RECENT FINANCIAL CRISIS Essay

Speaking about the recent crisis analytics usually means the collapse of financial system in the USA. However, the financial crisis in America cannot be analyzed without the links to economies of other countries. Nowadays the world financial system is so globalized that the collapse in powerful and rich country like USA cannot miss the financial system of other countries. Economist Peter Morici coined the term the “The Great Recession” to describe the period. The first stage of crisis of the housing prices bubble, which created the effect of domino in thee USA and all over the world. The bubble of the housing market appeared at the same time with “cheap credits”, provided by President George W. Bush administration. It led to appearance of some minor bubbles like commodity bubble, and later to the liquidity crisis. At the end of 2007 the bubble collapsed and US economy began suffering from “domino effect”: a series of downfalls and collapses in different spheres of economy. Very soon economic crisis in the USA spread all over the world and led to current global economic crisis.
This paper provides the analytical review of the recent crisis starting from the collapse of financial system in the United Stated and to the crisis of capitalism as the economic system.
Origins and causes of crisis
1.1 Real estate market bubble:
a number of reasons fore real estate bubbles appearance
huge demand on financial assets and not many places can actually provide them
US real estate market was the largest bubble ever (Smith, 2011)
graph shows (Fig.1) figure of bubble created by line of median sales price in 1968-2010
1.2 The problem of unsecured mortgages (Blundell-Wignall et al, 2008)
‘American Dream’ zero equity mortgage proposals Bush administration in 2004
growing volume of mortgages in 2004-2006
impossibility to pay mortgages after the start of crisis and growing foreclosure volume
volume of foreclosures still grows reflecting the ongoing crisis (Fig.2)
1.3 New banking business model (Blundell-Wignall et al, 2008)
– too complicated new system of banking business
– fertile soil for banking fraud and shadow economics
– impossibility of banks to rule low income mortgages following new system
1.4 Poor regulatory framework (Blundell-Wignall et al, 2008)
– ‘consolidated supervised entities program’
– a number of unlisted rules and complex regulations
– new Senate Bill in 2010 as the attempt to change situation
1.5 Fraudulent banking (Krugman, 2009; Roubini, 2007)
the whole system of shadow banking
banks operated “shadow” actives, which collapsed together with real actives
due to fall of shadow system assets of many banks decreased on 40-60%
1.6 Incorrect pricing of risk
– globalization of banking system investments in international assets
– complex financial assets were to complex to evaluate risks
– total losses were higher than is was predicted (Bloomberg, 2008)
Commodities bubble (Irving, Sanders, 2010)
search for new financial assets with high liquidity
appearance of new bubbles including commodity bubble
collapse of small bubbles fastened collapse of financial system
graph of metal prices also creates the figure of bubble as it seen on Fig.3
Economic policy of cheap credits (Kemp, 2010)
Fed decreased its credit rates to provide the available credits
low rates attracted extraordinary number of borrowers
significant part of these credits turn to bad loans and toxic assets
Stages of recent crisis
2.1 The liquidity crisis on the US market (Goodman, 2008)
raising prices prevented the increase of capital in many U.S. businesses
many businesses could not stay profitable
price growth was combined with sharp demand decrease (Reuters, 2010)
2.2 The employment crisis
– loss in profitability led to jobs shortage
– growth of unemployment requires the rise in budget funds intended for paying welfare
– expenditures for social needs and current account deficit emptied federal budget (BLS, 2010)
– in June 2008 the rate of jobless male aged 25 to 54 (the main working force) were slightly lower than 9,5%, but it increased and fluctuated near the mark 10,5% (Fig.4)
2.3 Credit rating crisis
– credit rating of some American insurance companies was lowered by rating agencies
– these companies insured municipal bonds
– lower rating led to fall in demand on municipal bonds and decrease of their liquidity (Reuters, 2010)
2.4 Stock market crisis
– first downgrade of insurance companies credit rates provided the effect of domino
– the fall of stock market indices caused the outflow of investments
– the outflow of investments led to the further indices decrease
– Dow Jones Index turned downward repeating the trend of Great Depression times (Fig.5)
2.5 Impact on global financial institutions
U.S. financial system influences on financial institutions all over the world
U.S. collapse led to a number of similar collapses in other countries
consequences of this collapses still create problems for banks and institutions
Fed monetary policy crisis
September 2008 – March 2010 Fed injected $1.4 trillion into financial system
money was intended to support the system and prevent it from aftershock
instead it created the huge volume of debt and mortgage-backed securities
total volume of debt and mortgage-backed securities together with US treasury securities exceeded $2 trillion – the highest level ever (Fig.6)
Transformation of financial crisis to global economic recession
The US economy has been spending too much and borrowing too much for years and the rest of the world depended on the U.S. consumer as a source of global demand.
US problems influenced on trade partners in negative way
financial crisis in the USA caused the global economic recession.
Significant decline in economic activity
financial collapse and economic downturn led to US import decrease
trade partners of the US suffered from trade volume decrease
– trade and production declined all over the world
Similarities with Great Depression (Zweig, 2008)
there is no single opinion what crisis was worse, Great Depression or recent one
the recent crisis is ongoing and can hardly be evaluated
some o similarities between these periods are obvious
“The Great Depression was not some Act of God or the result of some deep-rooted contradictions of capitalism, but the direct result of a series of misjudgements by economic policy makers, some made back in the 1920s, others after the first crises set in — by any measure the most dramatic sequence of collective blunders ever made by financial officials. More than anything else, therefore, the Great Depression was caused by a failure of intellectual will, a lack of understanding about how the economy operated.” (Edwards, 2008)
2.11.1 Asset bubbles
– stock market and real estate market in the USA suffered from bubbles
– development of bubbles was similar in 1930s and at recent time
– two peaks on graph look similar
Total US credit debt ((Federal Reserve)
both periods of economic crisis was related to high U.S. credit debt
during Great depression US credit debt reached 270%, in 2005 – 295%
this is many times more than credit debt size in other periods of US history
credit market debt can be considered as the sign of unhealthy economics and possible crisis aftershock (Fig. 7)
Corrupt gatekeepers and lack of transparency (Blundell-Wignall, et al, 2010)
lack of transparency in financial institutions leads to fraud
growth of financial and banking fraud was hidden by corrupt gatekeepers
development of shadow banking system increased total downturn in both periods
Dow-Gold ratio (Lindstrom, 2010)
relative price of financial assets on stock market differs from real assets
Dow-Gold ratio reflects the difference between real and marker price
just before both crisis market prices were significantly higher than real assets
System crisis (Posner, 2009)
the reasons of financial collapse can be deeper that poor regulation and fraud
it can be economic downturn at the end of long economic period
it is also possible that this is the crisis of capitalism as a system
Conclusion
The recent crisis is more broad phenomena that the crisis of financial system in the USA. Though the collapse started from the US financial system, very fast it spread all over the world and transformed into global economic recession. The Great Depression was almost similar to current crisis, but the involvement of other countries is higher nowadays. There are some obvious similarities: high level of credit debt, overvalued market prices of financial assets, poor regulation, and so on. However, “Great Recession” is more significant for the economy of the world. The main reason is in globalization. Nowadays financial system of different countries are linked more closely that it was in 1930. Economists do not have single opinion regarding the causes of the crisis and its place in the global economic history. Some of them think that crisis was caused by internal reasons hidden in financial system and described above. However, some analytics suppose the recent crisis is the crisis of capitalism as economic system.