Stock Markets During Financial Crisis - Essay Example

World & UAE: Stock Markets Before & After Financial Crisis "The Chinese use two brush strokes to write the word 'crisis'. One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger-but recognize the opportunity." John F. Kennedy The world was at its peak in every industry, investors continued to invest all their life time savings. People thought that the economic boom will never end, everyone started thinking about the amount they have earned today; thinking about short-terms living life like its about to end. Suddenly, the economies began to decline and the investors were not able to pull out their money from the crashing markets, hence, life only became nice to them for short-term and the long-term security was drained. The advent of globalization has make it even more difficult for the world, as the loss faced by one part of the world will directly effect the economies of the other half. Eventually, the crash of the entire world's economy was at stake. How did this happen What were the events that led up to it Will it ever end Is the debt bigger than the size of the economy Who is to determine who losses money and who can get his investments back Is this crisis only for the poor or will it make the rich poor According to Day, the main cause of the economic crisis is the "excess credit creation" over a long time period. As mentioned earlier the interest rate was really low and there was creation of 'artificial' money in the economy, which eventually led to "speculation and mal-investment." He also says that this is not one of the "normal cyclical" crisis. A normal cyclical crisis is when an economy faces recession after witnessing economic boom, but this one is much more than that it is not involving only one economy but the world economy. Also it is not something which happened suddenly rather it has been fueled over many years, it is referred to as a "secular de-leveraging contraction" (Day, p.1). The inefficient "Federal Reserve monetary policy" during the first few years of this decade might have been the reason for this financial crisis. It is sometimes thought by financial experts and economists that this crisis could have occurred in 2001 due to the flaws in the policies. The world economy, especially the United States economy suffered many losses due to the bursting of the dot com bubble. Other social acts such as the attack on world trade center and the war against terrorism also contributed towards the slow growth of the economy. Carefully and cleverly the financial experts avoided the crisis to happen in 2001 and prolonged its occurrence by ""keeping interest rates at abnormally low levels." Instead of addressing the problem the Fed authorities and policies kept advancing the high levels of liquidity in financial system they also "discouraged aversion to risk" not only in US but also among the "international investors" (Olivia, p. 5-6). Yet another issue was the "low interest rates," as the idea of "private consumption" was widely accepted in the US, and the government was acting as a natural right activist and fighting for the rights of the people of the world. Thus the amount of expenditure amounted to be really large. In order to maintain all forms of spending the levels of "debt" increased to a phenomenal level. This is usually knows as "global imbalances." The biggest problem however was the inefficiency of the entire financial system. This inefficiency was seen throughout the world and not only in the United States; the financial institutions were not following any strict regime or regulation before granting people access to use money (Olivia, p. 6). In November of 2007, the NASDAQ went down by 1,500 levels and Dow Jones touched because of fall in the retail sales. The same effect was seen in "Japan, Germany and Canada." Even companies in Asia, specifically India, started announcing decline in sales. Still there was no decline seen in the lending activities, however the falling rates of consumption proved that people just wanted to hold onto the money rather than spend it. As previously mentioned, people started thinking about today rather than long-term, even the financial experts started focusing on short term benefits and profits. Therefore their analysis and reports proved to be of no use to the company and they were removed from their respective jobs; contributing to an already accelerating unemployment rate (Dr. Krishna). This crisis is also known as "subprime crisis" which occurred due to the burst in the housing bubble of the nation (Shiller, p. 1). Buying houses was once considered to be a major identification of "admirable national" growth (Shiller, p. 5), however, once everybody starting owning homes and applying for mortgage loans it became impossible to tackle the market. Banks, eventually, turned to securitization which is when banks "pool their loans" and sell it to the interested investors. This enables banks to issue more loans as the investors are the now the owners of the previous loans. Banks thought they could mitigate the risk through such techniques; instead it worsened the problem (Shah). Confidence of the people fell, therefore the interested investors of the loans as well as the people who needed mortgage loans stopped spending, finally leading to a cease in the lending activity. The crisis the world is in right now is considered to be worst than the Great Depression of due to various reasons. Firstly, due to the happenings in the real estate market or the housing market. The real estate market was that it was "overvalued," which means that the prices of the properties were relatively higher than usual. It was seen that during the Great Depression of 1920s the same problem existed, however now, the over estimation of property values has crossed the bar of 1920s and is much greater than ever before (Petrov). The debt financing of the country and the world is considered to be another reason why the problem is greater than Great Depression. The economy during that time was financed "250%" by debt, now it has reached over "350%," implying that the economy owes 3.5 times more than it has at the time. People around the world, especially in developed nation, were financing their normal purchases through credit cards and debts, thus the entire economy was running on debt basis (Petrov). Another problem is of the global nature, as mentioned before today's world is much more globalized and the effects of one failing economy are felt throughout the world. This is majorly because businesses and financial institutions and policies are inter-related and connected. During the years of Great Depression, U.S. witnessed loss from "gross financial imbalances," but today "the imbalances have engulfed the whole world" (Petrov). The following graph shows the DowGold ratio of the world, which compares the real assets with the financial assets. A discrepancy or a higher ratio usually portrays an "imbalance" and usually leads to a depression. As seen in the graph, the ratio was higher during the Great Depression and again during the "stagflationary 70s." Again, now it is much higher therefore the effect of the depression is much greater. Figure 1: The Dow Gold Ratio Another issue that led to this problem was because of individual credit cards and the debts on credit cards. Each and every individual of the Western or developed states is a credit card holder and purchases his normal everyday products on credit cards. The lifestyle of these countries is rather lavish and extravagant because of which people feel that they should buy every new product or service in the market. The credit card gives them the opportunity to spend more than they actually earn. Therefore, they spend without considering the consequences of overspending. At the end of the month these people are unable to pay back their loans to the bank and therefore the bank charges fees over the amount that they own the institution. The amount they own the bank increases every month and the crisis is enhanced further. Now, not only the institutions but the individuals are also in debt. Judson has explained the chain of events that led to the crisis in a graphic form. According to him the crisis started when the prices of the real estate properties increased to a much higher level. The population all over the world started assuming that these home prices will never go down and people start buying homes without calculating their personal financial standing. In order to pay mortgages people turn to financial aid institutions, usually banks, for mortgage loans. Banks now have a large pool of customers who wants them to lend money. Banks start viewing this as a money creating opportunity and lend people money with much lower interest rates than usual mortgage loans. This is also referred to as "sub-prime mortgages." At the beginning the prices continue to rise, people continue to buy more, and banks continue to lend more amount. They also apply the techniques or securitization and create more artificial money to lend. Eventually, the home prices began to fall and the borrowers of the mortgages begin to default, they also lose money on the property as their property price is much lesser than their actual mortgage loan. In order to overcome and save themselves from going bankrupt in the future, people start selling their stocks to gain back as much money as they can. This leads to a decline in the prices of stocks and the stock market eventually crashes. Figure 2: Graphic Presentation of Chain of Events for Crisis The Middle Eastern and the "GCC states" were the last ones to suffer from the financial crisis, mainly because they have been "insulated" because they are the owners of the God-gifted "largest oil deposits" of the world. A shocking example was when Saudi Arabia by itself earned "$194 billion from oil exports in 2007, and $212 billion (in real dollars) between January and October 2008." At the time when Saudi Arabia was earning all this money, most of European countries and United States market were crashing. As these country remain the supplier of the basic element of industrialization they prove to be "less vulnerable to a shrinking global capital pool." However, it is evident that sooner or later these countries will also face some form of a loss (Sonukatha). Figure 3: Emerging stocks in the world before crisis The above graph shows the emerging stock markets and the values of the stock according to the regions. The stock markets on all nations went down a little in 1997 and 1998 but they were able to gain back their standing by 2000 and reach further from the level from where they dropped. Dubai, the man-made heaven, relied mostly on its "property" values and construction sites to earn its economic wealth and position in the world. However, with the burst in the property prices, the employers are cutting down the costs of their projects and taking steps to improving their own personal standing. They have started doing this by halting the current and future projects and laying off their employees. Dubai's stock market suffered a huge loss in the week of 2008, where it went down to where it took off in 2004. The speculators once considered the property and real estate market of UAE to be booming, however, now it is considered to be "dead." The main problem is because there is no means of financing for the project, the financial institutions have "tightened credit criteria" as they want to deal with their own problems first. Dubai's construction companies were providing jobs to not only locals but international migrants as well. People from poor and developing countries migrated to Dubai in hope and dream of a better future. With the crisis that the market is currently facing it is evident that a huge population of the world will soon be unemployed (Barea). Another point of concern for the "GCC states" is that their banking and financial sector are in their developing stages and they will suffer greatly from the "tightening" of "global liquidity and disappearing capital." However, as their main source of income remains to be the export of oil in various markets, their main concern remains to be the fluctuation and the effect of the crisis on oil prices. During 2008, a barrel of oil went up to an astonishing $140, but it soon declined and hit the bottom hard when it came down to "$50 a barrel." These countries might be "forced" to halt some development programs but at the end the reserves that they have saved for generations will eventually help them in getting back on their feet (Sonukatha). The countries with natural oil reserves thought that their economies will be able to survive the negatives of the crisis. The year 2008 started with a rise in the prices of oil, which according to some sources was between $140 and $142.27. However, when European countries and America started losing money at all end the auto industry also started to erode from their country. Thus the demand of the market declined to a great extent, as major parts of oil are consumed by individual consumers. This lead to a decrease in oil prices by "more than 60%" as the prices went down to "below 60 dollars a barrel" by end of July. The change hit UAE the hardest as UAE's GDP is made up of 35.9% from the oil sector. UAE, as mentioned earlier, was already facing a loss in the real estate market, and now the other profitable sector began its decline. Morgan Stanley reported that the real state market of UAE would suffer a "10% decline by 2010." The conditions of stock market in two major cities of Middle East, namely Dubai and Abu Dhabi suffered huge losses on November 16, 2008. The financial market of Dubai "closed at 1,981.44 points, falling by 68.51 percent from the year's peak of 6,291.87 points on Jan. 15 with a loss of 4.67 billion dirhams in market value." The financial market of Abu Dhabi also suffered losses on the same day "with its general index hitting 2,755.62, down 46.48 percent from 5,148.49 points on June 11 with a loss of 1.52 billion dirhams" (Xinhua). Middle East is a home of wealthy people who own the money from generations. It is also the second land of opportunities, after United States, as it lets the hardworking and diligent foreigners to establish themselves by benefiting from the boosting economy. The new trend was to invest in properties or stock markets to secure the wealth for future, however, once this crisis has hit Dubai and Abu Dhabi hard people have lost all of their life savings. Foreigners are thinking about leaving the country and going back to their mother land, whereas the locals have been admitted in the hospitals due to shocks that they faced after learning about their losses. According to a source, a local lost "close to Dh15 million" in this financial crisis (Al Lawati and Absal). Sulaiman Hamid Al Mazroui, Emirates NBD Group general manager for marketing and corporate communications, called UAE an "open economy" which is affected greatly by the economic situations of countries throughout the world. He also says that the response and the recovery of local banks depends largely on the recovery of the European markets and American market. He believes that since the crisis "originated" from the West the solution of the crisis will also emerge from Western countries (Husain). Figure 4: The effect of crisis on every economy The cyclical picture by Judson (p. 32) shows the overall effect of the crisis on the economy. It shows that with the bursting of the real estate bubble and less confidence of people the consumption in the economy will reduce. The business than will suffer from losses or will not be able to maintain high profits. This will eventually lead to the inability of organizations to pay all of its employees, and they will start laying people off. Job cuts will take away the only source of earning from the people and they will have no money to spend which will further decline the economical condition of the economy. The elect President Obama said that economic financial crisis will be dealt by investing more in the "infrastructure" which will create more jobs and people will eventually spend on the products and services. He assumed that through this the economy will get back on track as their confidence will be restored. The model represented by Judson also highlights the points and the effects of Obama's policy. However, this policy fails to take into account the major cause of the economic downturn, which was the housing bubble and the debt financing. It also fails to deal with these problems directly. The main issue in the economy is that people do not have a place to live, their houses are being sold by the banks at a much lower rate and they do not possess any property or money. Giving them jobs will eventually give them money but their first action would be to gain back their properties. Hence even the creation of jobs will lead to the same problem again. Figure 5: The proposed recovery plan by Obama Shiller said in an interview that because of globalization "balance sheets of individuals, corporations, and governments are all interconnected" and the adverse effect on one balance sheet poses some sort of threat to the other. He said that the world is no more restricted around national boundaries; instead it has become a global village in terms of "business arrangements and culture." Since United States is the world super power in terms of energy, business, technology and even academia the crisis that hits United States will eventually spread to other parts of the world. According to him the government should act as a constant supported for its people and business. He also said that a "new institution" should be made like the "Home Owners Loan Corporation of the 1930s" which would help in boosting the confidence of the people. Apart from people the government also needs to pay attention to the financial institutions that are going bankrupt. Government plays the most important role during financial crisis; it has to take an approach to let people know that it's treating individuals as well as the financial institutions fairly. Apart from that he says that crisis like these can be avoided by investing towards the betterment of information infrastructure. That he proposes can be done through enabling individuals to have access to data collected by experts specifically regarding "information for financial consumers, better disclosure, better protocols for public use of data, better and broader markets, and better lending institutions." This he says will aid people in making right decisions at the right time and letting them choose their future investments in a better and informed way. It is evident through graphs and the data presented above that it will take a long time for the world to recover from the current economic and financial crisis. The notion of globalization and the advent of global business market has expanded the effect of the crisis, now each and every nation is feeling and suffering from the effect of the crisis that originated from United States. Financial experts and economists have said that since the problem emerged from US the solution will also emerge from the same place. However, they need to realize that their first and foremost duty is towards fixing the economy of their own nation. The individuals are also depending on the governments of their nations to take actions for protecting their future generations. Standing and waiting for the United States to come up with a solution will not solve anything for the world. Rather the joining of forces and coming up with solutions and implementing them will enable a faster and quicker recovery from the crisis. Governments also have to implement financial monitors so that the mistakes that gave rise to this problem are prevented from ever happening again. Also, the government has to take out the financial institutions as well as individuals by finding out other financial solutions. For example, economists and financial experts are considering the implementation of the "Islamic financing" ways to overcome the problems of debt and interest based financing. It is now high time that we give up our cultural and religious differences and consider every racial, ethnic and social group as one to find ways to secure a better future. The world needs to become a promising place for our generations otherwise the next depression, God forbid, can be more damaging that this one. Works Cited Adrian, Day. "The Current Financial Crisis- Causes and Consequences ". The Gold Report October 17, 2008. Al Lawati, Abbas and Rayeesa Absal. "Stock market crisis hits UAE hard". October 09, 2008. gulfnews.com. April 20, 2009 . Barea, Phillips. "Dubai Hit Hard by Global Crisis: Shinning Star of the United Arab Emirates Losing Luster". November 14, 2008. suite101.com. April 22, 2009 . Calverley, John , Sarah Hewin , and Kevin Grice. Emerging Stock Markets After The Crisis. Amsterdam: Suerf Studies, 2000. Husain, Shakir. "Arab bankers to discuss global financial crisis". October 09, 2008. gulfnews.com. April 20, 2009 . Judson, Bruce. "Understanding the Economist Crisis in Plain English." Yale School of Management. PowerPoint presentation at Poughkeepsie Day School, 9 December, 2008. Katha, Sonu. "Financial Crisis and the GCC Countries". January 24, 2009. Dubai Stock Exchange. April 22, 2009 . Katha, Sonu. "Global Recession create Trouble Spots in GCC Countries". January 26, 2009. Dubai Stock Exchange. April 22, 2009 . Nalamothu, Venkata Krishna. "Are we underestimating the seriousness of the economic crisis" January 14, 2009. Stock Market Guide. April 23, 2009 . Olivi, Iliana. "What Makes this Financial Crisis Different from Others" ARI (38): International Cooperation & Development 4 January, 2009: 1-8. Petrov, Krassimir. "Current Economic Crisis Worse than the Great Depression ". The Market Oracle November 2, 2008. Shah, Anup. "Global Financial Crisis". November 2, 2008. Global Issues. March 02, 2009 . Shiller, Robert J. The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It. USA : Princeton University Press, 2008. Xinhua, "Yearender: Global financial crisis takes toll on UAE". People's Daily December 02, 2008. Read More