Global financial markets

When prices in many of the global financial markets plummeted precipitately, the housing sector bubble burst in United States became the epic center of discussion and analysis for many of market analysts, politicians, economists and investors. Many concluded that the housing bubble was the major cause. However, the question that was quickly over looked was how can homebuyers' activities in North America lead to derailment of the financial system within such a short period of time and across the spectrum of the financial market. The answer is not far fetch when one takes a critical look at the consequences of government interventions either by way of regulations or policies, the activity of market speculators (noise traders) and blatant risk taking of investors and corporate greedy by the business community , just to mention a few in a system which is considered to run efficiently.

Over the years, the housing sector has seen a significant shift in government interventional policy as an economic tool to boast economy because of its greater and rapid multiplier effects, as compared to others sectors saddled with greater lag effects in impacting the economy. The sector has becomes susceptible or common tool for continue government policy tool to influence the economy. This knowledge has become a universal concept to all and for most economies in the world. The irony is that however, the world's economies have significantly become much integrated over the years, such that any economic policy or action by one economy creates direct or consequential effect for others if not all the economies in the world within short possible time. The aggressive economic intervention by US Federal government in trying to stimulate the economy and making homes affordable for ordinary citizens amidst the already heated housing sector can be cited as one significant factor that led to the market collapse. While the government pumped more money into the housing sector, the Federal Reserve restricting market to set exchange rates through the usual arbitrage system posed to cut interest rates to record-low levels and U.S. politicians by means of legislation, propped-up risky ventures, tax credits, incentives for housing savings accounts, subsidies and sponsorship programs, which eased the accessibility to loans & mortgages for awful lot of people that the market normally considered uncreditworthy.[1] Other organizations such as Fannie Mae and Freddie Mac with the federal government backing created further securitization of mortgages for sale which turn out to be hot investment items for many financial institutions. They insidiously scrambled to repackage, replenish and sell mortgage loans with little or no fundamental values. The Federal safety net and the provision of federal sponsored deposit insurance made most financial institutions and investment companies daring to take greater risks than they would normally do knowing very well the federal government was there to offer bailout support under the pretext that they are too big to fail. They therefore ended in a lucrative position to privatize any gains but socialize any losses.

When housing prices began to fall and market interest in these mortgage-backed securities began to decline, waves of panic selling began to manifest. These, together with other reasons, put greater pressure on the financial institutions to absorb unwanted capital assets rather than advancing loans. While the markets were concerned and trying to navigate through many of the risks now confronting them, Federal Reserve in its usual regulative measure banned shorting-stocks, hedge funds, depriving the markets of sufficient cash flow and information when they needed it most.[2] Ironically similar policies and actions were being implemented by most developed economies notably Japan, Australia, Canada & Great Britain. These actions collectively overwhelm the capital markets around the globe leading greater higher. While the individual market participants' activity influence the market efficiency, government actions create greater noise in the capital market than any factor. The implementations of various bailouts and stimulus by the government depending on the sizes have much impact on the economy such that they end up creating greater noise for the market efficiency. Government action or policy can not be overlooked when we talk about the market and its efficient workings. With market efficiency denoting fully reflection of all market information and fluid to new and public corrected information government economic policy interferes with market operation.

The capital and financial markets are set to be rational so that at some point all information are incorporated in decisions making process on the premise that informed investor would act based on the information gathered. There is no guarantee that all participants would react identically to the same information because they may have different prior beliefs and some may have superior expertise to analyze financial statement information for them[3]. Neoclassical economic models which underlay this theory failed to see changes in human behaviour and the economy. Since the market is all about the millions of participants making decision to produce, act and invest and the slightest introspection is enough to realize that people do not act like the theory models. Since gathering lots of information before making decision takes time and money, people often times go with their gut-feeling, follow rules of thumb and copy what others have already done. The market ends up having a herd instinct, moving people at one direction at a point in time and other direction at another point in time. When other arbitragers seem to be successful and getting rich at something, others follow suit. But after a while, the hollowness of the enthusiasm pale off as information eventually become absorbed into the financial system level off any gain and panic and fear set in for many who were unsuccessful resulting in bubble bust or crush.

There is a broad consensus that the financial crisis came about because of aggressive government economic policy which induced one-sided spending, prolonged record-low interest rates, and expanded huge deficits which provided large-scale credit-financed consumption in the housing sector. Today, other governments facing the same dilemma are trying to solve the crisis by the same means. Many people now agree that the record-low rates of 2001 to 2005 pursued by many of these governments contributed to the near collapse of the financial system and the housing bubble burst was the major catalyst.

[1] Johan Norberg How America's Infatuations with Homeownership and Easy Money Created the Economic Crisis, published by the Cato Institute

[2] Johan Norberg How America's Infatuations with Homeownership and Easy Money Created the Economic Crisis, published by the Cato Institute

[3] Scott W.R, Financial Accounting theory, 5th ed. 2009, Pearson Prentice Hall

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