Financial Crisis: Assets Drops Rapidly Essay

Question:

Describe about the Financial Crisis and Assets Drops Rapidly.

Answer:

Introduction

Financial crisis refers to a situation whereby the value of assets drops rapidly. Usually this situation is associated with panic which at times may result into large number of investors rushing to bank to sell off their assets or even withdrawing money from their savings account with fear that the value of their assets may drop rapidly. Financial crisis can be caused by assets being overvalued and can usually be exacerbated by the behavior of investors. Global financial crisis is traced back to the middle of 2007 and 2008 whereby the world stock fell rapidly leading to collapse of large financial institutions globally. Government of different countries had to come up with rescue strategies to bail their financial plans. This essay provides an overview of Global financial crisis with an aim of digging deeply on some of the examples of financial crisis, their possible causes, the possibility of the crisis re occurring and the general reforms that have been developed to curb such crisis.

Examples of financial crisis

Financial crisis is a major economic catastrophe that is experienced in most parts of the world. There are series of financial crises that have been experienced since the famous global financial crises. Sub-prime mortgage is a good example of financial crisis that greatly affected the global financial market worldwide. In 1866, there was an international financial panic that accompanied the failure of Gurney in London, England. This crisis resulted to a lot of panic within the global market. In 1825, there was a pervasive recession in the British whereby nearly all banks including the Bank of England almost collapsed (Corsetti, Pesenti, & Roubini, (1999). The panic of 1847, started as a result of the collapse of British financial market. This subsequently led to the collapse of railway industry boom. In 1763 there was serious financial crisis which started in Amsterdam (Lemmon, Larry & Lins (2003). This crisis begun by the collapse of Leendert Pieter de Neufville. It spread rapidly to Germany and later entered the major cities of Scandinavia. Financial crisis remain one of the major catastrophic economic threat.

Back in 2009, the famous European debt crisis, which was famously known as Eurozone crisis saw many several Eurozone members unable to refinance their government without assistance of third parties (Taylor (2009). This crisis was caused by a combination of complex factors that included globalization of finance. There were easy finance conditions between the periods of 2002 to 2008 leading to this catastrophic financial crisis.

In 2008, the Great Recession was a financial crisis in Russian markets that was compounded by political fear after the war that occurred with Georgia. The plummeting price of crude oil was a clear indication of this financial crisis. As a result financial crisis is major global catastrophe that has hit several countries in the world. The diagram below shows graphical representation of the financial crisis that occurred in U.S.A between 2008 and 2009.

Possible causes of financial crisis

Excess leverage: excess leverage is one of the major causes of financial crisis globally. Usually there exists very little transparency in accounting for leverages. In fact at times, leverages go beyond balance sheet that subsequently results to financial crisis. This situation is usually beyond the skill of most legislators to handle.

Taxes and subsidies: Tax policies usually play a vital part on the flow of capital and the current tax code need a complete overhaul. Lack of Financial Transaction Tax encourage short term speculation and discourage the long term speculation, this results to financial crisis. Failure to eliminate the subsidy on debt based encourages more debt when we have much debt already.

Governance: a poorly governed democratic government results to mismanagement of funds. Here if exchanges are not properly managed by government, then the implication of poor governance would greatly result to financial crisis. If exchanges are governed as commons then there could be no way that civil society would condone the raised frequency which in most cases usually benefit the a few at the expense of low system resiliency.

Fraud: committing fraud is a major factor that has resulted to financial crisis. Some financial institutions have been prosecuted for their role in financial crisis. For example the Great Recession in Russia was of as a result of firms selling toxic mortgage-backed securities to institutional investors.

Conflict of interest: usually there exist conflicts of interest in a banking institution between which interests to serve first at the expense of another. Toleration of such blatant conflict would significantly result into financial crisis. Banks that serves self-interest at the expense of society interest is a clear indication of gradual emergence of financial crisis. Such situation would serve as self-serving and patently false assumption that is usually taken but in the long run would result into a serious financial crisis.

Liquidity: just like leverage, liquidity is very difficult to match. There is no reason for a bank to speculate building implicit backing of taxpayers. The liquidity ratio set by Basel 111 is an important battle to watch. At times it becomes very difficult to understand the true liquidity position of certain banking document. The difficulty in understanding true liquidity may result into critical financial crisis. Therefore it is important for a banking institution to strive and understand the liquidity of a given banking document.

These are the major root causes of financial crisis in most parts of the world. There are however reforms and strategies that have been set aside to handle such risks.

Can Global Financial Crisis occur again?

With various measures taken after the occurrence of global financial crisis, the question that still hit the mind of many financial institutions is that can the crisis re occur. After looking at the causes of financial crisis and the reforms that have then been developed to curb such crisis, I have tried to imagine of such crisis occurring again. (Mitton, 2002)My argument is entirely based on the causes and the major reforms that have been developed to deal with such crisis. I have also tried to look at the aforementioned reforms to check if really they work as expected.

Global financial crisis was not caused by a single factor but was caused by a combination of several factors ranging from political to economic factors. This is a clear indication that Global financial crisis would still re occur if such factors are not properly taken care of. Based on the reforms developed, we cannot assume that the reforms work perfectly. It is estimated that the crisis can reoccur but not like the 2008 financial crisis. This is because the reforms that were undertaken will mitigate the crisis. There are steady progresses after the famous 2008 crisis and in most parts of the world we have experienced a steady progress. This is a clear indication that the crisis may reoccur but not like the aforementioned 2008 crisis. (Mitton, 2002) A research conducted by Geithner shows that the government and the central government will be forced to act again in order to take the risks that the market will not be able to take. Stock market valuation appear high a condition that might lead to another financial crisis if not taken care of.

Scale and impact of financial crisis

The effects of financial crisis were widespread. It affected the investment in developing countries both directly and indirectly. Financial crisis also affected the banking sector in a number of ways leading to even collapse of some banking institutions. In this essay, I try to look at some of the impact of financial crisis both within my country and globally. In financial institution, the crisis led to panic as investors rushed to banking institutions to liquidate their assets in highly leveraged banking institutions. There was estimation by the International Monetary Fund that a lot of assets were lost. In developing countries, the financial crisis led to economic deterioration as there was insufficient funds to drive the projects that had been earlier initiated. (Reinhart & Rogoff, 2008) These countries that were hit hardest by the financial crisis unemployment arose due to the financial crisis. In fact in developing countries unemployed people were hit majorly as they were observed straining to acquire their unemployment insurance fund. In developed countries there was reduction in export earnings. Even though this was not a major impact on the economy of developed counties, it had a serious knock on their economy. Financial flow also reduced as a result of the crisis. The financial flow from the rest of the world greatly reduced during this period. It negatively affected the economy of the developed countries as there was global panic on the gradual financial flow. The following is a diagrammatic representation of some of the impacts of financial crisis in the federal balance sheet.

Proposed reforms to curb financial crisis

Regulatory responses have been set to address the effects of financial crisis. Several reforms have been developed to ensure that a repeat of the famous financial crisis be avoided at all cost. Regulations against as lending practices, tax policies and licensing have been developed.

Timothy Geithner blamed the governments for insufficient power to control the wreck less credit practices that lead to financial crisis. He further blamed bankers and financial sectors for failing to have memory to see what would happen if a large amount of money was build outside the safeguard of what economy would require. Financial firms were regulated from neither too big nor too interconnected to fail. . (Reinhart & Rogoff, 2008) When a firm becomes too big or too interconnected than we opt then legal authority need to be put aside to deal with this involvement. This strategy was missing during the aforementioned crisis but today has been implemented. The regulatory change that targets a particular asset such as hedge funds should be properly investigated. Transparency is needed such markets and all financial transactions need to pass through organized exchanges. They should also be a subject to strict reporting requirement to regulators. In America, the U.S president Barrack Obama and his advisors introduced some regulatory reforms in 2009 to curb financial crisis. These proposal were aimed at protecting consumer, bank financial cushions and the expanded the regulation of shadow banking system. Bills have been developed to regulate the lending practices that initially were not regulated. Government agency authority was passed to regulate government insurance and to refinance loans which was estimated at around 500,000 borrowers. . (Reinhart & Rogoff, 2008) Short selling restriction was also developed in the U.S. This included a ban on the temporary short selling of financial stocks. This reform aimed at reducing rapid price prior to its bankruptcy. There was a reform to close down all troubled financial institutions such as the hedge funds. Leverages that a financial institution could assume were restricted to help in regulating short term borrowing. These proposed reforms have led to a greater reduction of funds mismanagement and with time it is estimated that financial crisis will be entirely avoided.

Conclusion

Financial crisis still remain one of the major catastrophe in the economy of today. Undoubtedly it remains a setback to our economy of today and even tomorrow. Luckily this is a setback that can be overcome. There are many reasons why we should remain optimistic that financial crisis is a setback that we can overcome. Having leant hard lesions during this tough financial period, our economy has remained resilient as a result of good growth and better policies that have been adopted. There are large markets that continue to grow and will be able to assist the economy of developing countries. In the near future, the huge fiscal and monetary expansion programs, the developing may soon pluck the fruits of their renewed vigor to curb the global financial crisis that greatly affected their economies.

References

Corsetti, G., Pesenti, P., & Roubini, N. (1999). What caused the Asian currency and financial crisis?. Japan and the world economy, 11(3), 305-373.

Lemmon, M. L., & Lins, K. V. (2003). Ownership structure, corporate governance, and firm value: Evidence from the East Asian financial crisis. The journal of finance, 58(4), 1445-1468.

Mitton, T. (2002). A cross-firm analysis of the impact of corporate governance on the East Asian financial crisis. Journal of financial economics, 64(2), 215-241.

Reinhart, C. M., & Rogoff, K. S. (2008). Is the 2007 US sub-prime financial crisis so different? An international historical comparison (No. w13761). National Bureau of Economic Research.

Taylor, J. B. (2009). The financial crisis and the policy responses: An empirical analysis of what went wrong (No. w14631). National Bureau of Economic Research.

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