EFKAN OZTURK

BU 532 International Economics 12

EFKANOZTURK

BU532 International Economics

Online- Spring 2016

6/5/2016

Aglobal financial crisis can be described as a period of economicconstraints experienced by consumers and markets. It is a situationthat is quite hectic for the survival of businesses and consumershave a tendency of reducing purchases of different goods andservices. In such a case, the business environment gets unbearable,and the modes of operations tend to change. Due to the hostilebusiness climate, purchases of goods and services usually go downuntil the situation is resolved. A good example is the 2008 financialcrisis that hit the globe. The consequences and effects were feltacross the world in various capacities. The effects were felt acrossEurope especially the European Union, Africa, South Americancountries and Asia among others. Due to the severity of the crisis,many experts have tried to illustrate the causes, consequences, andcountermeasures (Young,2014).

Accordingto the article in consideration, the financial crisis resulted from acombination of events. The core elements involved mismanagement andmisperception of risk, control of the financial system, and thedegree of interest rates. These three elements were the core reasonsbehind the financial crisis. By looking at the events of the crisis,mainly basing on the mentioned factors, this paper will clearlydemonstrate the real causes. The macroeconomic results of the crisiswere quite severe. In the business environment, economies run mostlydue to confidence. In other words, once consumers lose assurance on aparticular product or service, they tend to lessen their spending onsuch products. On the other hand, banks, as well as other financialinstitutions, retract from lending once they lose confidence. Asentailed in this paper, such consequences will be expoundedshowcasing examples from different parts of the globe. The paper willalso dwell on countermeasures to the crisis and how some countriesmanaged to struggle out of the crisis. In that regard, analysis ofthe article will be based on causes, consequences and countermeasuresto the financial crisis (Wyman,2011).

Causes

Asearlier elaborated, in the course of human living, the concern hasnever been on just one object. The causes of the financial crisiswere many some of the causes were just recent as others have beenthere since time memorial. In this article I would like to dwell onthe three core elements that caused the global financial crisis i.e.mismanagement and misperception of risk, control of the financialsystem, and the degree of interest rates. Conceivably the vitaldriver of the fiscal crisis pertains human psychology on theperception of risks. Whenever things are flowing smoothly, acuity ofrisk decreases. The general notion is that the times are infinite.However, when things change to the other side, the perception ofrisks increases beyond the normal level, far much above what can beseen during boom. The aversion of risk tends to change drasticallyand the effects spontaneous across the globe. As shown by studies,the thoughts on risk altered in the years before the crisis.

Theyields on US companies or upcoming market bonds narrowed especiallyat riskier ends as compared to the government bonds as well as othersecurities that are deemed safe. The investors were more concernedwith searching for safety and not looking for yields. They avoidedtaking risks in some sectors leading to a decline in growth. Theboom-cycle impacts of psychology are augmented when investors utilizeleverage. Borrowing to acquire assets is quite lucrative especiallywhen the prices are on the rise. The benefits outside the interestcosts are enjoyed by the investor and not the lender. However, whenthings are going haywire, and asset valuations are very low, theinvestors’ losses tend to be enlarged by leverage (Ellis,2010).

Absenceof correct regulation of financial systems in most of the countriescontributed much towards the global financial crisis. Due to poorfinancial regulations, there are many issues that led to thefinancial problem for instance, capital requirements on somecomposite financial products like the collateralized debtresponsibilities, the payment structure, how credit rating agencieshave been regulated in any country, using the ratings designed byprivate rating agencies to regulate banks and the kinds ofrisk-taking initiatives in any country played a lot in causing theglobal financial crisis.

Beforethe 2008 global crisis, US investors had lost confidence in thesubmarine mortgage values causing a liquidity crisis. The US FederalBank was forced to inject a huge sum of capital into the financialmarket. The event was back in July 2007. By the year 2008, thedisaster had deteriorated as stock markets across the world crashedbecoming highly unstable. Most of the well known international bankscould not perceive, or even manage the risks that are associated withfinancial products and markets appropriately as regulators did notgive them the opportunity to thrive. Consumers become less activefearing what might happen. As entailed in many studies, theperception of risk is, therefore, a significant contributor to thefinancial crisis (Stijn,2010).

Thefinancial disaster is also widely due to the insufficient financialregulations. Some countries have limited financial regulationsleading to an unstable system. As various economists pointed out,some loopholes within the laws led to the financial crisis. Forinstance, the federal policies intended to enlarge homeownership inan “off-budget” criterion favored lending to people who acquiredhomes whose affordability was beyond them (Konczal,2009).

Dueto poor financial regulations, credit acquisitions became very easyand this resulted to low flow of money in the economy making neweconomic growth to dwindle and selling and buying of assets was alsovery slow. Such issues really hurt business people, citizens andfinancial institutions leaving most of the financial institutionswith a lot of mortgage that were backed up with assets that had verylow value and could service the loans that were taken by individualsto acquire such properties. The financial institutions were leftwithout funds in the reserves making them to restrict their lendingas they were also not able to make loans.

Dueto the lack of adequate regulatory policies and even feeble policies,individuals borrow or acquire commodities that they cannot afford.The same case applies to the governments, they use more than whatthey pose, thereby increasing the borrowing rates. It is a norm thataffects most third world countries. When a crisis hits the developednations, the impact is felt even in the underdeveloped countries(Willem,2008).

Thethird component that concurred with the perception of risk was theinterest levels that were quite small. Taking United States forexample, the interest rates were very low and Banks kept on givinghuge loans to borrowers as others were also getting loans to investin properties with the aim of ensuring long term savings. But then,that kind of money was being loaned to people without any alternativesources of income, they never owned any assets.

Thepolicy interest rates attained much low levels than it had been seenhistorically. The abnormal investor demand brought the long ratesdown. Some of the investors included central banks as well as othergovernment agencies in industrialized and emerging economies thataccumulated foreign reserves. The small degree of interestproportions resulted in high leverage to the amusement of manyobservers. The costs of taking loans were very low and many peopletook loans making more money to flow in the economy. And most of thepeople wanted to purchase just the same things, thus increased demandhence inflation resulted. At that time, the inflation pressures weresubdued, and the macroeconomic state did not call for high-interestrates (Hensarling,2013).

Consequences

Theeffects of the crisis were felt across the globe in differentcapacities. Due to the increase in the level of risk aversion,countries face a lot of negative macroeconomic effects. For instance,due to the crisis, firms and households developed no confidence inthe economy making them to stop spending. Banks and other financialinstitutions lost confidence in the economy, thus, the stoppedlending. Due to such actions, projects that were believed to beviable, became the most risky ones and attracted no investor (Ellis,2010).

Commodityprices boomed, industrial output declined as various macroeconomicindicators deteriorated. The behavior and actions of various banksi.e. regulations, can be sufficient to prove how the US mortgagecrisis led to the banking issues in the North Atlantic (Young,2014).But then, at the same time, trade and confidence losses explain howthe crisis developed from one place and grew into a global problem.The disaster consumed an enormous sum of housing and financialwealth. For instance, the U.S. household net worth hit $16 trillion,or 24%. Additionally, a considerable amount of human capital waswiped out both in discounted future and current wage income.

Therewere reductions in the level of industrial output in most parts ofthe world as the volume of world trade reduced drastically. Theunemployment levels also increased with limited opportunities indifferent sects (Luttrel,2013).Due to the consequences, forecasters were forced to downstate theirforecasts in an attempt to see continuous growth in the variouseconomic sectors. For instance, the IMF started to show an impressionthat the global output will contract in the year 2009. And this wouldmark the first annual contraction in output from the Second WorldWar.

Eventhough the consequences were felt in many countries across the globe,the south-eastern Europe showed resilience in limiting the crisis.The region had full support from foreign-owned banks and companies aswell as international organizations. The bodies did not exit themarkets leading to a stable economic period across the region.However in most of the African states, the disaster was quiteinjurious to their economy. Taxes on commodities were heightenedincreasing the prices. People opted to reduce their spending onlyshopping for essential goods (Sanfey,2010).

Thedeteriorated global result due to the global financial crisis showsthat by banks giving money to borrowers, they will be making so manymistakes as the condition of the economy views borrowers as riskypeople. Some of the borrowers will experience a lot of problems whenthey are trying to service their loans resulting into bad debts. Baddebts normally increase courtesy of the total lending when theeconomic situations in a country do not favor survival of projectsthus borrowers cannot find value for their investments. With this,less profit will be made making majority of banking institutions inmany countries to become very weak.

Thecrisis affected many countries other than United States, forinstance, major economies in Asia got swept up courtesy of thecrisis. Other countries only suffered indirect blows from the GlobalFinancial Crisis. Most of the export oriented countries like Japanand China lost consumers for their exports due to consumerretrenchments in the United States and Europe. Due to lack ofconsumers for their products, they were unable to find loans in theWest to finance their sales.

Mostgovernments panicked and they had to devise policies that would helpthem avoid the crisis and at least lower its effects on the economicsectors of the country. Most of the central banks in Europe decidedto coordinate their reductions in the interest rates. Somegovernments had to approve their public spending before releasingmoney into the economy (Young,2014).The aims of such actions being ensuring the effects of inflations arenot intense.

Countermeasures

Accordingto the article, in order for the crisis to be dealt with, policymakers all over the world should first focus on addressing theimmediate problems affecting the banking sectors. For instance,governments together with their central banks should be on theforefront in providing macroeconomic boosters by coming up with easymonetary and fiscal policies. And that recovering credit supply andeconomic activities in any country will make sure that restoration ofglobal banking systems take place (Willem,2008).

Immediatelyafter the results of the global financial crisis, reassuring monetaryand financial policies were put in place to help reduce the shockthat the crisis brought to the economies of various countries.

Restorationof the international banking system to a healthy state called formore stringent measures on some dockets. Governments providedconsiderable backing to the financial markets and institutions.Banks’ access to funds has been made certain through wholesale debtissuance. Some governments have injected a huge amount of capitalwhile few have been assisted in limiting risk within the balancesheet (Davies,2014).

Thegovernment plays an immense role in countering financial risks. Somepurchase the assets placing them in a unit detached from the bank.They then insure the assets still in the banks against losses ordevote in joint investment funds that purchase the assets. Apart fromthe efforts to deal with the immediate global financial crisis, thereis much focus on reforming the structure of the financial sectors tosee that such crises do not occur again in future. Policy initiativesto help prevent occurrence of the same in future includes changingthe regulations of the credit rating organizations, paying incentivesproblems faced by most of the financial organizations and theirstaffs and changing the regulation of bank capital and the nature ofliquidity (Sanfey,2010).

Manyinitiatives are in place courtesy of international groupings ofcentral banks and bank managers, i.e. the Financial Stability Forumand the Basel Committee on supervision of banks. The groups’ mainmotives are to ensure policies that will see smooth running ofeconomies are in place and that the policies are not allowingemergence of any crisis in any country. Most of these initiatives arein place as central banks around the world works together to dealwith any crisis. It then means that financial systems in manycountries are in the process of reformation. As per now, acquiringcredits is not very easy especially for asset acquisition as thefinancial systems are busy working on the ways to ensure restorationof confidence in all the economic sectors (Willem,2008).

Thepressures from the financial crisis were so intense that forced manyalliances to forge in order to counter the effects of the crisis. Forinstance, officials from, China, South Korea and Japan met and devisea means to respond to the crisis as a group.

Thoughthe article expounds efficiently on the different causes of thefinancial crisis, the countermeasures involved are not that clear.The measures are not yet tested and proven. They are just in apreliminary stage and whether they can be a success or not, it hasnot been elaborated effectively.

Conclusion

Thefinancial crisis is one big aspect that draws some ideologies. Manystudies have tried to address the cause of the crisis from adifferent perspective. Most of them concur that the perception ofrisk majorly caused the crisis. The changing notion on risks led to acautious approach to doing business that escalated to exits byinvestors from institutions. Investors opted against taking risksfearing massive losses.

Asa result, people acquired commodities they could not affordespecially houses leading to a disjointed economy. The regulationsdid not bar individuals from making unaffordable purchases. As thearticle clearly expounds, the effects were felt in a variety ofdegrees. For example, consumer purchases went down since people couldnot afford other commodities due to heightened prices. Nations wereforced to choose either to watch the financial system collapsing orto use tax payers’ money to rescue the main corporations and thefinancial markets. But at the same time, most citizens lost theirjobs, their homes and the savings they had with the major financialcorporations.

Thearticle concluded that the crisis could be avoided provided thewidespread failures in the way financial institutions are regulatedget some serious corrections, corporate governance of majorinstitutions should also be ensured as well as ensuring thatexcessive borrowings are not allowed in the countries and that thepolicy makers should always be ready to handle any crisis that mayarise (Wyman,2011).Countries should always watch their economic sectors to ensure thatthey do as required and the policy makers should always be proactiveand watch every performance and report any deviations to the policymakers so that mistakes that can bring about financial crisis aredealt with.

References

Wyman,O. (2011). The Finacial Crisis of 2015: An avoidable history. Stateof the Financial Services Industry, 1-28.

Willem,D. (2008). The global financial crisis and developing countries. Theglobal financial crisis and developing countries, 1-5.

Young,B. (2014). FinancialCrisis: causes, policy responses, future challenges.Luxembourg: European Union.

Ellis,L. (2010). The Global Finacial Crisis: Causes, Consequences, andCountermeasures. TheGlobal Finacial Crisis: Causes, Consequences, and Countermeasures, 24-34.

Davies,J. (2014, March 23). GlobalFinancial Crisis – What caused it and how the world responded.Retrieved from Global Financial Crisis – What caused it and how theworld responded:http://www.canstar.com.au/home-loans/global-financial-crisis/

Hensarling,J. (2013, September 24). Regulation– Not Lack Thereof – Led U.S. into Financial Crisis.Retrieved from Regulation – Not Lack Thereof – Led U.S. intoFinancial Crisis:http://www.americanbanker.com/bankthink/regulation-not-lack-thereof-led-us-into-financial-crisis-1062366-1.html

Konczal,M. (2009, September 21). DidRegulation Cause the Financial Crisis?Retrieved from Did Regulation Cause the Financial Crisis?:http://www.theatlantic.com/business/archive/2009/09/did-regulation-cause-the-financial-crisis/26880/

Luttrel,D. A. (2013). Assessing the Costs and Consequences of the 2007–09Financial Crisis and Its Aftermath. EconomicLetter.

Sanfey,P. (2010). South-eastern Europe: lessons from the global economiccrisis. South-easternEurope: lessons from the global economic crisis, 1-20.

Stijn,C. K. (2010). Understanding Financial Crises: Causes, Consequences,and Policy Responses . UnderstandingFinancial Crises: Causes, Consequences, and Policy Responses ,1-12.