Today's Crisis - 2009 vs. 2007 Crisis - Essay Example

?Today's Crisis - 2009 Crisis vs. 2007 Crisis The financial crisis of the period 2007 and 2008 has been an outcome of credit crunch and liquidity crisis mainly in the United States. This crisis has been generated in the United States at the beginning and then it spread through the entire world with the decline of the world’s largest financial system (Hirsch, 2011, p.5). Some of the biggest financial companies of the world, including Lehman Brothers and Merrill Lynch, have collapsed completely during this time (Savona et al., 2011, p.295). The crisis situation involves large number of aspects from restructuring of financial markets to that of economic policies across the globe (Kent et al., 2011, p.128). This decline has caused the decline in the financial as well as monetary system of countries across the globe. The financial crisis of 2009 has been a continuation of the financial crisis of 2007. This crisis has occurred because of the failure of world financial system to cope up with the growing level of demand for different goods and services and capital accumulation. This fact has been accelerated by the fact that during this time the rate of unemployment across the globe has reached a very high level (Poole, n.d., p.442). This paper is aimed at providing an analytical perspective of the crises situations. Global effects: The world economy has been facing a 30% risk of entering into the depression. This figure has been coined according to the “Economist Intelligence Unit”. The London consultancy has defined the fact that an economic or a financial depression as growth or development process in the developed as well as developing world averaging lower than 1% per year between the time period of 2009 and 2013. There has been a 60% chance that the fiscal as well as monetary policies now being implemented will stabilise the world economy by the next year that it said. "Deflation would be characterised as mass bankruptcies and job losses," the London consultancy argued. A third situation in which lessening assurance in the US directs to the dollar getting dumped contains a 10% probability, it argued. The “International Monetary Fund” observes the global economy contracting 2012 for the very first time since times of “Second World War”. The “Economist Intelligence Unit” has estimated 95 nations are at "high" or at "very high" risk of economic or financial unrest (World 'faces 30% risk of depression', 2009). Several banks across the country have failed or collapsed due to the prevalence of the financial crisis situation. These banks have been acquired by other banks or financial corporations. Hence, the negative effects have been exposed to the level of customer confidence on the banking and financial system of the country (Failed Bank List, 2012). The profundity of the financial and economic recession as well as widespread deflation has suggested the fact that nominal monetary policy rates are required to fall into negative region in order to supply sufficient incentive, which is impossible. Theoretically, in the equilibrium, the cost of acquired capital in respect to the aggregate economy must roughly be comparable to the rate of growth of nominal GDP. This is used as the substitute for the rate of capital return in respect to the aggregate economy). Both these policy rates as well as the rates of growth of GDP values have been reduced during this time of deep financial recession across the globe (A World Of Credit Easing, 2009). Also the creation of large number of tent cities across the US has revealed the severity of the crises situations which have been outcomes of greater level of job losses and loss of houses. These tent cities have been found in New York and in New Jersey to a great extent (USA tent 'cities' on rise as US economy crumbles (23Dec11).flv, 2012). Effects on UAE: The emerging market (EM) nations in the “Middle East and North Africa” (MENA) region (which also incorporates UAE and all other GCC nations) have been comparatively insulated from the effect of the crisis in the beginning. This fact has been observed provided their limited revelation to different structured financial goods and lower levels of financial and economic integration. However, the international slowdown has started to influence their economic and financial activities (Zaki et al., 2012, p.121). With overseas investors retreating from the “Gulf Cooperation Council” (GCC) markets, the industry of real estate in these areas also realise the impact of the crisis. The largest capital market in this area, Saudi Arabia, has lost the biggest with year-to-date failures of almost 36% on the country’s market capitalization. This has been followed by Dubai at almost -32% as well as Abu Dhabi at almost -18%. The market in the Kuwait also listed a loss of almost 13% whereas Qatar has lost nearly 15% during 2008 (Zaki et al., 2012, p.121). Professionals, business persons and independent workers have affected by lesser amounts in the UAE due to the advent of financial crises, mainly because of lesser amounts of dependence on world economies (Hourani, 2009, p.6). Government and central bank intervention: During this time the governments and the central banks are trying to reduce the negative effects of these financial and economic crises situations. Governments of developed as well as developing countries of the world are trying to create significant changes in the market orientations of these countries. These countries, including United States, Japan, United Kingdom, India, China etc., are trying to create greater level of favourable effects on the economic variables through effective application of planned economic policies. These policies are comprised of macroeconomic as well as microeconomic policies. Greater level of monetary regulation is getting imposed on these economies. Central banks of these countries are trying to create a command and planned financial structure in these economies. Regulators are effectively trying to create significant level of positive effects on the technological developments of these countries as well as that of the level of productivity of these countries. Higher level of generation of income in these economies is getting created with the help of greater level of government intervention in these economies. This increased level of government intervention is expected to create positive effects on the strategy of the reduction of dependence of these economies on the free market conditions. Also economic and banking or financial policies have been implemented in economies across the globe for the purpose of reducing the market inefficiencies and market asymmetries to some significant level. Also the people of countries across the globe are trying to reduce their level of asymmetric information for the sake of increasing the market efficiencies. These people are also trying to reduce their dependence on free market economies and away from planned economic structures (Brunnermeier, 2012, p.5). In 2002 after the tech bubble burst the lowest point for the S&P 500 was 768.6 (World 'faces 30% risk of depression', 2009). In 20 March 2009 it closed at 768.54. So everyone who has bought the stock index since 2002 has lost money. A year ago this banking stock of the company Citicorp was $52 (World 'faces 30% risk of depression', 2009). Recently it has been observed to be $1 (World 'faces 30% risk of depression', 2009). Hence, it lost almost 98% of the total value. Quantitative or credit easing, coupled with dramatic fiscal support, may be the only viable option to prevent a debt-deflation spiral from taking hold. World faces 30% risk of economic and financial depression (World 'faces 30% risk of depression', 2009). In respect to the recent real estate market of the United States, in July 2006 a housing price index was 206.52. This figure has been mentioned by the Case-Shiller Home price Index. In December 2008 the index was 150.66. That is over a 27% decline has been observed in the country (World 'faces 30% risk of depression', 2009). The level of unemployment is increasing at rapid speed in the country and also the banking system of the country is also facing severe damages as 20 banks in the country have lost their operational power in the country since January, 2009 (World 'faces 30% risk of depression', 2009). Possible causes: Imprudent Mortgage Lending and Housing Bubble: There have been several causes of these two global financial crises. Among these cause the most important has been Imprudent Mortgage Lending. Under this system of credit transaction, against a background of plentiful credit, low rates of interest and increasing house prices as well as standards of lending have been relaxed to the position that most of the people have been able to purchase houses they couldn’t manage to pay for. When prices of these assets began to drop and loans happening going dreadful, there has been a severe distress to the economic as well as financial system of countries across the globe. Also the notion of housing bubble has been an effective reason for being the creator of global financial crises. With its effortless money policies and strategies, the Federal Reserve has allowed housing prices in the country to increase to unsustainable amounts. The crisis has been triggered by the event of bubble bursting, since it has been bound to do so. Also the global imbalances have caused the crisis situation to become more terrible (Jickling, 2010, 5). Global Imbalances: Global financial and monetary flows have been exemplified in current years through an unsustainable pattern. Under this pattern few nations, such as China, Japan as well as Germany, experience large surpluses each year, although others, such as the U.S and the UK, run deficits. The level of external deficits of the U.S. has been reflected through internal deficits into the household as well as government sectors. The levels of U.S. borrowing cannot persist indefinitely; the resulting pressure underlies recent financial disruptions (Jickling, 2010, 5). Securitization and Rating Agencies: Securitization has fostered the “originate-to-distribute” model in the US, which has reduced incentives of lenders to be cautious, particularly in the light of enormous investor demand for the subprime loans which are packaged as AAA bonds. Possession of different mortgage-backed securities has been widely dispersed, thus causing consequences throughout the world system when different subprime loans have gone bad in 2007 (Jickling, 2010, 5). Different credit rating agencies have started to give AAA ratings to several aspects of subprime mortgage-backed securities, most of which have been consequently demoted to refuse status. Critics have cited poor economic and financial models, disagreements of interest. Also the lack of efficient regulation as causes for the failure of the rating agencies has also been observed (Jickling, 2010, 6). Mark-to-market Accounting: Another important factor has been the market’s excessive level of reliance on credit ratings that has been toughened through numerous rules, laws and regulations. The market has used credit ratings as the standard for allowable investments or as the aspect in necessary capital levels. The FASB standards need institutions for reporting the fair or recent market value of different types of securities which they hold. Various critics of this rule have argued that these strengths banks to identify losses based on the notion called “fire sale” prices which exist in troubled markets, prices supposed to be under long-run basic values. Those losses weaken market confidence and worsen banking system difficulties. Some propose postponing mark-to-market; EESA needs a research of its effects (Jickling, 2010, 6). Off-Balance Sheet Finance: Large number of banks recognized off-the-books particular purpose entities (incorporating different structured investment vehicles, or SIVs) for the purpose of engaging into various risky speculative investments. This has allowed banks and other financial intermediaries to make greater volume of loans during the period of financial and economic expansion. However, this process has also created dependent liabilities which, with the beginning of the financial crisis, lowered market confidence in regard to the creditworthiness of these banks. Also at the same time, these had allowed banks and other financial institutions to hold lower level of capital against possible losses. Investors had small ability to comprehend banks’ accurate financial positions (Jickling, 2010, 7). Excessive Leverage: In the period after 2000, low rates of interest and plentiful capital, fixed level of income earnings have been low. In order to compensate, large number of investors started to use borrowed assets and funds to enhance the return on capital of these banks. Excessive level of financial leverage has magnified the effect of the housing recession in the US and deleveraging sourced the interbank market for credit to tighten (Jickling, 2010, 8). Global financial market in future: The global financial crises of 2007 and 2009 have badly affected the financial and economic strengths of financial intermediaries including banks across the globe. Banks have been severely affected financial institutions across the globe. But mainly banks and financial structures in the developed countries of the world have been seriously affected by these financial crises (Brummer, 2011, p.282). The outcomes of these financial crises have negatively affected the financial structures of USA and many other countries across the globe in such a way that economists and policymakers are uncertain about the future of these economies. These economists have argued that it will be very difficult to recover this situation without greatest level of government intervention. This government intervention is required to induce significant changes in the development of employment scenarios across countries which will increase the demand for goods and services. This increase in demand will finally lead to greater level of production of goods and services and thus higher income growth and higher profits (Sikorski, 2011, p.17). Conclusion: The financial crises of 2007 and 2009 have been resulted from the failure of the banking and financial system across the developed part of the world. This has caused the developing and less-developed part of the world to suffer as well. However, the oil dependent countries, such as UAE, did not suffer much from these crises situations. These crises have been caused by several other factors which incorporate the failure of the free market mechanism in the markets for financial products and services across the globe. Therefore economists have argued in favour of greater level of government intervention to reduce the inefficiency of the free market mechanism and thus to reduce the intensity of future crises situations. References 1. A World Of Credit Easing, (2009), BCA Research, available at: http://www.bcaresearch.com/public/story.asp?pre=PRE-20090311.GIF (accessed on May 16, 2012) 2. Brummer, C. (2011), Soft Law and the Global Financial System: Rule Making in the 21st Century, UK: Cambridge University Press 3. Brunnermeier, M. K. (2008), DECIPHERING THE LIQUIDITY AND CREDIT CRUNCH 2007-08, NBER WORKING PAPER SERIES, No. 14612, available at: http://www.immagic.com/eLibrary/ARCHIVES/GENERAL/NBER_US/N081222B.pdf (accessed on May 16, 2012) 4. 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Zaki, E. et al., (2012), Analysis of Financial Crisis in UAE Financial Markets, International Research Journal of Finance and Economics, Issue.83, pp.120-133, available at: http://www.internationalresearchjournaloffinanceandeconomics.com/ISSUES/IRJFE_83_09.pdf (accessed on May 16, 2012) Read More