Financial Crisis of American Central Bank - Case Study Example

Financial Crisis of American Central Bank Abstract Financial crisis in the recent years has projected a huge threat on the financial system of an economy. It is noted that the different strategies that were safeguarding the system to maintain the financial setting has been insufficient to meet with the present day changing business scenario. The failure of the financial system to maintain economic stability during the time of crisis has been evident of the fact that certain regulations were insufficient. Furthermore, the insufficiency of the economic system has been noted to be affecting the policies relating to crisis management. The different literary evidences that are available even support the fact that the regulatory bodies were incapable to manage the different adverse situations in the financial system. However, it has even been observed that the different strategic development that was incorporated within the system made the system more stringent. The Federal Bank of America made the financial system stringent, so that the similar crises could be avoided. With a close monitoring of the financial system, the regulatory bodies could ensure that a transparent system is developed in order to prevent such adverse situations. Table of Contents Abstract 1 Table of Contents 2 Introduction 4 Discussion 5 1. The Soundness and Sustainability of the Financial Market (Part 1) 5 2. Efficiency of the Financial Institutions (Part 1) 7 3. How The Interest Rates Are Determined In The Country And The Competitiveness Of The Interest Rate Policy With Respect To Foreign Investment Lending And Borrowing (Part 2) 9 4. Effect of Financial Crisis on the Country in General and Financial Market In Particular (Part 3) 10 5. Role of the Central Bank (Part 4) 11 6. The Effectiveness of Monetary Policy of the Country with Examples (Part 4) 13 7. Based On Your Analysis, Your Suggestion for the Country to Strengthen Their Financial and Economic Performances (Part 1-4) 14 Conclusion 16 References 18 Introduction Financial crisis creates a severe menace on the economic and financial position of a country. It develops a situation, which leads to a sudden as well as an unrecoverable fall in the price of the assets. The situation even evidences a huge demand of money and the supply of money fails to meet with the increased level of demand. The major impacts of the financial crisis are observed on the banking as well as other financial sectors. As the large demand for money increases, the tendency among the public to withdraw cash in greater amount to meet with the demand of the market also increases. This phenomenon forces the banks to sell their bonds and other financial instruments and accordingly, the financial institutions are at the verge of insolvency. Another developed trend of the financial crisis makes it evident that the recent financial crisis can have a huge impact across borders (Claessens & Kose, 2013). As an outcome of the financial crisis, the face value of currency falls drastically lowering down the purchasing ability of an economy. The risk management ability of different financial institutions falters massively creating a situation of confusion and dilemma within the economic system. Similarly, the recent financial crisis that was faced by America during the recent years was evident of the fact that the country lost its ability to manage its risks. The severe downturn that the country faced during the initial phase exposed the country to different international and national risks of economic downturn (Claessens & Kose, 2013). With this context, the essay elaborates on the different issues that are faced by the American Central Bank during the time of the financial crisis. The financial crisis in the recent years has influenced the financial system of the country to a large extent. The essay focuses on the different strategic development that was incorporated within the system in order to enhance financial performances and stability. The different risks that the country faced during the tenure of crisis have been duly elaborated by providing stress on the different tactics that were developed by the country to mitigate the crises. Discussion 1. The Soundness and Sustainability of the Financial Market (Part 1) Economic development has emerged to be one of the most important parts of the nations and the countries across the globe for developing their competitive domain in order to enhance their economic development and develop their image across the globe. With the development of this tendency among the nations, the need for developing their financial system has also evolved (Schich, 2009). According to Naude (2009), this change into the system has made the financial system quite complex. It has also increased the instances of risk creating a huge lack of ability among the planners to anticipate the projected risk. Schich (2009) further stated that the massive exposure of the financial market has made it vulnerable to the different risks and has enhanced the epicentre of crisis. The impact of the financial crisis was faced directly by the different financial institutions specifically the insurance and the other mortgage industries that were dealing directly with the financial operations. Terazi & Senel (2011) noted that the mortgage sector in the US market acted as an epicentre of the financial crisis that was faced in the recent times. Furthermore, the changed setting of the financial system that has been imposed by the recent globalisation has in turn created a negative impact on the different financial turmoil that was faced during the recent years. According to Bexley & et. al. (2009), the banking industries faced one of the largest financial catastrophes in the recent times. The last financial crisis was even evident of the fact that around 305 banks have faced difficulties and complexities in the following year of the financial crisis, which led to their failure. The failure of the mortgage and the loan markets and the compounding rate of defaults created a negating effect on the complete financial system (Bexley & et. al., 2009). Xafa (2010) commented about the dramatic intensification of the crisis that emerged with the fall of the giant Lehman Brothers followed by a complete breakdown of the economic system of America. The failure of the regulatory as well as the supervisory role played by the different agencies within the economy of the nation has been the sole cause that has led to such meltdown of the market (Xafa 2010). Crotty (2009) argued about the flaws of the regulatory boards to monitor the different issues that have led to the failure of the economic system one after the other leading to such a catastrophic fall of the economic system of the nation. This crisis even made it evident that the financial institutions were incapable of maintaining their level of soundness at the time of global turmoil. Globalisation has increased the need of the nations to manage their different financial operations and maintain their credibility in the global market. Financial crisis that was faced in the recent years was due to the failure of the different financial intermediaries to meet with the needs of the changing time. With the lack of proper monitoring of the market, the appropriation of risk and developing strategies to mitigate the same failed largely. This situation created a huge confusion among the investors and led to the failure of the overall economic systems. Correspondingly, the different mortgages and lending strategies in the market boosted up the mortgage markets and created a raised up demand different from the actual situation (Bexley & et. al., 2009). 2. Efficiency of the Financial Institutions (Part 1) Goldin and Vogel (2010) stated the global policies that are recently incorporated by the different systems have made the financial system fragile and have exposed the system to different systematic risks. The financial crisis of the recent years made it evident that the interlinked economic system has acted as a catalyst for the crisis to spread like a fire. Furthermore, the severity of events and the drastic fall of the financial system in the US have even made it clear that the prevalent policies were incapable to meet with the needs of the system (Goldin & Vogel, 2010). The subprime crisis that led to global crisis was observed to be an outcome of the different short term lending policies that were operating in the US market. The financial instruments that were used by the corporations at both macro and micro level were not properly speculated or regulated. This created a situation of unplanned lending and further increased the chances of defaults. Financial crisis that was even evident of the fall of the different financial giant such as Lehman Brothers made the financial system fragile and created a huge amount of distress in the economic system of the nation. It was noted that the housing bubble created by the subprime lending crisis later engulfed the complete economic system as well as ramshackle the entire financial system of the nation (Ait-Sahalia & et. al., 2012). Figure 1: Wrong Disclosure of Reports (Source: Creative Commons Attribution, 2012) The above pictures depict the voluptuous situation of the market that had a huge impact on the different financial operations within the nation. This was even evident that the wrong reporting on the financial position created a picture that was affecting the market at large. There was a huge deviation amid the actual position of the financial market with that of the forecasted. This even highly affected the financial market and even had an impact on the financial planning of the different financial intermediaries (Creative Commons Attribution, 2012). 3. How The Interest Rates Are Determined In The Country And The Competitiveness Of The Interest Rate Policy With Respect To Foreign Investment Lending And Borrowing (Part 2) Anderson & Gascon (2009) commented on the development of the different financial instruments that increased the ability of the market to perform. The federal bank regulated by the government was intervened in order to develop the market and stabilise the economy. Harrington elaborated on different federal government policies that catalyst the rapid expansion of lending and mortgages. This uncontrolled lending system gave rise to huge amount of mortgages and situation of loan defaults in an extensive rate. With the lack of the proper monitoring of the system, the anticipation of the amount of risk that the market was exposed to was not conducted in a proper manner. This led to the further failure of the system and raised the level of risk for the financial system to operate (Harrington, 2009). Labonte (2014) stated that the development of different policies and the implication of the monetary policies finally enhanced the position of the US States with the assistance of which the economy was able to manage and revive from the financial crisis. The financial crisis during 2007-2009 made it evident that the financial institutions that regulated the system needed to be more conscious about monitoring the different financial transactions (Adrian & Shin, 2010). Berrospide (2013) argued about a series of failure in the financial market followed by the failure of the different financial intermediaries led to the severity of different crises. Adrian & Shin (2010) stated that the implementation of different strategic plan were successful in developing the country’s financial environment during crisis. Correspondingly, Kroszner & Melick (n.d.) argued on the different interventions programs that were incorporated within the system in order to enhance the situation of the economic rundown. Singh & LaBrosse (2012) argued about the different regulations and supervisions that enhanced the transparency of the system and developed a proper approach of the system. According to Kacperczyk & Schnabl, the commercial papers that were issued by the large corporation proved to be risky and were one of the major causes that led to the failure of different financial system in America. The Federal Reserve Bank developed strategic plan to change the operating policies that were prevalent in the credit rating system for lending and mortgaging. The government even intervened by providing grants and financial help to different sectors to stabilise the situation (Kacperczyk & Schnabl 29-50). 4. Effect of Financial Crisis on the Country in General and Financial Market In Particular (Part 3) According to Lavoie & et. al. (2009), the financial institutions operating in the US financial market relied on various capital market and financial intermediaries to meet with their financial requirements. The central bank that is operating in the system has been identified to be adopting different measures to mitigate as well as resolve financial crisis for economic revival. The central bank even provided with the regular funding needs and developed its different strategic measures to provide a better regulation based on which the financial system can be managed effectively (Lavoie & et. al., 2009). The economic and the financial system of the nation were dealing with different Federal Reserve. Alessi & et. al. (2014) noted in this regard that the Federal Bank of New York operated effectively during the recession periods, but failed to anticipate the level of crisis that may be caused due to the change in the financial system. The lack of proper regulation on the financial market has led to the different financial crises that were faced during the recent years. The failure of financial intermediaries operating with different financial instruments led to such a catastrophic disaster (Alessi & et. al., 2014). The failure of the interbank system of funding further deteriorated the situation of the financial system. Lack of proper monitoring of the short term money market lending led to the failure of the complete financial system to manage adverse situations at the time of the crisis. This was even noted that the different financial instruments that were prevalent in the market failed to maintain the stability during the time of financial crisis. The crisis led to negative outcomes owing to the failure of the public to have faith on the financial system. This led to the massive outflow of cash and developed a situation of demand that outpaced the supply of money. This failure of the financial intermediaries to meet with the changing needs of the society enhanced the severity of the crisis. This further catalyst the need of liquidation of assets and created a gap in the financial operations (Berrospide, 2013). 5. Role of the Central Bank (Part 4) As stated by Carpenter & et. al. (2012), the lack of the proper monitoring of the funding regulations that were followed by the financial institutions created a loophole within the system and even hindered proper management of the economy. The non-standard policies acting as the guiding principles for the banking systems were increasing volatility of the overall financial system. Mehran & Mollineaux (2012) stated that the lack of governance on the banks and financial system by the federal system created a massive backlog and developed a situation of financial downturn. Mehran & et. al. (2011) commented on the lack of proper corporate governance of the central banks on the financial intermediaries leading to the severity of events and created such a huge financial disaster. The lack of proper examining of the liquidity holdings of the banks and the level of different financial transactions are observed to be creating such a situation of catastrophic financial turmoil. The complexity of the banking system operating in the market was increasing the riskiness of the system and creating a further situation of economic turmoil (Mehran & et. al., 2011). Additionally, Afonso & et. al. (2011) commented on the complex financial system that even created a huge stress on the development of the proper policies enhancing the system. Lack of proper policymaking created a huge impact on the different governance systems of the government and made it a huge challenge for the government to develop strict policies that would enhance the economic system largely (Afonso & et. al., 2011). The central bank policies developed a system combining the different traditional approaches to the economic system and accordingly, integrating new policies aided in enhancing the ability of the organisations operating in the US market to perform. The effective role played by the different federal banks at the time of the recession enhanced the steady turnaround of the complete economic system (Taylor, 2010). 6. The Effectiveness of Monetary Policy of the Country with Examples (Part 4) Pozsar & et. al. (2012) stated that different financial transactions that were undertaken by the financial intermediaries created a huge backlog for developing a proper financial system that would meet with the needs of the economic system. With this lack of proper development of policymaking, the different systems that include legal, economic and political system among others within the economy faltered, that further created mismanagement within the system and led to the failure of the different governmental policies relating to governance and economic policies and others (Pozsar & et. al., 2012). According to Afonso & et. al. (2011), overnight interbank market popularly known as the federal fund market acted as a positive source for funds for the regulated banks. The failure of this market to meet with the liquidity requirement at the time of the crisis gave a massive blow to the complete financial system and created a gap between demand and supply of money. The development of the systematic risk through the bursting of the house bubble led to the failure of different financial institutions, which created such distress within the financial system (Afonso & et. al., 2011, Harrington, 2009). The different policies and procedures that are developed within the organisation made it evident that these were done for effective management of the different monetary policies. These changes effectively developed the GDP conditions that were present within the country and enhanced the financial condition that the country was undergoing. Figure 2: Growth in GDP (Source: US Department of Treasury, 2012) The above picture explains the growth and fall in the GDP during the recession and post recession. The monetary policies that were effective to develop the condition of the market during the recession phase. The monetary policies that were implemented by the different federal banks of USA were effectively developing the conditions of the GDP within the nation (US Department of Treasury, 2012). 7. Based On Your Analysis, Your Suggestion for the Country to Strengthen Their Financial and Economic Performances (Part 1-4) The Federal Bank of New York has passed certain guidelines that will help in developing the system of monitoring the financial transactions and enhance transparency of operations, so that financial operations are performed appropriately and in accordance with the desired guidelines (Pozsar & et. al., 2012). Strategic monitoring of the market will enhance the system of financial management and even administer adverse situations like panic run among public. The global crisis of 2007-2009 was one of the prominent learning examples of the severity that can be caused by panic run among the consumers. Thus, it was eminent that the recent financial system must be developed, so that this type of adversity can be faced effectively in future. In this .context, shadow-banking system was incorporated in the financial sector for enhancing the ability of the Federal Reserve Bank to monitor the different operations of the financial intermediaries (Singh & LaBrosse, 2012). A check on the role of securitisation was initiated during post recession as a strategic implementation to prevent similar crisis. By providing a stringent regulation on the financial system, the federal bank involved a huge amount of speculations on different financial operations that were taking place in the system. These regulations are planned to be implemented for preventing the financial intermediaries from making improper disclosures of their financial transactions. This will further enhance the ability of the regulatory body to have a strict control on the inflow and outflow of money. By implementing the same, the federal banks and other government bodies will be able to control improper transactions within the system (Singh & LaBrosse, 2012). Furthermore, excessive lending as well as mortgages reflected the lack of proper management of the financial system. This further created a huge gap in the management of the financial intermediaries that were operating in the market. Improper monitoring of the defaulters in amid micro as well as macro borrowers created a shortfall in funds for the lending bodies that further catalyst the incidence of financial crisis (Pozsar & et. al., 2012). In addition, improper usage of commercial paper and lack of regulation of the market led to the failures of other financial intermediaries and created a rickety situation in the overall economic system. The Federal Reserve Bank operating in US is recently incorporating strict guidelines that would enhance the ability to monitor the different operations undertaken by the financial bodies. By implementing stringent reporting, the banks are even integrating a system that would enhance their credibility to perform and develop a transparent financial system (Singh & LaBrosse, 2012). Conclusion Global financial crisis faced in recent past in mostly all the sections of the globe was an outcome of the subprime crisis in the mortgage sector of the US. This crisis evidenced the fact that mismanagement of the financial system can lead to a severe situation of economic downturn. The meltdown faced by the US at the time of global crisis has completely distorted the situation and even led to a severe misadministration within the system. In addition, lack of proper monitoring and free flow of money among the corporate who were the key players of the financial system was one of major reasons of the financial downturn. Mismanagement of the financial system led to the failure of administering the lending and borrowing rates as well as the number of defaults. This gap in the management of the financial system created a huge backlog in the economic system and even led to severe crisis. Moreover, lack of monitoring the operations in the Federal Reserve Bank created a further disorder to manage the different aspects of the financial market. This even led to the misappropriation of the different risks and created an adverse situation leading to the underdevelopment of the economy. Thus, it can be comprehended that there is a need for the development of strategies that may create a better regulation and monitoring of crises. The development of regulatory bodies was eminent to monitor the financial intermediaries and even prevent them from non-disclosures. The Federal Reserve Bank in the post-recession eras is integrating different terms and conditions for developing strategic planning for the management of the financial system. By developing programs such as shadow-banking and maintaining stringent financial disclosure norms, the bank has been facilitated with the opportunity of developing an appropriate management system and implementing structured regulations. This further increased the ability of the federal government to ascertain that the financial intermediaries are operating following strict and structured guidelines. With this development, the Federal Reserve Bank is able to successfully monitor the different operations and maintain a transparent economic system. In this context, monitoring of the financial system will prevent from improper management of finance and prevent form adverse crises. This would even help in developing a stable economic system and enhance the ability of the regulatory bodies to anticipate projected risk effectively. References Ait-Sahalia, Y. & et. al., 2012. Market Response to Policy Initiatives during the Global Financial Crisis. Journal of International Economics Vol. 87 pp. 162–177. Adrian, T. and Shin, H. S., 2010. The Changing Nature of Financial Intermediation and the Financial Crisis of 2007-09. Staff Report 439 pp. 1-34. Afonso, G. & et. al., 2011. Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis. Staff Report 437, pp. 1-51. Anderson, R. & et. al., 2009. The Commercial Paper Market, the Fed, and the 2007-2009 Financial Crisis. 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