Abstract

The great financial crashes of history tend to be sudden and shocking, like the bursting of the south sea bubble in the 1720s, and to have disastrous effects on the wider economy, like the Wall Street Crash of 1929. The scene for the crisis of 2007-2008 was set by international macroeconomic imbalances, low interest rates and rapid credit expansion and much greater use of complex financial instruments in a search of better returns, so the markets became harder to understand. But little heed was paid to the risks before the bubble was burst. As Chuck Prince the ex chief executive of Citibank, said �as long as the music is playing, you'll have to get up and dance". (House of Lords, 2nd report of session 2008-2009)


Introduction

The global financial crisis is already causing a considerable slowdown in most developed countries. Governments around the word are trying to contain the crisis, but many suggest the worst is not yet over. Stock markets are down more than 40% from their recent highs. Investment banks have collapsed, rescue packages are drawn up involv�ing more than a trillion US dollars, and interest rates have been cut around the world in what looks like a coordinated response. Leading indicators of global economic activity, such as shipping rates, are declin�ing at alarming rates (Dirk willem Te velte 2008)

The crisis broke when confidence was lost between banks around the world. Alan Greenspan, the former chairman of the federal reserve went so far as to say of modern risk management levels that � the whole intellectual edifice collapsed" in the summer of 2007. The effects on the global financial system were far- reaching. Interbank lending dried up. The impact on some financial institutions in UK and USA were catastrophic. Huge government bailouts followed.

(House of Lords, 2nd report of session 2008-2009).


The main causes of the global financial crisis

The sudden deepening of the financial crisis in the US during the September and the October, and the accompanying start of deleveraging across financial institutions worldwide, triggered a wave of sell off in merging market assets across the globe. Widening sovereign spreads and sharp currency depreciation and a halving of domestic equity prices have been witnessed across emerging markets. The magnitude and the extent of these developments in US, Europe and central Asia are of concern. (Global economic prospects, 2009, World Bank)


The main causes of the financial crisis in US

There was a massive housing residential bubble, relaxation of standards, subprime, giving loans to people who in earlier years wouldn't have been eligible for it, low down, zero down, negative equity for ex. �a house costs $300000 and the loan given would be $350000" there were 70% house owners in 2006, and it raised to 78% in 2007, and it happened because of zero or negative equity.

(R Hudson, S Maioli, 2010)

Warren buffet said �the single biggest cause of the credit crisis was a huge real estate bubble in the US. They had 300 million Americans, their lending institutions, their government and their media all believing that the house prices would go consistently. That created a $20 trillion residential home market and when you have a 20% fall in a $20 trillion asset, you have 4 trillion in losses. When those losses land in the wrong part of the economy it can gum up the whole place" (the Charlie Rose show 2008)


Over leveraging of the financial sector globally

The financial sector created more debts to create more business, a statistics shows that �in 1980, the debts to assets in the banks in US was at the ratio of 21% for $100, and in 2007 the debts to ratio was 116 % for every $100 dollars. So because of massive leveraging the banking system was bankrupt on paper, they had more debts than assets. (R Hudson, S Maioli, 2010)


Deregulation of financial service industry globally

Some banks separated investment banking from commercial banking, which was known as the comprehensive thrift and bank fraud prosecution. And in 2000s more and more deregulation occurred which led to lot of risk taking and deregulation, unregulated subprime lending and mortgage banking security that bundled up home mortgages and resold them to investors and there by raising more money and lend again.( M Goto and A makhija, 2009)


Inability to accurately measure risk

In 2007, investing in a Russian rouble would fetch 2% more than investing in the US treasury or investing in Vietnam would fetch 1.5% more than the US treasury. But the risk was no longer measured because in the early 90s the difference used to be 12-15%.

The investments were blindly made.

The rating agency also had problems dealing with the bank and mortgagers. (S Miller, 2008)

What steps could the UK government take to reduce the dangers of another crisis?

British Prime Minister Gordon Brown announced an unprecedented 500-billion pound bailout package as central banks around the developed world cut interest rates in a coordinated move aimed at rescuing the global economy from a crippling credit crunch.

In a series of steps announced early, the British government said it was making available an amount of 50 billion pounds to eight banks and building societies to enable them to continue lending to small businesses and individual homebuyers.(web source 1).

The government also made available 200 billion pounds in short-term loans from the Bank of England, and up to 250 billion pounds in loan guarantees at commercial rates to encourage banks to lend to each other.( web source 2).

In what Brown described as a �bold solution", British banks in exchange will have to agree to controls - they will not only continue lending to small businesses and individuals at existing rates but also place limits on huge executive pays and rewarding bankers who take excessive risks.( web source 3).

In the UK, at the height of the turmoil in the banking sector last Fall, the British government brokered a merger between the struggling HBOS banking group and its competitor Lloyds TSB, creating a new banking giant�the country's largest bank and mortgage lender. To enable the merger to go ahead, the government took the radical step of changing the law to allow the Secretary of State for Business, Enterprise and Regulatory Reform to Intervene in the normal merger review procedure and override competition concerns on the basis of the public interest in preserving the stability of the UK's financial system.( A Gomes & m Samson, 2009)

The first significant credit crunch event in the UK occurred in September 2007, when it emerged that the Northern Rock bank had been granted �25 billion of emergency financial support from the UK's central bank, the Bank of England. This prompted the first

Run on a UK bank in over 100 years, with depositors withdrawing �1 billion from the bank in one day until the UK government stepped in to guarantee their savings. Attempts to sell Northern Rock to private sector bidders failed and, in February 2008, the UK government decided that Northern Rock would instead be nationalized. (A Gomes & M Samson, 2009).

Apart from what the government has already done and what they should also must take into consideration is

It could pass another Law to get Banks to pay back all the money that they have borrowed within 5 years. The Government could/ can impose restrictions on house price rises for the next few years, to allow more people to buy their own homes. The Government needs to reduce its own spending and ensure that public money is not wasted. The Government could/ can pass a Law to stop Banks paying bonuses. The Government could/ can prevent house repossessions, by forcing Building Societies by law to allow people to remain in their homes, and pay back arrears over a number of years.

It was basically a massive bubble, and was bound to burst at some point. Now, house prices haven't fallen that much, and are still at unsustainable levels. To sort this out they need to reduce demand. They also need to encourage the banks to be a lot more careful when it comes to lending. Lending money to people who can't really afford to pay it back is only going to cause trouble. They also need to pay off the debt we have as soon as possible, and then start putting money aside, and saving for a future crisis. It needs to stop focusing on investment banking, and start looking at the housing market and Build more housing and make sure it is sold at reasonable prices.

At the moment the government is focusing too much on investment bankers, and bank bonuses, which is basically is to divert attention from the real cause. Reducing bonuses is not going to reduce the most likely of a future crash.


Reference

1) The global financial crisis and the developing countries, by Dirk willem te velde 2008. Overseas development institute.

2) House of Lords, 2nd report of session 2008-2009. Banking supervision and regulation, volume 1

3) Global economic prospects, 2009, world bank, Commodities at the cross roads

4) Web source 1 2 & 3 (http://profit.ndtv.com/2008/10/08194534/Britain-launches-500bn-pound.html)

5) The Charlie rose show, 2008. http://www.youtube.com/watch?
v=MKuqLRbTGhU&feature=PlayList&p=8B0AF830D8C4A41C&playnext=1&playnext_from=PL&index=3.

6) Andrea Gomes and Mark Simson: Antitrust Implications of the Financial Crisis, spring 2009. Emerald group publishing ltd.

7) A response to reflection on a global financial crisis, 2010, Hudson Robert and Maioli Sara. Emerald group publishing ltd.

8) Mika Goto and Anil Makhija : the impact of deregulation and corporate structure on productive efficiency:2009: Emerald group publishing ltd.

9) S Miller: journal of risk finance: title :betting on county alphas to hedge asian crisis risk:2005 emerald group publishing limited vol: 3

Source: Essay UK - http://turkiyegoz.com/free-essays/finance/global-financial-crisis.php


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