The Global Financial Crisis, Essay Example

Abstract

The present paper is dedicated to the examination of the global financial crisis and its impact on the economy of the USA and other countries of the world. Major attention is drawn to the underlying causes of the crisis, the impact of the US critical situation on the world’s financial situation, international trade, and other aspects of international cooperation such as FDI and international stock exchange. Various aspects of the crisis impact are investigated, e.g. the effect on the US housing market, the impact on borrowing money, and the commodity boom and bust. Further on, the variety of global implications is observed: the impact of the US crisis on the global financial system, the impact on globalization etc. is in the center of focus. A brief overview of implications for separate countries and regions of the world is undertaken. Finally, a series of conclusions and recommendations for the future perspectives of the global crisis as well as the ways to have avoided the crisis are presented in the concluding part of the work.

Introduction

It is obvious that nowadays the world is still deeply involved in the global crisis, recession, and depression in the majority of significant sectors of national and international economy. Both the developed and developing countries of the world have been stuck by the soaring figures of economic growth, large-scale lays off and enormous financial losses due to the financial market collapse. As a result of the fall of the US financial market due to the prior boom of the housing and consumption market, the interconnected commodity and financial markets showed the sudden downturn in 2008. The financial consequences of the major financial firms’ collapse could not have been predicted at that period of time, but soon the situation revealed its dramatic image. The mass lays off led the country to the increased borrowing practices in an attempt of the nation to pay its debts off in a conventional manner. However, the second facet of the US market, an unrivaled fall of lending capacity and lender confidence, completed the picture by leaving people without borrowed money and without any possibility to find it.

One can imagine to what results the comprehensive troubles in the financial market of the US led; since the majority of capital in the country was mortgage-backed, it collapsed at the foreground of soaring housing prices and led to the overall despair. People without jobs and without money were urged to sell their homes, but they could not do that because of the collapsing housing market. The unpredictability of the financial situation, the dramatic problems in the banking sector leading the most stable financial firms, bankers, and insurers to nationalization and being bailed out by the Federal Reserve caused subsequent reactions in other countries. Capital was gathered from developing countries to save the economy of the US, thus aggravating the international relations situation and hindering the whole process of international cooperation. Developing countries feeling lack of finance showed in economic growth and decreased the levels of import, thus infecting the whole global economy. There seemed to be no way out of the situation, and there is hardly any at the present period of time, taking into consideration the disastrous consequences of the US economic destruction.

Taking into consideration the current catastrophic situation in practically all markets of the world, and consequently the field of international trade and financial exchange, one should think it is appropriate to investigate the causes and stages of the US financial crisis in depth, and to produce a set of conclusions on how the crisis emerged and expanded, how it managed to affect other countries of the world so bitterly, and whether there initially were any ways out to predict and prevent the crisis at its roots. It is logical that the US financial market turned out to be too much inter-related with other economies and markets of the world, which caused the global spread of the crisis infection. In addition, the US market was too reliable on the risky mortgage-backed securities, which led to the enormous systemic risk causing the downturn of one sector of economy after another. The US marker has always been of central importance in the global economy, which caused the serious impact on other countries. Hence, the ways to restore the situation in the USA and the whole world are seen in the reconsideration of reliance on risky securities, the comprehensive action on the macro- and micro-economic level, and the international cooperation and mutual support by countries deeply affected by the crisis in the USA.

Literature Overview

The present paper relies heavily on four major sources chosen for consideration. The first source deals with the exploration of the global financial crisis and its implications on the global economy. Baily and Elliott analyze the initial burst of the housing market as the first step to the critical situation that began to manifest itself in 2005, and overview the consequent stages of crisis development in the field of housing and commodity consumption (Baily & Elliott 6). The authors’ main thesis statement is that the problem was aggravated because of the large-scale unemployment that made the domestic economy literally stuck. People who had no jobs and no money for spending could not push the economy out of the economic recession because they had no purchasing power for that.

No purchases were undertaken, but only sales of property by citizens in despair were a typical image for 2008 and the beginning of 2009 (Baily and Elliott 7-8). Therefore, the authors see the systemic impact on the crisis from the consumption field and from the direct effect of the nation’s reaction to the situation. The conclusion they make is that too much reliance was evident on the banks with much lending power, much borrowing which was practically always mortgage-based and little economizing and saving for the sake of securing one’s future in case of trouble (Baily & Elliott 10).  The high-risk lending practices have also been indicated as the driving force of the US crisis by Brandon and Welch; the authors explored the role of financial planning in the outbreak of the crisis and as a measure of its mitigation (Brandon & Welch 96).

The purely financial angle of attention to the US financial crisis is taken in the work of Dick K. Nanto; the author provides a detailed analysis of the four stages of the financial crisis that were evident in the USA (Nanto 8-10). Among other issues of Nanto’s attention are the measures for coping with macroeconomic effects of the crisis and regulatory and financial market reform steps (Nanto 10-12). The author pays attention to the importance of eliminating political, social, and security effects of the crisis as well: among the problems of number one priority  he names coping with poverty and coping resources allocation, problems of international leadership and formulation of healthy attitude to the US, and organization of proactive political leadership on the national level (Nanto 15).

Baily and Elliott explore the causes for the global impact of the financial crisis in the US and see the prime reason for this in the excessive confidence in the mortgage-based CDOs and CDSs (the essence of notions will be explained further) that lost tremendously in price as soon as the troubles in the housing, and consequently financial, market became evident in the USA (Baily & Elliott 5). Nanto also pays much attention to CDOs and CDSs in the formation of the crisis in its current state, and indicates that CDOs appeared to be the primary cause of the AIG collapse (Nanto 4). The main reason for the global reach of the crisis is seen by Nanto in the overall reliance on American securities that lost their prices in 2008 and paralyzed economies of the major part of the world (Nanto 2).

The final source taken for the present analysis is the 2009 estimate of the critical situation all over the world by IMF. The measures IMF specialists outline as a source of overcoming the financial tragedy in the major part of the countries in the world include repairing the financial sectors in a domestic manner, supporting aggregate demand of the nation, easing the external financial constraints (through promotion of financial cooperation despite the hard financial conditions), and facing the medium-run policy challenges (IMF xiii). The most serious impact on the global economy is estimated in the IMF is seen in weakening the national currencies (especially the ones of developing countries), curtailed access to external financing, and fiscal deficits that widen sharply (IMF xvi). Speaking about finding the coping solutions, the IMF specialists underline the expected hardships in the process of building the saving potential by households, and the reduction of financial leverage that will inevitably occur (IMF xvii).

The Crisis in Perspective

Upon a thorough investigation of the crisis outbreak, the majority of researchers come to a unified conclusion that the problems in the housing market appeared the major cause of problems. Baily and Elliott note that the residential investment in the USA reached high volumes at the beginning of the 21^st century, which caused a rise in the commodity market as well (e.g. buying new furniture, appliances etc.) (Baily & Elliott 6). However, the market had become saturated by 2005, and the following years witnessed a growing decline (-18% in 2007, -21% in 2008, and -38% in 2009) (Baily & Elliott 6). The logical reaction to the decline was the fall in housing prices. As a result of that trend, households lost $13 trillion in equities and home prices – mortgages remained the same while the prices fell, and the families appeared unable to pay off their mortgage loans on the background of the declining economy and national financial prices (Baily & Elliott 6).

The problem revealed itself when the levels of consumer spending started to fall; during the period of the boom ‘innovative’ products of the financial market and consumer spending (and consequently borrowing) fueled each other to reinforce the economic growth. However, as soon as the decline started, the two deeply interrelated fields started to drown each other due to the systemic correlation they represented (Baily & Elliott 7). At that point, the problems in the housing market transformed into problems in the financial market, which was revealed in the borrowing issues (Brandon & Welch 96).

Borrowing money from the banks and large financial institutions has for a long time constituted the core of the US prosperity and high living standards. While the crisis was still not evident, people did not have saving habits and enjoyed the high level of trust from lenders, therefore obtaining many possibilities for financing their large-scale acquisitions like homes or cars with the help of borrowed capital. Confidence in the securities was also rather high, so people made investments and saved money in the form of CDOs and CDSs. The credit default swaps (CDSs) and collateralized debt obligations (CDOs) are the central figure in the financial side of the crisis. CDOs were primarily based on subprime mortgages. Payoffs and collateral calls on CDSs issued subprime mortgage CDOs became the largest cause of AIG problems (Nanto 3-4). The 2007 liquidity crisis hit was another point in the downward direction of the US financial market (Baily & Elliott 5).

Therefore, the crisis that began as a burst of US housing gave rise to the foreclosures in the market and resulted in the global financial and economic crisis. As the credit flows froze in 2008, and lenders’ confidence dropped, the fundamental weaknesses in the financial systems worldwide were revealed in the systemic inter-reliance on each other (Nanto 2). The US attempt to save its domestic economy from a crash resulted in the worldwide crash of less stable and more dependent economies. As a result of pulling capital from other countries, the US managed to achieve partial restoration of its financial structure, but at the same time the chain reaction because of lack of external financing caused the downturn of economies worldwide, which still returned to the USA in the form of international trade decline (Nanto 2).

Consumption market in the USA could not help affecting the overall state of the economy, and added to the aggravating effect of the crisis. The reason for this is the direct relationship of consumption habits and the borrowing possibilities of US citizens. As Baily and Elliott note, the US took the first step of tightening the bank lending standards, with the total freeze of loans shortly after that (Baily & Elliott 8). What was seen as an urgent rescue measure for the financial market in the US, turned out to be the total drama for the US consumers. At the background of massive lays off, as estimated by Nanto at the level of 111,182 in May 2009, people were left without the prime source of income, without health insurance, and with huge mortgage debts they had to pay off to remain with a dwelling (Nanto 82).

Therefore, consumers left without financial sources cut their expenditures dramatically, which was the start of the commodity market collapse. Later on, with the cuts of external financing for the developing countries, the US was left without a significant share of import reported to decline by 34% (Baily & Elliott 16). This tendency appeared to aggravate the state of the US domestic market seriously, and revealed the heavy dependence of the USA on the capital flows from the rest of the world (Baily & Elliott 20).

Global Crisis

As it has already become evident from the information above, the US financial and economic crisis produced the disastrous effect on all economies of the world. The reason for such vast effect of financial problems in one country is the close relationship between economies in the international trade and financing nowadays. Each country depends on the set of others in terms of securitization of the financial market and the globalization of the stock exchange, the internalization of business due to the increase in emergence of multinational corporations tying the international business into a unified biological organism. Thus, problems in one organ of the body inevitably cause the infection of all organs and systems of organs, which actually took place with the global economy. The Asian market that thought to be shielded by the sound banking system and corporate balance sheets witnessed a decline from 10% to 25%, mainly in new industrialized economies such as Singapore, Korea, Taiwan, and SAR (IMF 711). The main reason for such a dramatic downturn was the quick fall in demand for consumer durable goods in the USA and other countries impacted by the recession (IMF 71).

Europe appeared vulnerable to the turbulence in the US economy as well. The main causes for the plunge in the US markets were the lower expectations about the future income European households had, which resulted in the decrease of the international trade (IMF 75). The crisis in Europe had begun earlier than the US financial collapse manifested itself because of the increase in oil prices (IMF 75). However, the countries hit the most by the recession were the CIS countries that represent the emerging European economies, and developing countries depending heavily on FDI. The CIS economies are thought to have experienced the triple blow of the crisis, including the effect of financial turbulence, the slumping demand in terms of export to advanced economies, and the fall in commodity prices, namely the prices for energy (IMF 84).

Conclusion

As one can see from the present research paper, the US financial crisis started as a problem of financing the growing consumption demands of the US citizens, and the crisis of lending practices. Further on, the inter-relation of the global community in terms of finance, trade, and economy revealed itself in the systemic risk; the initial efforts taken by the US policymakers caused the unrivaled economic downturn all over the world, with the most distant and independent economies affected. The main consequences for the advanced economies included the collapse of financial and security markets, freezes in the domestic housing and commodity markets, and huge job losses. The developing economies were troubled much more as they appeared paralyzed in their development and advancement because of the lack of external financing from the US and other advanced countries. Being the bystanders of the crash in the most developed and prosperous markets of the world, developing countries became the innocent victims of the downturn, so they need urgent help as well, being unable to cope with the crisis only due to their internal resources.

Generally speaking, it is clear that only a comprehensive effort of the US financial legislators and the cooperative measures from other countries can help the contemporary world get out of the deep slump of the economy, consumption, and securities market. To outline the major perspectives of coping with the crisis for the near future, one should turn to Nanto’s consideration of the solutions proposed by the US Congress. They include:

• Introducing strong financial regulations to detect threatening institutions and economically unstable enterprises
• Establishing comprehensive supervision of financial markets
• Protecting consumers and investors from financial abuse
• Providing the government with tools to manage increased international regulatory standards (Nanto 6-7).

It is clear that the whole world, the US included, will need several decades to cope with the crisis and its consequences. The destructive ideas on self-reliance hinder the international trade, so a new level of mutual trust should be established for countries to regain confidence in each other. Households will need more financial guarantees and time to accumulate capital for securing themselves from another turn of the crisis. Therefore, coping with the crisis and restoring the trusting and deeply interconnected international trade space is a long-term perspective that should be given a number one priority alongside with domestic restoration and recovery.

Works Cited

Baily, Neil Martin, and Elliott, J. Douglas. “The US Financial and Economic Crisis: Where Does It Stand and Where Do We Go From Here?” Initiative on Business and Public Policy at Brookings. 2009. Web. 30 November 2010.

Brandon, E. Denby, and H. Oliver Welch. The History of Financial Planning: The Transformation of Financial Services. San Francisco, CA: John Wiley and Sons, 2009.

IMF. “World Economic Outlook: Crisis and Recovery”. World Economic and Financial Surveys. April 2009. Web. 30 November 2010.

Nanto, K. Dick. Global Financial Crisis: Analysis and Policy Implications. Washington, DC: DIANE Publishing, 2010. Print.