Post the great depression 1929, the world has faced its worst financial crisis.
Due to fundamental financial deregulation process that began in 1970s in the western countries post World War 2, the financial markets started to grow. Along with deregulation, rapid financial innovation arouses powerful financial booms which then ended in crisis. Crisis started showing its effects in mid of 2007 and 2008 when many large non-financial institutions such as mortgage inventors, investments banks, rating agencies, insurance companies, etc together took over long-established commercial banking markets. As this financial crisis began to threaten the society, governments began to bailout few big firms. But this process ended in global financial crisis which is badly embedded that even governments intrusion failed to cure it. This crisis then turned into an economic crisis, employment crisis, social crisis and political crisis. The financial system of Iceland collapsed and destroyed the conservative prime minister's career when the entire cabinet resigned during Iceland's economic crisis. According to International Labour Organisation (ILO), British unemployment rose to 1.79 million in August 2008 since the country's last recession 17 years ago.
With the impact of the sub-prime crisis and fall of US sub-prime mortgage market complied with the problem of housing boom in other industrialized economies had a negative flowing effect around the world. The advent of investment instruments known as Collateralized Debt Obligations (CDOs) is equally responsible for mortgage crisis. Due to the Dot com burst on September 11, 2001, Federal Reserve chairman Alan Greenspan cut interest rates to 1%. The Wall Street firms like Merrill Lynch, Morgan Stanley & Citigroup bought billions of dollars from other financial institutions to lend mortgages through which they sold collateralized mortgage debt in form of CDOs to other banks. Mortgage companies sold mortgages to less responsible people with no down payment and low incomes which are known as sub-prime mortgages. It means other banks equally shared the risk of these sub-prime mortgages. As these sub-prime mortgage debts were bought by highly repute banks, risk agencies gave these risky debt bundles AAA safety ratings which made banks ignored their risky financial position. Due to inflationary pressures in US, interest rates rose up to 4% which led to an increase in mortgage defaults and companies losing money. With the fall in house prices the CDOs and mortgaged assets lost their collateral value leading to the subprime crisis. Merrill Lynch, for example, lost $23 billion in sub-prime crisis due to drop in the value of securities backed by risky home loans and unsold risky CDOs. The other victims of sub-prime mortgage crisis are Lehman Brother, American International Group and Fannie Mae & Freddie Mac.
According to New York Times, Lehman Brothers was one of the 10 largest firms playing in credit default swaps (CDS). Credit default swaps are insurance-like contracts that guarantee to insure losses on certain securities in a case of default. Being unregulated, they have aggravated the financial crisis. When Lehman Brothers went bankrupt, a lot of credit default guarantees went unrewarded because of their CDS protection being abolished. Another example is Northern Rock bank providing CDS protection depended on getting money on the financial markets to fund its every day operation. In 2007, it couldn't raise enough funds on the money markets and ultimately had to be nationalized by the UK government.
Securitization is also one of the causes which triggered financial crisis. It's a tradable securities which changed the picture of finance and banking by letting more kind of assets to be traded on markets and opening new opportunities for families to take part in money markets. Mortgage-backed securities enabled the globalization and socialization of United States mortgage supply and default risk. This led to emergence of a complex financial market system which was unstable. The effect of securitization on international capital market led to the fall of US housing market and shut-down in 2008. According to Steve Forbes, chairman of Forbes media, market-to-market accounting was “the principal reason” financial system of US collapsed in 2008. As the market was frozen in 2008, the prices of assets like mortgage, corporate bonds, etc have fallen below their real value. This led many banks to liquidation and forced them to sale assets at very low prices which then caused values to fall even further.
After the arrival of post-industrial society in US, there has been decline of large scale manufacturing base shifting to increase in service base. This resulted into restructuring and reshaping of large corporations. Due to this restructuring of economic activity, there became rising wage inequality from manufacturing to service industry. United States lost 5.25 million jobs in manufacturing industry between 2000 and 2009 that amounted to nearly 2% of its employment force. This caused havoc in stock markets where people heavily invested in large corporations like General Motors and Chrysler seeing their profits. Due to post-industrial society, the availability of long term jobs reduce as service industry jobs average term remains considerably low compared that to the manufacturing industry jobs. In short due to this shift from manufacturing to service base, there has been disaggregation of employment in which the attachment of workers to particular firms is more weak and short-term. In 2009, Wal-Mart became largest firm by hiring highest number of employees compared to General Motors which had highest number of employees in 1980. With a shift in employment prospects, there was change in portable defined contribution systems and pension financing. People became investors through investing pension plans and issuers of securities. This turned out system to be complex which turned trading in various types of capital unstable and resulted into crisis. Some of the major affects of financial crisis are stock markets crash. In Indian stock market, SENSEX fell down to 17,605 mark plunging more than 1600 points in a single day on January 2008. Banks alone are reported to loss credit worth of £393.4 billion globally. Big number of layoffs announced in US in 2008 for example 111,000 job cuts in financial sector and 96,000 in automotive sector. Britain ploughed more than £300 billion for this financial crisis. Companies such as Ford, General Motors, and Toyota reported 30%, 45% and 23% decline in sales respectively in 2008.
The current financial crisis has taught a lesson to the whole world and warned countries to be focusing on how to avoid a similar repeat in future. According to recent G20 summit, world leaders discussed key issues to strengthen countries financial regulatory regimes and restore lending by repairing the financial system. According to a senior United Nations official when government makes new policies, it should include employment, investment and economic security policies in nation development strategies to move forward of the current financial crisis. The UK government will be forced to reform and transform regulatory both in the rules and structure and in their implementation. The UK government should keep an eye on banks and other financial institutions lending activities. Only responsible individual, family or institutions should be authorized to raise debt along with careful lending standards because sub-prime mortgage/loans put financial system at a risk of losses along with volatility of operations. The UK government should encourage banks to have monetary policy to deliver price stability and low inflation in order to support increase in growth and employment. It should be mandatory for financial institutions to provide clear margin collateral against their Over-the-counter (OTC) derivative liabilities. As financial institutions can manage collateral at low cost, this would not be a problem. In order for financial institutions collateral to cover the actual liabilities of their derivative exposure, they should account position of an asset on a fair value rather than a book value.
UK prudential government should encourage incentives that support systemic stability and remove regulatory arbitrage, and assure effective execution of regulation. The board members, senior management and regulators of different financial institutions should exhibit sufficient understanding of the financial technology and risk management concepts compulsory to execute their oversight roles effectively. Money markets must have a strong regulation with no scope of inflated valuation of securities by few stake holders for their benefits. Assets which can be used for securitization should be categorized. For example, credit card debt should not be considered as credible asset and allowed to be converted in security. UK government should pass tax law changes which will improve the long-run firmness of the economy by reducing the incentive for leverage. In few countries it has been observed that many institutional investors have misrepresented the stock prices which resulted in losses to general investor, decreasing confidence of investors in the market. Government must put firm policies to run stock markets so that institutional investors are unable to manipulate prices of the stocks to their benefits.
President Barack Obama expressed banks were the direct responsible for the financial crisis. He also mentioned that he wants to work with financial market and avoid history being repeated once again. A major reform of banking regulation has been ruled out in US to prevent future financial crisis. Due to stronger growth in production and services, UK economy grew by 0.3% in the last quarter of 2009 faster than estimated. In order to help survive the recession, UK government also announces a plan to guarantee up to £20 billion of loans to small and medium-sized firms. To summarise the banking system coupled with capital markets and human greed had led to the financial crisis. The impact was felt across the globe especially in US and Western European countries including UK.
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