This is what this paper tries to do. It proceeds in three steps. The first reviews what do we mean by the term Financial Crisis or Credit Crunch and also a brief description on global financial crises. The second identifies what is the Causes of Global financial crisis (2008onwords). The third, and the most tentative of the three, takes a first pass at the contours of different macroeconomic policy i.e. U.S Government Macro-economic Policy measures.
Financial Crisis or Credit Crunch
A credit crunch (also known as a credit squeeze or credit crisis) is:
“A sudden reduction in the general availability of loans (or credit), or a sudden increase in the cost of obtaining loans from banks”
Bernanke and Lown (1991) define a credit crunch as a decline in the supply of credit that is abnormally large for a given stage of the business cycle. Credit normally contracts during a recession, but an unusually large contraction could be seen as a credit crunch.
When point comes to a financial crisis, it means a “poorly functioning financial markets” this inadequate performance of financial markets can lead to the limited entry of new firms, low production in the firms on hand, and greater financial constraints form small and medium enterprises. (Anna and Robert, 2005)
There are several reasons why banks may suddenly increase the costs of borrowing or make borrowing more difficult. It can be used, because the expected drop in the value of collateral when granting loans to banks, or even to a greater awareness of the risks associated with the solvency of other banks in the banking system. It may be a change in monetary conditions (for example, when the central bank suddenly raising interest rates), or because the central government introduced direct instruction credit checks or banks do not engage more in loans additional. The negative effects of trade losses considerably, while the slowdown in growth, worsening of macroeconomic balances and huge inflationary pressures, etc.
“It is now clear that the current turmoil is more than simply a liquidity event, reflecting deep seated balance sheet fragilities and weak capital bases…” stated the International Monetary Fund.
Global Financial Crisis
The world economy experienced a severe economic downturn. Global financial crisis has caused economic activity, stop and dimmed the outlook for global growth. Although the severity and duration of the crisis are still unclear, the major industrialized countries have already or close to recession and global slowdown should lead to deeper and far more than previously thought. As the deepening financial crisis intensifies its grip on the global economy, Asian economies have begun to feel its effects. (James, William E. et al. 2008).
According to Mohan, (2007) & Taylor, (2008) the proximate cause of the current financial turbulence is attributed to the sub-prime mortgage sector in the USA At a fundamental level, however, the crisis could be ascribed to the persistence of large global imbalances, which, in turn, were the outcome of long periods of excessively loose monetary policy in the major advanced economies during the early part of this decade.
DeBoer (2008) believes that it was series of events which caused the crisis; it begins with the collapse of currencies in East Asia in 1997 and became edgy due to the financial crisis of Russia in 1998. Next, in USA was the “dot-com” stock collapse in 2001, and the final stroke was again in USA, when after a swift decline in housing prices and “rapid contraction in credit, it fell into recession.
Rasmus (2008) has the same thoughts; he, while discussing the reasons of economic recession of U.S said “The ‘real’ ailments afflicting the US economy for more than a quarter-century now include sharply rising income inequality, a decades-long real pay freeze for 91 million non-supervisory workers, the accelerating collapse of the US postwar retirement and healthcare systems, the export of the US economy’s manufacturing base, the near-demise of its labor unions, the lack of full time permanent employment for 40 per cent of the workforce, the diversion of massive amounts of tax revenues to offshore shelters, the growing ineffectiveness of traditional monetary and fiscal policy, and the progressive decline of the US dollar in international markets.”
Facts behind the Crisis
According to Friedrich-Ebert-Stiftung the current economic difficulties have a United States origin.
The original underlying assets were houses whose prices were falling.
The collapse of the securitized US mortgage market
Causes of Global financial crisis
As Nikolson (2008) acknowledged that financial crisis which instigated from USA has now become a global phenomenon. At present, not only in U.S but across Asia and Europe, stock exchanges crashed; collective losses of the London, Paris and Frankfurt markets alone amounted to more than 350 billion Dollars. Stock Exchange 100 index closed more than 323 points down in January 2008 (Times online 2008).
There are some positive factors present in the circumstances. A rapid decline in prices of raw materials and energy caused by falling demand is temporarily tamed the inflation pressure. The proposed response to the Asian Development Bank, the Global Financial Crisis (2009), several countries have tried, the impact on the global economic slowdown and financial crisis of monetary policy (liquidity injections and rate cuts), the fiscal policies (tax benefits packages and revenue expenditure) and fiscal policy (deposit insurance and rescue).
About the cause of current crisis Bartlett (2008) said that crisis was started with the downfall of US sub-prime mortgage industry , the intensity of this collapse was significant; “Mark-to-market losses on mortgage-backed securities, collateralized debt obligations, and related assets through March 2008 were approximate $945 billion.” He further stated that it is “The largest financial loss in history”.
Global Macroeconomic Imbalances
According to Portes (2009), global macroeconomic imbalances were the major underlying cause of the crisis. The savings-investment imbalance, which provide much of the transnational flow of capital too much weight to the funding process to produce global imbalances and the interaction with the defects of financial instruments to specific features of the crisis. This view is, however, provides only a partial analysis of the recent global economy.
The deep and lingering crisis in global financial markets,
the extreme level of risk aversion,
the mounting losses of banks and
the elevated level of commodity prices (until the third quarter of 2008) and their subsequent collapse,
and the sharp correction in a range of asset prices, all combined, have suddenly led to a sharp slowdown in growth momentum in the major advanced economies
Subprime Mortgage Crisis
YÄ±lmaz (2008) charged U.S subprime mortgage industry to be the major reason of current global financial crisis, he also stated that the total loses estimated initially up to $300 to $600 billion are now considered to be around $1 trillion.
Sub-prime crisis is the housing crisis and the financial crisis, triggered by the sharp rise in defaults and foreclosures in the United States, the main negative impact on banks and financial markets through the world. The crisis of the late 20 Century appeared in 2007 and is disclosed stem constantly weaknesses in the regulation of the financial sector and the global financial system.
Khatiwada and McGirr (2008) stated that many of these subprime mortgage loans in the balance sheet of banks they never have been born, and they are to attract foreign banks, which are high investment rating, with subprime borrowers to repay their s mortgages, originating institution closure of his own money to finance its assets back to the balance sheet. There was a lot of banks in the sustainability of public finances, uncontrollable relatively short calendar.
Global Trends (2008 onwards)
I would like to highlight some Global trends leading to the crisis are:
High Commodity Prices: In 2008, the prices of many commodities such as oil and food, so high that it causes real economic damage. In January 2008 the price of oil crossed $ 100 a barrel for the first time, the first step in a series of awards after this year. In July, the oil price was $ 147 per barrel, though prices fell quickly.
Trade: In mid-October 2008 Baltic Dry Index, a measure of cargo volume decreased by 50 percent from one week loan crisis, it was difficult to obtain letters of credit for exporters
Inflation: In February 2008, Reuters reported that headline inflation to historic levels, and that domestic inflation was 10-20 years a large number of people. “Supporting the oversupply of money in the world, growth spurt, a loose monetary policy in Asia, speculation in commodities, years of poor harvests, rising imports from China and the growing demand for products food and raw materials, rapid growth of emerging economies, “Possible causes of inflation, as indicated. In mid-2008, IMF data showed that inflation was highest in oil-exporting countries and Asian developing countries, because the price of oil and food prices.
Unemployment: The International Labour Organization estimates that are 20 million jobs lost, when he have the end of 2009 because of the crisis – particularly construction, real estate, financial and automotive sector – unemployment lay in the world more than $ 200 million for the first time. (Muhammad Usman IPRI Journal)
US Government and financial crises
Barack Obama, the new president of the United States has implemented a comprehensive economic policy in the United States on the economic crisis. Although the United States is facing the financial crisis now, and there is a recession looming economic problems of the United States several were taken to standardize.
DeBoer (2008) believe that such bailout programs and other supporting packages from governments is like offering protection from a negative outcome which is more appropriate to be called as “moral hazard”; this trend could increase the possibility of future bad upshots
Governments are providing support and doing what so ever they can to prevent their economical structure; US government injected $800 billion in the economy to support the structure, UK government has announced a package of $692 billion, European Union is about to start an economic recovery plan and IMF has called for minimum financial support of $100 billion (BBC news, 2008).
U.S Government Macro-economic Policies and Legislations
First, the U.S. policy to contain the infection and deal with the recession that followed. The two main legislative Troubled Asset Relief Program, which is supporting the U.S. economy, and institutions recovery and reinvestment for the year 2009 it aims to give impetus to the economy (Clinton T. Brass et al., 2009). Political proposals Thurs forces of change in the regulations and structure of regulation and supervision of national and international level have been coming through the legislative process, the maintenance of the recommendations of international organizations like the International Monetary Fund (Global Financial Stability Report, 2008), Bank for International Settlements (Walter W. Eubanks CRS report), and Financial Stability Board Forum(Report of the Financial Stability Forum2008).
According to Fred Moseley (2009) the federal government has acted fairly vigorously in attempts to prevent a more serious crisis, and has been modestly successful in the short-run, but it remains to be seen how successful it will be in the long run.
The Federal Reserve has a very accommodative policy (lower interest rates, which was short term and increased lending by commercial banks), and hopes that the banks increase their lending to companies and households. These traditional policies are not effective, because banks are reluctant to their loans are increasing, because they trust the creditworthiness of borrowers and the capital loss they have suffered (and still) that are required to reduce shortages to loans, the to approve loans, to maintain the equity ratio. Most importantly, the Fed loans to investment banks continued first in its history. Investment banks regulated by the Fed, so it has always been of the opinion that the Fed is not the responsibility as lender of last resort “act, the investment banks, if they are in difficulties. In September 2008, when the bankruptcy of Lehman Brothers (then as the fourth largest investment bank in the United States), exacerbation of the crisis triggered by the Fed still extraordinary and unprecedented steps to rescue AIG, the largest insurance company in the world. AIG, the market for credit default swaps, the insurance policy, a government defaults on loans, which represent, including high-risk mortgage-backed securities and form of speculation that dominates the bonds and default However, the commercial banks and investment banks stopped lending have increased. And the Fed cannot solve the fundamental problems of excessive household debt, falling house prices and rising rates of foreclosure.
Congress. In February 2008, Congress quickly passed a financial incentive “Paper of 168 billion $, which includes tax relief for households and tax cuts for businesses. These tax cuts would have a positive effect on the economy last summer, but their impact was minor and transient. At best, tax relief, even if the pace of consumption, because such reductions can only be used once. In 2008, Congress adopted the anti-sealing operation, which the existing mortgages, the default for new installations, which represent about 85 percent of the fair value of the home refinancing can be verified, and the Federal Housing Administration to ensure, can then end of September, when the crisis worsened, Treasury Secretary Henry Paulson has requested and Congress approved (in the context of the threat, the rapid decline in stock markets), $ to buy 700 billion subprime-backed securities (toxic waste), the U.S. banks. “s $ 700 billion a lot of money, it is $ 2,300 for every man, woman and child in the United States. Soon the law was passed, Paulson changed his mind and decided to use is 700 billion dollars by “capital” of banks (rather than buying toxic assets), and hopes that this increase is best way to encourage bank lending. The situation shows that leaving the financial capitalist system, their future, is inherently unstable, and only “avoid government crises” live at the expense of taxpayers. It is twice in the capitalist financial system is inherently unstable and rescue operations are necessary economically unfair.
After discussing the most common causes of the global financial crisis, I found that show some predictions that the world from a crisis that is unique in nature is suffering, because the Mortgage Industry in the United States and whether is then spread around the world but there is no general consensus about the same thing. The governments turn when they control their financial research, calculate, and the protection of their economic structure.
In order to prevent future financial crises and the allocation of capital occurs at the “mania” of the monetary authorities would be asset price inflation and deflation, not only the price index (CPI) inflation and deflation – because of their political activities, including governance. There is something disturbing about how the central banks have acted in the past: they are relentless commitment to keep inflation low, and revise their refusal, the inflation of resources, manufactured era marked by a combination of slow low wages and persistent economic instability.
Regulation of health care should be taken in public funds to the safety and credibility of financial institutions, such as capital adequacy ratios (especially if the assets are weighted and the mark-to-market price increases) or tightened accounting to comply with the standards of booking, when the expected losses also unveiled its distorting effects, because they have led to convictions in honour of and sudden fire sale of assets. This proved to be strongly pro-cyclical, especially when the crisis has already erupted.
It is important that the per capita gross domestic product is expected to grow because the new economic policy in the United States. Unemployment and underemployment are reduced, and exports of the products would soon seek U.S. economic policy.