Global crisis Essay in 500
Answers
Financial crisis is defined as “a situation characterized by severe disruptions in the value of financial institutions’ assets, their access to funding or their client’s trust, to the point of endangering the financial system’s sustainability” (Argandona 2009). This essay will discuss the various likely causes of Global financial crisis and the preventive measures that the UK government could take to avoid or diminish the threats of another crisis. Global economic crisis of 2008 resulted due to some fundamental and undesirable changes that took place in the efficient use of resources in America (Davis 2009, p. 1). According to Davis (2009), some changes that could be easily perceived were breakdown of information technology and the ever increasing globalization across the world. He has discussed in his article, the consequences of emergence of Post Industrial Society in US which led to an increase in unemployment as the largest employers shifted from manufacturing organizations to service industry which later contributed as a cause of credit crunch. The essay will first place the possible causes that led to the downturn in the financial position of the various economies across the world and finally it will talk about the methods that UK government can adopt to prevent itself from the hazards of next financial crisis. The essay concludes that while some countries were largely affected by the impact of crisis in 2008, there remain few countries that managed to overcome the shock and survived because of their policies and the best possible steps taken by them.
“The IMF remains bedeviled by philosophical disputes about the scale and scope of its lending and crisis related activities. These disputes distract the institution from its role as a global lender of final resort.”(Truman 2006b, p. 532) Truman (2008) says that at the time of unfolding of economic crisis, members of International Monetary Fund failed to provide any kind of assistance to the economies that required a short term need for external liquid resources. According to him, one of the various possible causes was macroeconomic policies of several countries across the world that jointly holds the responsibility to a great extent for the crisis. He further commented that easy monetary policies and fiscal policies of countries like US, Japan and others reduced the savings rate of these countries and distorted the balance of the financial system and led to a soaring of global credit and elevated the price of houses. “Collateralized debt obligations are bonds ultimately backed by bundles of loans such as subprime mortgages.”(Davis 2009, p. 103) Financial institutions had a good amount of money in the form of foreign exchange reserves so it started lending money to everyone at a very low interest rate (Truman 2008, p. 23) and also to the people who had no capacity to return it back, that is, subprime mortgages came into picture (Davis 2009). After a certain period, when the supply started exceeding demand, housing prices in US began to drop, mortgage holders found that the price or value of their house was less than what they were owing to the banks and so they started defaulting in high numbers and a rise in foreclosures was observed. Emergence of post industrial society, i.e. a shift from manufacturing to service industry in US led to large unemployment. In an effort to improve productivity, companies started cutting down on labour and ultimately small number of skilled labours were left. So the competition for skilled labour increased. With the materialization of defined contribution pension plan, the incentive to stick to a particular company came to an end. And employees started moving from one company to another. This new plan of pension fund led to the growth of mutual fund industry (Davis 2009, p. 31) which resulted in decline in employee attachment with the company and increased participation by financial institutions through mutual funds. “Securitization [altered the traditional pattern of banking by] turning assets into securities traded on markets” (Davis 2009, p. 35). This way of banking allows the bank to lend more amount of money. One form of securitization was mortgage backed bonds (Davis 2009, p. 35). Deboer (2008, p. 5) says that any commercial bank must have approximately 10% of the total amount of loan issued by it, in its capital assets. Many financial bodies issued mortgage-backed financial derivatives and eventually when the housing prices started falling, the value of mortgage backed securities declined too which in turn started making them bankrupt. Realizing this, banks started issuing small number and small quantity of loans. This strapped the credit situation tightly and thus housing prices started narrowing further.
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