Digital Information Technology - Case Study Example

The role of digital information technology in the Global Financial Crises A financial crisis of massive proportions has been unleashed upon the globe, a crisis unprecedented in present times. The causes of the crisis and the means to deal with it are still the subject of discussion, because so far, all measures taken by Governments to reduce interest rates and prop up failing financial institutions have not been successful in reversing the recessionary trends that appear firmly set to continue well into 2009. While there is an increasing level of recognition of the need for Government intervention and regulation in the crisis, there is also a contravening line of belief which suggests markets function best when they are allowed to float freely without undue interference from Government institutions. This belief has propelled the ever increasing levels of deregulation of the financial industry, which in turn had a domino effect and produced the collapse of the financial markets. The global nature of the crisis is however the result of globalization and the connectedness of the world’s financial markets. This level of connectivity has been made possible only through the evolution of digital technology, which allows a high level of interconnectivity that would not otherwise be possible. The rapid spread of the financial crisis across the globe and the impact of the crash of the Dow Jones industrial averages on stock markets across the world has been so widespread because of the facility of instantaneous transmission afforded by the electronic medium. The efficient market theory has been the guiding force in economic theory and the basic assumption of this theory is that markets are self correcting. This is the policy which has dominated economic policies and financial regulation, but it is now being blamed as one of the causes of the global financial crisis (Wighton, 2009). According to Alan Greenspan, former Federal reserve Chairman, the theory is flawed because the big mistake inherent in it was the assumption that banks’ self interest would prevent them from doing anything that threatened their own survival. The greatest lesson that is emerging from the global financial crisis thus far is addressing the lack of an international regulatory framework. The steadily increasing levels of international transactions and interactions in the financial world have largely occurred through the medium of the Internet which facilitates instant and inexpensive communications across the globe. A Regional expert, speaking at a conference in Dubai, has pointed out that modernization and globalization “have brought the world closer than ever before, allowing easier global capital flows and offering opportunities for investment gurus, bankers and other financial master minds to compete to attract such wealth to create more profits for themselves by offering high returns on new capital.” (Anonymous, 2009). As a result, banks are able to use other peoples’ money for speculative purposes, because under normal market conditions, they are only required to keep about 10% of monies deposited in the bank in the form of cash reserves (Anonymous, 2009). In the event they face a shortage, they can always borrow cash from other banks by using the central bank interest rates. This high level of activity is however possible largely because of the digital modes of communication that exist, which allow for instantaneous transactions to take place. The origins of the current financial crisis may be traced to the crisis in the U.S. sub prime mortgages that occurred during the summer of 2007. Since customers were unable to repay their mortgages, banks were unable to roll over their short term credit.(Sachs, 2008). Investors began to suffer losses which made them reluctant to take on additional CDO’s. Banks became reluctant to lend to each other, because they were not sure how many of these bad loans were a part of other banks’ financial structure. Century Financial, one of the specialists in sub prime mortgages, began to sell off many of its bad loans/debts to other banks around April of 2007, which caused the bad debt contagion to spread. Interest rates were cut, but this did not stem the panic in the markets or restore customer and investor confidence. This is one of the important reasons for the emergence of the global financial crisis. The important question that must be considered in this context is how an inability of Americans to repay their mortgages could have had repercussions on the global economy. The mortgage crisis resulted in a tightening of credit and a lowering in consumer spending, which impacted negatively upon the American economy. But the practice of securitization of home loans contributed to the propagation of the crisis throughout the global economy. As pointed out by Vasudevan (2008) the practice of securitization means that loans such as home loans for example, are sliced up, repackaged into new securities and sold in the global capital market. While the idea behind such a practice is to spread the risk inherent in loans, it may also result in a spreading of the financial crises and implications that are associated with such spreading of risk. Furthermore, it also becomes difficult to determine the actual sources of losses and exposure in the markets because these debt instruments and the distribution of risk is such an obscure and complicated process. Securitization itself would have been next to impossible in the pre-Internet age. As pointed out by McMohan (2009), it was the securitization of home loans as prime grade investments which resulted in an unsustainable housing boom. The tools of digital technology were used to promote and sell these toxic debts to investors across the globe, as shining examples of global capital mobility in an increasingly globalized world, whereas the cumulative result has only been an increasing level of financial destabilization. Sub prime mortgages of home owners in the United States was split up among thousands of investors across the globe, largely through the communications and networking that became possible through the use of the Internet and the possibilities for communication and transmission of documents that it offers. In an age where the Internet did not exist, the vast geographic distances as well as logistic difficulties in discovering and convincing investors to take on such packages of debts would have involved a huge amount of time and effort, as well as costs incurred in travelling vast distances to get signatures affixed on to documents. But the Internet facilitates the activity of banks, by allowing them to make such loan packages available online, source and make contact with investors worldwide or allow them to make contact and also facilitates the quick and inexpensive exchange of documents, all of which enhances and speeds up such financial operations. The existence of digital technology also allows for features such as digital signatures, online verification of identity, the use of passwords and verification measures to ensure that investor confidentiality and the security of their financial information is preserved, all of which encourages investor activity and has been largely responsible for the large scale acquisition of U.S. loans by overseas investors. This has also meant that a financial crisis arising out of the sub prime crisis has not remained restricted to the United States, but that the contagion has spread across the globe, travelling through the medium of the Internet that has been made possible by the development of digital technology. Sachs(2008) points out that in economics, nothing occurs in isolation and especially in a globalized economy, economic events occur within the context of the world economy. The crash of the stock markets in September of 2008 is now showing up in the real economy, with unemployment and recession forecast to hold throughout 2009. According to Thakur (2008), the inadequate U.S. regulation of its financial and banking world is the direct cause of the crisis, because it produced the “excessive and less than transparent leverage of complex securities and derivatives that introduced one degree of separation too many between the bubble and real economy.” He has pointed out that currently regulatory frameworks are national, whereas what may be required is a global regulatory framework. While the financial systems of the world have become interlinked through the increased communication facilitated by digital technology, there has been no corresponding regulation to ensure that such activities do not fly out of control. In the wake of the global financial crisis, there is a growing recognition that systems that manage the world’s banking, finance and capital systems must be redesigned, because the high levels of interdependence among various countries and their markets cannot be adequately met by national regulatory systems. According to Irving Fisher, the availability of too much credit leads to a case of over-indebtedness, which in turn leads to increased speculation: “Easy money is the great cause of over-borrowing.”(Fisher, 1993). Due to the existence of digital technology, it has become more easy for banks and speculators to offer promises based upon paper money and a vast amount of financial transactions have been carried out using such promises of money based on credit and interest rates, while the actual cash backing up these financial deals has been low or non existent. Irving argues that when over indebtedness occurs, this leads to liquidation, through the alarm caused to debtors, creditors or both, causing distress selling and triggering off a chain of events including fall in prices. This aspect was also further aggravated due to the existence of digital technology, because the smallest bit of news about any kind of financial risk was transmitted at lightning speed to investors across the globe via news channels and the Internet, creating panic about stocks. The stock market exchange crash on October 24, 1929 may have been caused by the rush to liquidate assets and pay off debts, as more and more investors reacted to news they received over the electronic medium. Yet another important aspect of the global financial crisis is the rise in the incidence of financial scams and fraud. According to Mr. Kell, the Deputy Chairman of the Australian Competition and Consumer Commission, one in every 20 Australians is likely to become a scam victim in the forthcoming year and the ACCC reports that over the past 12 months, there has been a 67 percent increase in the number of people reporting a loss of money (Annonymous, 2009b). Such scamming activity has proliferated only because of digital technology; because scammers are able to use tactics such as text messages and bogus profiles on social networking sites to persuade people to part with their financial information, which is then misused. Another example is the financial fraud perpetrated by Bernard Madoff, a former head of the Nasdaq stock market, through his hedge fund and investment advisory business (BBC news, 15 December). Mr. Madoff was charged with fraud for engaging in the ponzi scheme – a fraudulent investment scheme where investors are paid using the money paid in by other investors rather than from real profits. A total sum of 50 billion dollars has been lost through the fraud, with the victims including the Bank of Scotland and HSBC. Digital technology also allows the facility of financial manipulation in several different ways. One of them is also the ability to modify and amend financial information in such a manner that it cannot be easily detected. For instance, whereas alteration or manipulation of paper documents is easy to detect, manipulation of information done online leaves virtually no trace or footprint that may be used to track a culprit and makes it easier for scammers to profit from such fraudulent financial activities. The digital medium and the tools of technology have thus facilitated the spread of the global recession by enhancing the ease with which financial manipulation and fraud can be perpetrated. It has also contributed to the crisis by speeding up communication, not only about the kind of securitized investments available but also by causing bad news about problems in financial institutions to also spread faster and trigger mass selling of stocks. References: Anonymous, 2009. “Smart bankers and clever investment gurus took the world into financial crisis, says regional expert”, Middle East Company News, Feb 24, 2009. Anonymous, 2009b. “ACCC: Scams proliferate in global financial crisis”, MS Presswire, March 2, 2009. Banks hit worldwide by U.S. fraud”, BBC News, 15 December, 2008. http://news.bbc.co.uk/2/hi/business/7783236.stm; McMohan, Patrick, 2009. “It’s time to return to basic banking”, Waterloo Region record, March 2, 2009, Page A6 Sachs, Jeffrey, 2008. “Disruptions and potential in the global economy”, Current History, 107(705): 19-24 Thakur, Ramesh, 2008. “Current institutions inadequate to tackle global financial crisis”, The Economic Times, 13 November, 2008. http://economictimes.indiatimes.com/News/International_Business/Current_institutions_inadequate_to_tackle_global_financial_crisis/articleshow/3707974.cms; Vasudevan, Ramaa, 2007. “Finance, Imperialism and the hegemony of the dollar”, Monthly Review, 59(11): 35-51 Wighton, David, 2009. “Efficient market hypothesis is dead....for now”, The Times, London, January 29, 2009, p 43. Read More