Global Financial Crisis
The global financial crisis sent shockwaves across the globe. Observers cite institutional failure while others believe cultural and social factors played a leading role towards the near collapse of the economy. Serious questions were raised regarding the handling of the capital markets. By way of illustration, the decline in the limitation of liability for over a period of thirty years and the extent of market deregulation remained questionable. Issues regarding what exactly went wrong came up in the lead up-to the last US elections as the Democrats accused the Republicans for facilitating the emergence of the economic problems. The elections are mentioned here based on the intense heat that the credit crunch generated.
The most baffling question revolved around the role of deregulation in the crumbling of the credit markets. By way of illustration, the often-touted attitude of 'light touch' has been linked to the fall of the Northern Rock in the UK. On the other hand, in the United States, the long running history of deregulation coupled with financial plutocracy was seen as major contributing factors to the economic slump. In light of this, a review of the factors that contributed to the financial crisis follows in order to reach a conclusion whether institutional or cultural/social factors were responsible for the economic concerns. The paper also compares and contrasts the approaches taken to managing the crisis by the American, British and European authorities respectively
Shadow banking system played a role in the occurrence of the financial crisis. Shadow banking grew out of securitization of assets coupled with the integration of the system into the capital markets. The system hugely affected the United States. When firms engage in the shadow banking approach, the capital markets become inseparable from the banking sector. As such, the conditions that guide funding become closely tied to the leveraging that companies apply. When balance sheets of the institutions reflect growth, a sense of credit availability is generated. However, possible contradictions in the balance sheets present a misleading picture which facilitates the emergence of a credit crunch. Although, the intention of securitisation was to transfer credit risks to firms able to handle them better, instead, such contributed to increasing fragility in the entire financial markets (Bellamy and Magdoff, 2009).
The emergence of the housing bubble in 2007 and 2008 presents a significant turning point in the credit markets. If the authorities had taken the correct measure to regulate the financial markets, then the housing bubble could have been avoided. In addition, the regulatory mechanism should have regulated takeovers, mergers and bankruptcies. Offering such regulation could have helped in restoring confidence in the markets.
Fiddling foreclosures was a serious mistake prior to the financial crisis (Blinder, 2009). Regarding this aspect, the government is put on the spotlight. Concisely, the government failed to take action as the recessionary tendencies began showing up. By way of illustration, had the government taken appropriate measures to limit foreclosures, then such could have helped in mitigating the issue. A proper working government could have spotted the foreclosures early enough and take corrective action. As a matter of fact, the government had foreseen the foreclosures twelve months before they actually happened. Based on this establishment, the reason why the government did not act presents a dilemma. Barney Frank the Massachusetts democrat and the then chairperson of the Federal Deposit Insurance Corporation, saw the problem ahead and raised it before the Congress and the Federal Treasury. However, the two bodies declined to act on the advice due to the preference of the free market enterprise. In addition, the two bodies were unwilling to commit the taxpayers' money in a bid to prevent the foreclosures.
Some observers would point out that the action by the Federal Reserve to scale down the Federal funds rate was the actual trigger of the financial problems (Brigo and Torresetti,2010).The move by the Federal Reserve pushed the US economy into unbearable levels of uncertainty. After the horrific move, interest rates in the country went tumbling down by almost seventy-five percent. Further losses in the Dow Jones market compounded the problem. Although the move was critical in stemming the economy, it actually triggered the recession.
The other issue of concern was letting Lehman go. The question of letting Lehman Brothers sink suffices because the authorities bailed out other players such as the Bear Steams. Based on the action, the authorities did not see the value of protecting the Lehman Group. After letting Lehman Brothers collapse, the picture was clear that the economy was in trouble. The Lehman Brothers was a big company which was doing well moments before the credit crunch. As such letting it go was a big mistake on the part of the authorities. The wisdom behind the act of saving Steam Bears and letting Lehman go is questionable since the latter was twice as big as the former. After the collapse of Lehman, lending was frozen. In effect, the move slowed the economy.
Social and cultural issues also emerge as contributing factors to the credit crisis. The high leverage is attractive to high risk takers. The investors were willing to gamble. This indicates that the society was moving away from its cultural way of life by upstaging accepted confines of doing business. In short, the society had become greedy and was seeking opportunities that offered the highest rates of interest. This shift allowed the financial institutions to take advantage.
The growing levels of debt in the society also present a significant contributing factor to the global financial problems. As keen observers review the events leading to the crisis, it emerges that a good percentage of citizens were seeking funding from financial institutions for various investment purposes. More significantly, the chase to own homes among the middle class was a huge factor that facilitated the occurrence of the credit crunch.
Whereas, overwhelming evidence point to the institutional aspect of failure as the main cause of the financial meltdown, social factors such as the response to the emerging truths on the capital markets exacerbated the situation and thus they effectively contributed towards the crisis. Further, in the capital markets, investors speculating for higher returns played a role in the meltdown. They committed resources into firms such as the Lehman Brothers based on the belief that such organizations offered a big opportunity to earn more. However, such moves were fuelling the financial crumbling. The fact that the investors panicked after prices began falling underscores the idea that the fear of societal members contributed to blow the crisis out of proportion.
Transformation of the banking institutions was also an issue. The nature of banking was facing huge transformation. More specifically, the purpose of banking was shifting as the sector reflected a high level of proprietary trading (Ferguson, 2009). The changes in the capital markets cut across a big percentage of the economy sectors as well as in most countries. Famously, the widespread changes were duped the 'global financial services revolution'. In order to illustrate this case, reference is made to the financial services sector in the period between 1930 and 1970. During this period, financial systems operated within national boundary confines. The system also remained largely uncompetitive. Although the financial services sector was largely under regulation, it self-regulated. The close regulation perhaps explains why the sector was uncompetitive.
The role of politics in the economic slowdown is also visible. The US Congressional politics revolves around dollars. Discussions on financial matters are also premised on dollars even outside the United States. Switching focus to the UK, party politics are modelled on pounds. In the UK, the decline of mass membership led to the expansion of City financing.
The reinvention witnessed in the banking industry perhaps played a significant role in the unfolding of the credit crisis. Under the new banking system, banks began creating mortgage-backed securities. The move to create such securities was to serve the purpose of minimizing risk to the banks. The buyers of these securities were interested in making abnormal profits. The reintroduction of investment banking in 1990's is also an alarming concern in reference to the emergence of the credit crunch(Ferguson, 2009). At this time, investment banking was reintroduced. The baking was modelled alongside the merchant style of banking. The issue of concern here lies on the rise of own account trading.
The review of the causes of the financial crisis establishes that both institutional and cultural/social factors played a significant role. However, the institutional factors appear to have been more influential. Despite the realisation, institutional factors were boosted by the cultural/social factors in causing the credit crunch. By way of illustration, the desire by the society to own homes and to invest in high return investments soared due to market deregulation.