The Effects of the Credit Crisis on the UK and US Financial Systems - Essay Example

CREDIT Introduction As a consultant working jointly for the Bank of England and the Board of Governors of the US Federal Reserve System, I have to give leveraged advice without making explicit recommendations about the current financial situation, and the international economies of these two countries presently. A main focus is the point of the economy before the US recession that sparked the global problems, versus the state of the economy presently in terms of what has changed. In both the US and the UK, government reaction to the crisis has been to institute a series of bailouts, in which major industries are saved by the government from financial ruin, after which they either can pay the government back, or become partially or completely owned. In my perspective as a consultant, I advise both governments that the situation has changed somewhat due to these bailout reactions. No explicit mention of macroeconomic factors is made, and the report focuses on policy. In the last two years, policy changes have taken place superficially, although the UK and US financial systems remain fundamentally unchanged. New public scrutiny may continue to change this trend to emphasize a more mandatory nature of releasing financial disclosure reports, thus easing anxiety. As a consultant, I would state that US and UK leaders may or may not pay close attention to disclosure and transparency in business operations. “The imploding British economy has set off deflation in key asset classes, particularly real estate. Unemployment is skyrocketing, having reached an official figure of 6.7 %, or 2.1 million jobless” (Financial, 2009, 1). The basic assumption of the current report is that the fundamental financial system has not changed in the wake of financial crisis, in either the UK or the US, when looking at the long-term rather than the short-term. US and UK financial systems The US and UK financial systems are very similar in terms of basic policy; much of US law and other systems were changed only slightly after the American Revolution, and many systems in the US retain UK and European roots, including the economy. The root of the financial systems of both countries is the commercial bank. Historically, commercial banks have been around since the beginnings of history, during the development of monetary systems in early trading between kingdoms and empires. Banking is a very old institution, and most of the commercial banking rules and regulations in place in the US, as mentioned, are actually inherited from European systems of banking from the colonial era, such as Dutch and English systems. Banks have historically given people a place to store their money as well as a place to obtain loans and credit services within a framework of control and regulation based on trust. Although there have been breaches in this trust historically, such as the breaking of many banks during historical bubbles and crashes, commercial banks have historically been considered overall to be a relatively stable place to store money and obtain credit. “Historically, banks were virtually the only source of credit to many households and businesses, and burgeoning needs for credit services were a major impetus for growth of this industry. Accordingly, a measure of bank output should reflect borrower services along with depositor services” (Fixler, 2003, 44). Commerical banks do not just lend to individual consumers, but also businesses, and they vary greatly in size. Generally in the past in both the US and UK, there tended to be more smaller, localized banks, whereas as the world graudally became smaller through increases in communciation technology, there became fewer small commerical banks and more regional, national, and international chains. “The American economy is built on credit. Credit is a great tool when used wisely. For instance, credit can be used to start or expand a business, which can create jobs. It can also be used to purchase large ticket items such as houses or cars. Again, more jobs are created and people’s needs are satisfied. But in the last deade, credit went unchecked in our country, and it got out of control” (Financial,2009, 1). Looking at a general history, the role of a financial intermediary depository institution such as a commercial bank, is development and networking of the UK and US system. In this financial system, many intermediaries act as networks which give benefits to members because members are perceived to be unitary either as customers or other preconditions for membership (for example, in credit unions members are often employees of the same business). These intermediaries have historically acted as channels for funds reaching from public and private sources to organizations that can claim membership in the intermediary network. This network can be organized around a specific purpose or it can be more general, as is the case in commercial banks and credit unions. At the heart of the financial system in the UK and the US is the concept of interest. As one sources states, “Investment behavior depends on interest rates. In fact, almost everything depends on interest rates. High interest rates discourage investment; low interest rates encourage investment” (Pool and La Roe, 1985, 12). Some banks offer accounts with high interest rates, and this is seen to be the optimal situation for the customer: it means that their money will grow, usually in a savings account, by an established rate. Both banks and the government have a hand in establishing this rate, or in keeping it fair or economically beneficial for the microcosm. But in terms of potential weakness, this is not always the case in reality. Recent changes in policy Due to the economic crisis of 2008-09 in the US and the UK, the respective governments under Brown and Obama have instituted a reactionary series of government bailouts, affecting key national industries. These industries have not been nationalized or socialized, but they have been changed in the short-term and superficially, shored up by government funding. As in the US, the UK has focused on the banking sector as a major point for bailout money. “Complicating the economic problems in the UK is its disastrous banking crisis, which rivals that of the United States. Much of Britain’s banking sector is insolvent, prompting a costly bailout by Gordon Brown’s government” (UK, 2009, 1). Presently, the UK is dealing with a global problem that basically started in the US. But in such a global society, blame can be placed all around, and chain reaction effects are quite common. “Chinese consumers saved and the government built up foreign currency reserves. Much of this money was lent to the US and it enabled American consumers to borrow easily. They did and many got into financial difficulty” (Global, 2009). As a consultant, I can state as background that there are many causes to the 2008-2009 economic collapse in the US and UK, which led to many other collapses around the world. Some would criticize bailout measures for not following economic principles, or being purely reactionary moves. “ Resources cannot be reallocated from what have been revealed as useless projects to more urgent ones, again, as determined by the consumers. The government is channeling the money into uneconomic uses” (Chernikoff, 2009). But one must ask after the bailouts of the banks in the UK and US, what has really changed in the underlying system. Commercial banks, both small and large, are still the subject of inter-governmental integration of economics through fixing interest rates, just as they always have been, and also remain the subject of a lot of financial management literature regarding the importance of their position as loaners and increasingly international institutions. This type of banking has been relevant to the general subject of financial institutions management, in terms of providing an accessible link of principles of finance to the everyday consumer that has stayed the same throughout the crisis. It is also relevant that commercial banks were and remain regulated industry in both the UK and the US, because this increases both accessibility for study and relevancy. “Commercial bank liabilities usually include several types of nondeposit sources of funds, while their loans are broader in range, including consumer, commercial and real estate loans. Commercial banking activity is also regulated separately from the activities of savings institutions or credit unions” (Saunders and Cornett, 2007, 242). Overall, the commercial bank remains one of the most important financial intermediaries, and therefore it is difficult to question its general relevancy. The basic policy of banks in the UK and the US is that they are controlled partially by the government, which does such functions as setting interest rates. The mortgage industry is currently affecting the consumer and banks in complicated ways, and was one of the main scapegoats of the 2008-2009 financial crisis and recession. There is a lot of media coverage about it and there is at times the atmosphere of panic, with economists have over-valued the impact of the current mortgage industry and also seeing this sector through a sort of blinder effect, due to its proximity to financial sectors. As one source states, “Shock waves from the collapse of the subprime mortgage market have been shuddering through segments of the economy for months. But this month, with the announcement of as many as 12,000 layoffs at the nation’s largest home mortgage lender, an unemployment report that showed net job losses for the first time in four years, and some economists are predicting a recession” (Larsen, 2007). Learning from this disaster means that banks are fairly safe places for our money, as they are highly regulated, but they are not completely fail-safe or fool-proof. It may be better and safer to have a savings account collecting interest than to have the money under the mattress generally, but during specific times of crisis this faith in banks and the banking industry tends to slip. In America, the government and Fed has been involved in the domestic banking system on a macroeconomic level for a long time, and has probably learned some lessons from the American 1930s about the applicability of its making the banking industry a secure space for consumers. But there always have been, and arguably always will be, grave doubts that are rightfully leveled against there being any such thing as a free lunch. The price for banking security is often passed on directly to the taxpayer. “must return to the basic principles of banking - and set clear limits to the absurdity of mark-to-market accounting. Investors can pay attention to accounting standards and rating agencies if they want to, but it is time for regulators and governments to recognise that market prices are sometimes plain wrong” (We, 2009, 1). Although bailout measures have received criticism, they have not changed the fundamental system of the US or UK economy. “Note another thing that the bailouts represent: special privilege to particular market players to protect them from failure. This isolates these firms from the market forces, such that they remain afloat whether they do good or bad at satisfying consumer wants” (Chernikoff, 2009). The understanding of these issues is still developing, and there is no last word yet. Financial intermediaries such as commercial banks play many different roles in the economy, and there are many different kinds of financial intermediary that are available as a sort of go-between between savers and businesses, which remain so after the crisis. The basic system has not changed. Commercial depository institutions still offer financial products and also create these products and in many cases market them. “The financial intermediaries do more than simply transfer money and securities between firms and savers—they literally create new financial products. Since the intermediaries are generally large, they gain economies of scale in analyzing the creditworthiness of potential borrowers, in processing and collecting loans, and in poling risks and thus helping individual savers diversify” (Brigham and Houston, 2004). The institutions themselves are also capable of increasing diversification, showing further strengths. “As vast sums of money begin to flow into the US economy, and other governments prepare to commit even more, observers around the world will be watching closely to see whether saving the economy can, in fact, also save the planet” (UK, 2009) In America, actions of the Federal Reserve and government, such as bailouts of major banks and the US auto manufacturing base, have helped to shore up some elements of the economy, but underlying problems do remain. As one source notes, “The Fed has quelled the panic that prevailed in the financial markets until recently. But it still has to nurse an economy weighted down by massive bad debts. That is likely to require a period of easier money… with banks hoarding, consumer confidence in the pits, and housing still in freefall, it may be too early for optimism” (Coy, 2008). Still another source notes that while some elements of the economy may actually benefit from the current situation, the mass majority of indicators shows a situation in which there are problematic dimensions: “As long as the largest asset on household and bank balance sheets continues to deflate, the credit and consumption hits will keep coming. The worst is not over… commodity prices and gold will go up. The loser? Oh, pretty much the rest of us” (Up, 2008). Of course, this is just one subjective opinion, that seems to be somewhat slanted towards an over-valuation of the housing market’s impact on the microeconomic situation. Traditionally, proximity to given sectors tends to skew or bias reportage. From a policy perspective this also may mean concentrating more on micro economic factors. Conclusion In terms of economic effects, as a consultant, I can reassure the government representatives that no one knows for sure what will happen in the future, because most of the exercises that people take in risk avoidance are hypothetical and based on what might happen if the current system changes. No one has a crystal ball. This allows sources a lot of leeway in terms of how they can present this economic future of corporate and consumer debt under a new plan in terms of costs and opportunities. What this means to the field of corporate and consumer debt, is that consumers are feeling a dual impulse because of the currently slow economy. On the one hand, they are being encouraged to spend, and on the other hand, their confidence has been shaken by the crisis of 2008-9. Therefore, when they do spend, they are not going to spend highly. What they want is something safe, comfortable, and casual, with an emphasis on value, but that is not cheap. Consumers in the UK as well as the US are more hesitant nowadays when it comes to spending; they are tending to go more towards saving their money instead. In many cases, politics tends to cloud issues. “What regulators around the world must now do, if they want to prevent a purely financial problem degenerating into a genuine economic crisis, is to stop the lemming behaviour of financial markets” (Can, 2009, 1). UK and US financial bank and lending leaders also may or may not choose to focus on their own behavior in terms of ethics. Willis and Lightie represent how different sources include corporate ethics and accountability, and others include general disclosure, but in any case, the importance of financial controls is a baseline from which interpretation stems. In the current cultural and economic setting of the corporation or business internationally, finances are becoming increasingly related to issues of transparency and internal stabilization, from perspectives of both auditing and shared vision. “Public companies increasingly include management reports on internal controls in their annual reports even though no regulators require them” (Willis and Lightie, 2000). In terms of economic effects, no one knows for sure what will happen in the future, because most of the exercises that people take in risk avoidance are hypothetical and based on what might happen if the current system changes. This allows sources a lot of leeway in terms of how they can present this economic future under a new plan in terms of costs and opportunities. As mentioned above, some sources are hopeful about the status of the US and UK economy, and other sources see still more bad times on the horizon. The consumer is in a position of caveat emptor when it comes to the media in cases like these, and will likely follow what they believe to be the most accurate portrayal available in the public domain. In any case, bailout measures certainly have not changed either UK or US financial systems in terms of their respective root reliance on fiduciary institutions. REFERENCE Chernikoff, D (2009). Bailouts as privilege. http://blog.mises.org/archives/008633.asp Coy, P (2008). The Fed may have more cutting to do. Businessweek. Fixler, D (2003) Measuring the services of commercial banks in the NIPAs: changes in concepts and methods. Survey of Current Business. Osbourne, A (2009). US growth highlights Britain’s plight. http://www.telegraph.co.uk/finance/economics/6463349/US-growth-highlights-Britains-plight.html Brigham and Houston (2004). Fundamentals of Financial Management. New York: Thompson. Pool, John Charles, and Ross M. La Roe (1985). The Instant Economist. Reading, MA: Perseus Books. 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