self-regulation in terms of lending policy that ensures timely returning of the borrowed money, lending interest rates that enable generation of the needed revenue for the banks and other financial institutions, grading the organisations based on proper justification and not out of arbitrary wishes. In case of the failure of the borrowing individual or group in repaying the loan the financial institutions should employ strict mechanisms to ensure that the amount lent out to the individuals are returned with an additional interest rate as a mark of penalty or punishment. The adoption of such workable policies by the financial institutions helped them to survive. The adoption of stringent policies is useless unless supported by legislation that ensures that they are implemented in the truest terms and sense. The financial institutions that survived the blow of the crisis framed such legislation and ensured that they are strictly followed. Such a procedure also reflects transparency in the system (Kothari, 2010). The prevalence of transparency in a way greatly contributes to the creation public trust in the financial institutions. Thus it collectively works to restore public trust which paves the way for furtherance of the balanced and thus stable economic condition of the world (Laeven and Fabian, 2008). Conclusion From the above detailed discussion it was revealed that the financial institutions are very much a social entity with quite a few responsibilities for the public as well as private or self-interest responsibilities. The social responsibilities of the financial institutions projects a more human and responsible image towards the public which in the long run plays a great role in achieving its self-interests. Unfortunately, the financial institutions of Iceland did not adhere to its social responsibilities and even made an arbitrary use of the de-regulation that hugely affected the economy of Iceland and in a series of effect affected the economy of the entire world. References Brunnermeier, M (2001), Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding, Oxford University Press Bethany, McLean and Nocera, Joe (2010) All the Devils Are Here, the Hidden History of the Financial Crisis, Portfolio, Penguin, 2010, p.120 Barnum, John W (1998), "What Prompted Airline Deregulation 20 Years Ago? Presentation to the Aeronautical Law Committee of the Business Law Section of the International Bar Association", retrieved 2009-08-17 Cipriani, M and Guarino, A (2008) 'Herd Behavior and Contagion in Financial Markets'. "The B.E. Journal of Theoretical Economics" 8(1) Christopher, Alessi (2013) . "The Credit Rating Controversy. Campaign 2012". 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