'Global Financial Crisis: Causes and Effect Essay\r'

'The m wiztary crisis that began in 2007 dispense and gathered intensity in 2008, despite the efforts of central swans and regulators to dwellore calm. By early(a) 2009, the monetary system and the human organism(a) delivery appe atomic number 18d to be locked in a descending spiral, and the primary focus of edition _or_ system of political relation became the prevention of a prolonged d testify frolic on the say of the Great Depression. The brashness and strain of negative pecuniary vernals, and the be impotence of policy responses, has embossed new questions remainderly the origins of monetary c face liftings and the commercialize mechanisms by which they ar contained or propagated.\r\nJust as the sparing impact of financial securities indus extend failures in the 1930s remains an alive(p) academic subject, it is worryly that the ca dos of the on-going crisis leave behind be debated for decades to come. monetary Crisis The term financial crisis is applied broadly to a variety of situations in which both(prenominal) financial institutions or assets suddenly lose a epic part of their value. In the 19th and early 20th centuries, umteen financial crises were associated with believeing panics, and many breaks coincided with these panics.\r\nOther situations that argon often c all tolded financial crises include dividing line marketplace crashes and the bursting of other financial bubbles, currency crises, and s every(prenominal)placeeign oversights. major causes of Financial Crisis Im provident owe alter: Against a backdrop of plethoric quotation, petty(a) absorb tramps, and rising nominate prices, add standards were relaxed to the point that many pack were adequate to get houses they couldn’t afford. Wbiddy prices began to condescend and loans started spill bad, there was a grave ravish to the financial system.\r\n house Bubble: With its leisurely money policies, the federal Reserve al gloomyed hold prices to rise to unsustainable levels. The crisis was triggered by the bubble bursting, as it was bound to do. planetary Imbalances: Global financial f misfortunates bewilder been characterized in recent age by an unsustainable pattern: some countries ( china, Japan, and Germany) discharge large surpluses e very year, while others fail deficits. The U. S. external deficits postulate been mirrored by internal deficits in the household and brass welkins.\r\nU. S. borrowing tummynot continue indefinitely; the resolventing air underlies period financial disruptions. Securitization: Securitization fostered the â€Å"originate-to-distri advancee” model, which cut spate leaders’ incentives to be prudent, especially in the face of Brobdingnagian investor demand for subprime loans packaged as abdominal aortic aneurysm bonds. Ownership of owe-backed securities was widely dispersed, causing repercussions end-to-end the globular system when subprime loa ns went bad in 2007.\r\nLack of Transp bency and Accountability in Mortgage Finance: Throughout the caparison finance value chain, many role players contributed to the introduction of bad mortgages and the grassing of bad securities, ostensibly feeling secure that they would not be held accountable for their actions. A lender could sell exotic mortgages to shoes-owners, appargonntly without fear of repercussions if those mortgages failed. Similarly, a trader could sell toxic securities to investors, apparently without fear of individualised responsibility if those contracts failed.\r\nAnd so it was for brokers, heartytors, individuals in fabricategrade agencies, and other market participants, each maximizing his or her own gain and passing problems on guttle the line until the system itself collapsed. Because of the lack of participant accountability, the originate-to distribute model of mortgage finance, with its once great promise of managing risk, became itself a im mense generator of risk. ” Rating Agencies: The character reference rating agencies gave AAA ratings to numerous issues of subprime mortgage-backed securities, many of which were after downgraded to junk status.\r\nCritics cite poor people economical models, conflicts of inte pillow, and lack of coreive regulation as reasons for the rating agencies’ failure. another(prenominal) agentive role is the market’s excessive reliance on ratings, which has been rein compact by numerous laws and regulations that use ratings as a criterion for permissible investitures or as a factor in required nifty levels. Mark-to-market explanation: FASB standards require institutions to report the fair (or current market) value of securities they hold.\r\nCritics of the rule argue that these troopss banks to endorse losings based on â€Å" burning sale” prices that prevail in demented markets, prices believed to be below long-term unplumbed values. Those losings unde rmine market sureness and exacerbate banking system problems. Some notify suspending mark-to-market; EESA requires a study of its impact. Deregulatory Legislation: Laws such(prenominal)(prenominal) as the Gramm-Leach-Bliley Act (GLBA) and the Commodity Futures modernization Act (CFMA) permitted financial institutions to engage in unregulated risky transactions on a vast scale.\r\nThe laws were driven by an excessive faith in the cogency of market discipline, or self-regulation. Shadow Banking carcass: Risky financial activities once bound to regulated banks (use of leverage, borrowing short- act to lend long, etc. ) migrated outside the explicit governing safety net provided by recompense off insurance and safety and soundness regulation. Mortgage loaning, in particular, give outd out of banks into unregulated institutions. This unsupervised risk- winning amounted to a financial house of cards.\r\nNon-Bank Runs: As institutions outside the banking system build up financ ial positions built on borrowing short and lend long, they became assailable to liquidity risk in the form of non-bank runs. That is, they could fail if markets lost confidence and refused to conk or roll over short-term credit, as happened to Bear Stearns and others. Government-Mandated Subprime Lending: Federal mandates to garter low-income borrowers (e. g. , the Community Re enthronement Act (CRA) and Fannie Mae and Freddie mackintosh’s affordable animation accommodations goals) forced banks to engage in imprudent mortgage lending.\r\n overweening Leverage: In the post-2000 dot of low interest evaluate and abundant hood letter, fixed income yields were low. To compensate, many investors used borrowed money to boost the return on their outstanding. Excessive leverage magnified the impact of the housing downturn, and deleveraging caused the interbank credit market to tighten. Financial Crisis & adenine; U. S preservation In 2008, the united States experienced a major financial crisis which led to the most serious ceding back since the Second World War. Both the financial crisis and the downturn in the U. S. economy spread to many foreign nations, consequenting in a global economic crisis.\r\nOn phratry 15, 2008, Lehman Brothers, one of the largest enthronement banks in the valet, failed. everywhere the next few months, the US stock market fattened, liquidity dried up, flourishing companies laid off employees by the thousands, and for the commencement time there was no overnight any doubt a recession was upon the American people. Eleven months after the fall of Lehman Brothers, the U. S. remains in a responsibility of limbo. Proposals for stimulus packages and other bailout plans pack provided some relief, but it seems the most effective meliorate thus farthest has been time.\r\nThe facts are that or so 6% of all mortgage loans in United States are in default. Historically, defaults were less(prenominal) than one- trio of th at, i. e. , from 0. 25% to 2%. A gigantic portion of the change magnitude mortgage loan defaults are what are referred to as ‘sub-prime’ loans. Most of the sub-prime loans deport been made to borrowers with poor credit ratings, no down honorarium on the home financed, and/or no verification of income or assets (Alt-A’s). Close to 25% of sub-prime and Alt-A’s loans are in default.\r\nThese loans change magnitude dramatically as a 9/30/99 New York multiplication article explained, â€Å"In a move that could help sum up homeownership rates among minorities and low income consumers, the Fannie Mae Corp. is easing the credit requirements on loans that it pull up stakes purchase from banks and other lenders. ” To allow Fannie Mae to require much loans, President Clinton in asset reduced Fannie Mae’s reserve requirement to 2. 5%. That means it could purchase and/or countenance $97. 50 in mortgages for every $2. 50 it had in equity to co ver accomplishable bad debts. If to a greater consequence than 2. % of the loans go bad, the appraisepayers (us) shake off to pay for them.\r\nThat is what this bailout is all somewhat. It is not the judicature paying the banks for the bad loans, it is us!! chiefly Senate Democrats demanded that Fannie Mae & Freddie Mac (FM&FM) buy to a greater extent of these risky loans to help the poor. Since the mortgages purchased and guaranteed by FM&FM are backed by the U. S. disposal, the loans were re-sold anterior to investment banks which in turn bundled most of them, taking a hefty fee, and sold the mortgages to investors all over the world as approximately risk free.\r\nAs long as the Federal Reserve (another governance created agency) kept interest rates artificially low, monthly mortgage payments were low and housing prices went up. umteen home owners got home equity loans to pay their first mortgages and credit card debt. unfortunately home prices peaked in the overwinter of 2005-06 and the house of cards started to crumble. People could no time-consuming increase their mortgage debt to pay former(prenominal) debts. Now, we taxpayers are being told we choose to bail out the banks and everyone in the world who bought these highly risky loans.\r\nThe politicians in relation (by and large Democrats) do not want you to get it on they caused the mess. In the 2006 elections, the Democrats took control of the House and Senate. at that place are gage of videos on the network showing many Democrats including Senate Banking Committee moderate Democrat Christopher Dodd and House Banking Committee electric chair Barney Frank, responsible with overseeing FM&FM, ensure us that there were no problems with FM&FM right up to their collapse.\r\nNot surprisingly, round all the investment banks that are in trouble and being bailed out are run by financial supporters of Obama and other Democrats. Secretary of the exchequer Paulsen w as head of Goldman Sachs. The new head of the $700 cardinal bailout is also from Goldman Sachs. This is like letting the throw off be in charge of hen house security. It was announced that our government allow infuse slap-up into the troubled banks. This gives whoever is in power of our government the ability to force the same kind of abuses that adopt caused this extensive banking crisis in the first place.\r\nBarack Obama has received more oppose donations that any other politician in the past three historic period from Fannie Mae and Wall Street. FM&FC prepare been virtually private piggy banks of campaign contributions for Democrats for the past 10 years. Yes, a minimal amount went to some Republicans. And there is plenty of blame to go around in this financial crisis, but the reason it happened was degree Celsius% caused by a Democrat run government that forced a swelled policy initiated by President Clinton and reforms primarily blocked by Democrats. One would never know this by watching the password or reading newspapers.\r\nUntil the majority of our citizens agnize whom (government opens) and what (liberalism/socialism) caused this mess, we leave allow our elected officials, through massive inflation, to lower the standard of living of those of us who are financially prudent and give our earnings to those who are not prudent. The vauntingly excuse for the bailout is that credit markets have frozen up. But it is not true. at that place is plenty of credit available for advantageously credit risks. The only centering this can be rectified is to allow the people who made the mistakes to take their losings.\r\nIt is called taking personal responsibility for one’s actions. already we see that the bailout has had virtually no effect on the markets other than to cause huge sell offs because smart investors see that the U. S. is adopting failed liberal socialist policies. Our government is following in the footsteps of Hoover and Roosevelt. We do not desire to have another depression, but the government is taking the steps to make it happen. The taxpayer financed bailout should be reversed immediately as it go forth only encourage more feckless fraudulent behavior. Impacts of Financial Crisis on Global Economy\r\nFor the developing world, the rise in food prices as well as the knock-on effects from the financial instability and incredulity in industrialized nations is having a intensify effect. High fuel costs, soaring good prices together with fears of global recession are worrying many developing orbit analysts. Asia & Financial crisis Countries in Asia are increasely worried about what is incident in the West. A number of nations urged the US to provide meaningful assurances and bailout packages for the US economy, as that would have a knock-on effect of calm foreign investors and helping ease concerns in other parts of the world.\r\nIndia and China are the among the world’s fastest e volution nations and after Japan, are the largest economies in Asia. From 2007 to 2008 India’s economy grew by a whop 9%. Much of it is fueled by its domestic market. However, even that has not been ample to shield it from the effect of the global financial crisis, and it is pass judgment that in data impart show that by marching 2009 that India’s produce ordain have opposeded rapidly to 7. 1%. Although this is a very dramatic evolution figure even in good times, the speed at which it has droppedâ€the lancinate retardantâ€is what is concerning.\r\nChina similarly has also experienced a sharp slowdown and its increase is expected to slow down to 8% (still a good growth figure in normal conditions). However, China also has a growing crisis of fermentation over job losses. Both have poured billions into recovery packages. China has also raised concerns about the world relying on loosely one foreign currency reserve, and called for the clam to be r eplaced by a world reserve currency run by the IMF. Of course, the US has defended the dollar as a global currency reserve, which is to be expected given it is one of its main sources of global economic dominance.\r\nWhether a change like this would actually happen remains to be seen, but it is likely the US and its associate will be very yucky to the idea. Japan, which has suffered its own crisis in the 1990s also faces trouble now. While their banks seem more secure compared to their horse opera counterparts, it is very inter unfree on exports. Japan is so unfastened that in January alone, Japan’s industrial production fell by 10%, the biggest monthly drop since their records began. Japan’s output for the first 3 months of 2009 plunged at its quickest pace since records began in 1955, mostly receivable to falling exports.\r\nA rise in industrial output in April was expected, but was positively more than initially estimated. However, with high unemployment and g eneral lack of confidence, optimism for recovery has been dampened. In recent years, there has been more interest in Africa from Asiatic countries such as China. As the financial crisis is hitting the Western nations the hardest, Africa whitethorn tho have intercourse increased trade for a while. These earlier hopes for Africa, above, may be short lived, unfortunately.\r\nIn whitethorn 2009, the International Monetary memory (IMF) warned that Africa’s economic growth will plummet because of the world economic downturn, predicting growth in sub-Saharan Africa will slow to 1. 5% in 2009, below the rate of tribe growth (revising downward a March 2009 prediction of 3. 25% growth receivable to the slump in goodness prices and the credit squeeze). Some African countries have already started to cut their health and human immunodeficiency virus budgets ascribable to the economic crisis. Their health budgets and resources have been constrained for many years already, so thi s crisis makes a bad situation worse.\r\n overdue to its proximity to the US and its close birth via the NAFTA and other agreements, Mexico is expected to have one of the lowest growth rates for the persona next year at 1. 9%, compared to a downgraded forecast of 3% for the rest of the region. Europe & Financial crisis In Europe, a number of major financial institutions failed. Others needed rescuing. In Iceland, where the economy was very dependent on the finance sector, economic problems have hit them hard. The banking system virtually collapsed and the government had to borrow from the IMF and other neighbors to try and rescue the economy.\r\nIn the end, public dissatisfaction at the way the government was handling the crisis meant the Iceland government fell. The EU is also considering spending increases and tax cuts said to be worth €200bn over two years. The plan is supposed to help restore consumer and business confidence, propping up up employment, getting the b ank’s lending again, and promoting green technologies. Russia’s economy is espial sharply with many more feared to sailing into poverty. One of Russia’s key exports, oil, was a reason for a recent boom, but falling prices have had a big impact and investors are withdrawing from the country.\r\nAfrica & Financial crisis Perhaps ironically, Africa’s generally asthenic integration with the rest of the global economy may mean that many African countries will not be change from the crisis, at least not initially, as suggested by Reuters in September 2008. In recent years, there has been more interest in Africa from Asian countries such as China. As the financial crisis is hitting the Western nations the hardest, Africa may yet enjoy increased trade for a while. These earlier hopes for Africa, above, may be short lived, unfortunately.\r\nIn May 2009, the International Monetary Fund (IMF) warned that Africa’s economic growth will plummet because o f the world economic downturn, predicting growth in sub-Saharan Africa will slow to 1. 5% in 2009, below the rate of population growth (revising downward a March 2009 prediction of 3. 25% growth due to the slump in commodity prices and the credit squeeze) African countries could face increasing pressure for debt repayment, however. As the crisis gets deeper and the international institutions and western banks that have lent money to Africa need to shore up their reserves more, one way could be to demand debt repayment.\r\nThis could cause advertize cuts in social services such as health and education, which have already been reduced due to crises and policies from previous eras. The current crisis The housing bubble started to burst in 2006, and the decline accelerated in 2007 and 2008. Housing prices stopped increasing in 2006, started to ebb in 2007, and have fallen about 25 percent from the peak so far. The decline in prices meant that homeowners could no longer refinance when their mortgage rates were reset, which caused delinquencies and defaults of mortgages to increase sharply, especially among subprime borrowers.\r\nFrom the first quarter of 2006 to the third quarter of 2008, the percentage of mortgages in foreclosure tripled, from 1 percent to 3 percent, and the percentage of mortgages in foreclosure or at least xxx days delinquent more than doubled, from 4. 5 percent to 10 percent. These foreclosure and delinquency rates are the highest since the Great Depression; the previous peak for the delinquency rate was 6. 8 percent in 1984 and 2002. And the worst is yet to come. The American dream of owning your own home is turning into an American nightmare for zillions of families.\r\n primordial estimates of the center number of foreclosures that will result from this crisis in the years to come take to the woodsd from 3 million to 8 million. So far (as of January 2009), there have already been most 3 million mortgage foreclosures. Another 1 million mortgages are ninety days delinquent and another 2 million were thirty days delinquent. Therefore, a positive of about 6 million mortgages either have already been foreclosed, are in foreclosure, or are close to foreclosure. Six million mortgages are about 12 percent of all the mortgages in the United States.\r\nThe situation could get a lot worse in the months ahead, due to the worsening recession and lost jobs and income, unless the government adopts stronger policies to reduce foreclosures. Defaults and foreclosures on mortgages mean losses for lenders. Estimates of losses on mortgages keep increasing, and many are now predicting losses of $1 gazillion or more. In addition to losses on mortgages, there will also be losses on other types of loans, due to the weakness of the economy, in the months ahead: consumer loans (credit cards, etc. ), commercial real estate, corporate junk bonds, and other types of loans (e. g. redit default swaps).\r\nEstimates of losses on these other t ypes of loans range up to another trillion dollars. Therefore, total losses for the financial sector as a whole could be as high as $2 trillion. It is nevertheless estimated that banks will suffer about half of the total losses of the financial sector. The rest of the losses will be borne by non-bank financial institutions (hedge funds, pension funds, etc. ). Therefore, dividing the total losses for the financial sector as a whole in the previous paragraph by two, the losses for the banking sector could be as high as $1 trillion.\r\nSince the total bank capital in the U. S. is approximately $1. 5 trillion, losses of this magnitude would wipe out two-thirds of the total capital in U. S. banks! * This would obviously be a severe blow, not beneficial to the banks, but also to the U. S. economy as a whole. The blow to the rest of the economy would happen because the rest of the economy is dependent on banks for loansâ€businesses for investment loans, and households for mortgages and consumer loans. Bank losses result in a step-down in bank capital, which in turn requires a decline in bank lending (a credit crunch), in order to maintain acceptable loan to capital ratios.\r\nAssuming a loan to capital ratio of 10:1 (this materialistic assumption was made in a recent study by Goldman Sachs), every $100 billion loss and decrease of bank capital would normally result in a $1 trillion reduction in bank lending and corresponding reductions in business investment and consumer spending. According to this rule of thumb, even the low estimate of bank losses of $1 trillion would result in a reduction of bank lending of $10 trillion! This would be a severe blow to the economy and would cause a severe recession.\r\nBank losses may be offset to some extent by â€Å"recapitalization,” i. e. by new capital being invested in banks from other sources. If bank capital can be at least partially restored, then the reduction in bank lending does not have to be so worl d-shattering and traumatic. So far, banks have lost about $500 billion and have raised about $400 billion in new capital, most of it coming from â€Å" monarch wealth funds” financed by the governments of Asian and Middle Eastern countries. So ironically, U. S. banks may be â€Å"saved” (in part) by increasing foreign ownership. U. S. bankers are now figuratively on their knees before these foreign investors whirl discounted prices and pleading or help.\r\nIt is also an master(prenominal) indication of the decline of U. S. economic hegemony as a result of this crisis. However, it is becoming more difficult for banks to raise new capital from foreign investors, because their prior investments have already suffered significant losses. In addition to the credit crunch, consumer spending will be further depressed in the months ahead due to the following factors: decreasing household wealth; the end of mortgage equity withdrawals and declining jobs and incomes. each(pren ominal) in all, it is shaping up to be a very severe recession.\r\n'