a) Financial crisis definition Financial crisis is defined as the financial meltdown, or in other terms as the credit crunch. A financial crisis is an economic incidence makes it hard to obtain and access the capital for use in investment. The economic crisis is an ongoing economic problem that was more pronounced in 2008 resulting in the liquidity in the global credit markets and its financial systems (Berlatsky 77). This means that there was no credit available for the investors, which adversely affects the poor countries.
For the developed countries, this crisis created panic and was perceived as the most horrible in the previous years. It was equated to the 1930 depression of the economy. In addition, to understand the causes of the financial crisis in 2008, it is crucial to know that it is a representation of the fall of the interlocking set of the organization, governing the economy since the 1980s. The financial crisis has numerous dimensions (Wallison 31). For example, the build of debt, signified by the household and corporate debts, but majorly the household debt played the major role.
Furthermore, the possibility of recurrence of the international monetary instabilities and the global refusal to fund the US and the UK economic crisis is one of the dimensions of the financial crisis. The third factor that can affect the economy is the ecological crisis, which brings the possibility of the prospects of a stop to the decline in the prices on goods and services, which can be seen as the medium term development and the determination of the underlying tensions requiring immediate changes (Gup, 2010).
It is important to define the competing strategies of capital for investments in the attempt to manage the crisis. ) Past financial crisis I) Worst Economic Slowdowns in History The end of the First World War ushered in the beginning of a new era in the history of the US. Enthusiasm, optimism and confidence marked this era. During this era, the invention of airplanes and more of the electronics made life easier. The stock market was not perceived as a risky investment as this investment seemed as a business that could not fall. However, as the numbers of the people investing in the stock market as on the rise the stock prices began to rise and was clearly seen in the 1925.
The stock prices began to fluctuate up and down throughout the consequent two years, followed by an upward trend in the year 1927. In 1928, the market boom transformed the perception of investors for the possibilities of making long-term investments in the business. The interests in the market increased as most of the people believed that this was the only mechanism through which they could be rich. The whole of this processes culminated in a financial recession reaching its peak in 1930 (Gup 74). The 2008 economic crisis is a representation of fall of the set rules to govern the global economy since the 1980s.
Some of the set rules are a representation of the solution for capital for investment that had emerged in previous decades. The 1970s crisis and its attempts to be resolved in the 1980s was due to the contradiction a midst capitalism, exemplified by the creation of profits and the realization of the profits in circulation and in the exchange of the currency (Kolb 23). The crisis during this period was increased by the historical weakness of the British capital that left the UK vulnerable to the economic crisis.
Most of the banks were ready to lend, therefore, imposing cheap lending rates, with even borrowing with later interest rates, created the debt crisis for the poor and middle class economies. The financial crisis in the 1980s led to the coming up of the new just financial order by the WCC. Some countries, such as the Asian countries, were elevated by the speculative transformation of money into the form of commodities that could be sold delinking the properties from the purposes of the real production of services (Suter 34).
I) National effects The United States is one of the biggest economies globally, due to its creation of the planetary currency. This position has given it some of the substantial reasons for it to stir the economies of the world, and in the 1990s, the banks in the USA became the financial instruments for deposits of the surplus from the oil producing countries. The Real domestic product (GDP) began to contract towards the third quarter of 2008, with a gradual annual fall since the 1950s (Suter 45). The capital investments which was n the decline in 2006 matching the 1958 post war record in the first quarter of 2009, dropping by 23. 2%. Furthermore, the rising tide on bad debt threatened the solvency of most of the banks. The changes in the Federal Reserve policies created panic in the inter-blending market (Gup 44). This was due to the uncertainty in which banks would survive their tenure in the lending of money to anyone leading to the censure of the economy. The investors in the stock market panicked making them send all their stock shares to a free fall.
The decline in the shares significantly reduced the capital shares that greatly affected the bank regulatory system as it is based on the idea that the loans borrowed have to be a certain multiple of the bank capital (Dalton 63). This led to a massive decline in the lending system that significantly threatens the stability of the system. The significant effects of the financial crisis were more apparent was first detected in the US and UK, where housing booms and the deregulation in the banking was on the rise.
It was clear that most of the banks in many other countries and specifically in Europe made the loans in these markets making the banking crisis affect the major industrialized countries. ii) International Effects The economic crisis brought many impacts to wide of the different economies cutting across the globe. The negative effects of the economic recess were reported majorly in most of the developing countries. There was the emergence of the shadow banking systems and the proliferation of the prime lending that greatly affected the economies dependent on the US.
For instance, the United Kingdom together with most of the other European countries were immensely affected due to the existence of a complex network within the financial institutions with toxic assets transactions (Arestis et al. , 56). Most of the regulatory authorities lost track of the debt as it was repackaged in new financial packages, and a sale was made to institutions. This was exemplified by the way mortgages were converted to the collectivized debt obligations and then sold to others.
Due to this financial crisis, Germany was greatly affected as most of its banks had invested in the financial instruments that contained mortgages on the properties in states such as the San Diego and the southern parts of California. At this location, the prices on houses rose by close to 22% in 2002. The effects are brought out clearly on Goodstadt Leo:- The lending banks transferred these risks to other countries ultimately meaning that there was the reduction in the quality of investments in the pension funds. This resulted to the sudden changes in the bailout banking policies, which varied among the countries.
There were also significant effects of the financial crisis on the African countries. For instance, there was a fall in the prices on the raw materials by the African countries due to the recess. The recess eventually wiped out the economic gains in previous developments in these countries; The export and the import rate dropped in 2008 in South Africa followed by the fall in the revenue earned from the sale of the precious metal, which is one of the major sources of wealth. In Zambia 65. 8% fall in the price of coal led to a substantial fall in government reserves. )
Devastating economic events I) Foreclosure Crisis The mortgage foreclosure crisis caused a critical drop in the cities revenues, an increase in the crime rate and homelessness, evidenced by the increase in the vacant properties according to the results of the survey carried out using an online questionnaire. Both the predatory lending and the excessive household overreaching occurred during the subprime housing bubble. The foreclosure crisis is described in Wallison, Peter:- Wallison attributed the major cause of the foreclosure crisis to be a result of the policy implications.
This is because if the predatory lending as the primary cause, strong consumer protection laws could have been sufficient to avoid future foreclosure crisis. This is because the existence of such laws could prevent There was an increase in homelessness and the demand for temporary accommodation as the crime rate increase due to the lack of money for employing cops on the streets. Most of the buyers were the African Americans who were enticed by the zero down mortgages on the averaged priced homes. The survey also indicated that the lower income families disproportionately were affected by the housing crisis.
The fore closures created ramifications have been spared of the worst crisis. Dodd-Frank law may be adequate to avoid a future foreclosure crisis. This is because such laws would stop Wall Street banks from creation of high-risk loans that borrowers could not possibly afford. If household exceed your limit was the primary culprit, preventing another foreclosure crisis is a much more complex policy challenges (Darity 89). ii) Stock Market Crash The US stock market reached its peak in the third quarter of 2007, with the Dow Jones industrial index exceeding 14000 points, which entered a distinct acceleration in the last quarter of 2008.
During this period, the market experienced some days of negative movements in October 2008. According to Dalton, (2011), the years that preceded the credit market collapse, was thrived by the mortgage industry. The people with poor credit borrowing capacities were given an access to loans that they did not afford, and though the homes prices were on the rise the poor lending practices were ignored. As the mortgage defaults became on the rise, the national economy started to trample, despite the efforts of the federal banks to stabilize the credit market.
During this period, the congress had passed the bailout bill, but there was panic. The Labor Department reported that the economy had lost close to 159000 jobs in September, and the Dow dropped 800 points, closing before 10000 for the first time since 2004. Consequently, the federal bank Reserve was fighting to stabilize the banking liquidity crisis that was ongoing by lending close to 540 billion dollars to the market funds and the coordination of the global central bank bailout and lowering their funds rate to 1 percent (Kolb 98).
The Dow responded swiftly by plummeting 13% throughout the month as the economy contracted by 0. 3% in the third quarter. In November, this year, the labor Department reported the economic loss of 240000 jobs as the AIG bailout grew swiftly to 150 billion dollars; the Government Treasury announced that it had started to use the $700 billion reserve to purchase the stocks in the national banks as the Big 3 automakers requested for the federal bailout.
d) Main causes of the 2007-2008 Financial crisis I) Under-regulated banking system The main causes of the crisis are linked to the systemic fragility added to the existing imbalances within the economy. These imbalances contributed to the inadequate functioning of the world economy. Some of the underlying causes include the inadequacy of the structural reforms leading to the poor coordination of the macroeconomic policies leading to unsustainable coordination of the policies. Failures in the financial regulatory systems, its supervision and monitoring of the financial sector were some of the major factors propelling the adversity of the crisis (Kolb 78).
The crisis was made acute by the inadequate surveillance and early warning on the crisis. The regulatory failures were due to the over reliance on the market self-regulation, lack of transparency and financial integrity. Others include irresponsible behaviors that led to excessive risk taking consequently leading to the unsustainable assets prices. In addition, there was an elevation in the irresponsible high levels of consumption and leveraging which was enhanced by the ease in the acquisition of credits from the banks and asset prices.
Almost 50 percent of all the mortgages outstanding in the US in 2008 were subprime, deficient and high-risk loans. The government directly owned approximately 19. 2 million of the loans and government sponsored agencies. Two thirds of the mortgages were on the balance sheets of different government agencies and the firms regulated by the government, implying that the government housing policies were responsible for most of the weak mortgages, an indication that the defaults in the unprecedented numbers (Chinn and Jeffry 34). i) Reckless Greed There was a collective responsibility on the different financial institution that contributed to the factors that in small parts led to the financial crisis through greed and incompetence. For instance, the Wall Street did not put into place sound risk management processes that could raise (Haytmanek, 67). In addition, the government regulators failed to oversee the financial process or to monitor the lending of cash by the banks, the investment banks and international financial systems.
The rating models were also flawed as there was a conflict of interest among the agencies themselves that allowed complex toxic instruments released to the financial market (Kolb 89). Most of the individuals obtained their mortgages under false pretense, through unregulated mortgage brokers who took advantage of the unsophisticated buyers due to the negligence and the greed of the investment banks and the mortgage lending institutions. The housing bubble involved the increase in the real home prices of 80% over the last decade as the earlier ones nvolved the increased for 10 years, before deflation. By the end of June 2008, there were 27,000 million subprime housing loans. Most of the home-buyers due to negligence and greed to own more homes believed that the housing prices would go up always. On the other hand although these factors played a role in the creation of the financial crisis, it is not the absolute cause as greed and incompetence have always been part of the community making it quite difficult to believe that these factors combined perfectly to create the financial crisis.