It has been rightly said by many newspapers all over the world that "When US sneezes, the whole world catches cold." The United States was the world's leading economic power in the second half of the 20th century and London was a leading financial centre of the world. When the markets fell in 2008, their powerful status in the global financial sector came under a threat. This report is a research into the MAIN causes of the global financial crisis. The essay also proposes recommendations for the UK government in order to reduce chances of another crisis. The financial crisis has been defined by Gerald (2009, P. 27 - 44) as the worst global economic downturn since the Great Depression of the 1930s. Deep recession has struck advanced economies while the emerging markets are facing a sharp economic slowdown.
The financial crisis has been a topic of great discussion in order to understand what exactly happened and who can be blamed for it. The essay presents an analysis done by different authors, reasons given by them and concludes the main causes/roots of the crisis along with steps that should be taken by UK government to reduce danger of another crisis.
According to Booth (2009, P. 52) the roots of the financial crisis 2006-2009 go back to the great depression of 1930s when credit was tight and mortgages were hard to sell. Therefore, in order to revive the markets, the government had to step in to form many regulations and laws. Amongst them was the Banking Act of 1933 (Glass-Steagall Act) which made it illegal for any one institution to form any kind of combination of a commercial bank, aninvestment bank and/or aninsurance company. TheGramm-Leach-Bliley Act of 1999 is anactof the106th United States Congress(1999-2001) which repealed part of theGlass-Steagall Act of 1933, opening up the market amongbankingcompanies,securitiescompanies and insurancecompanies. Booth (2009) argues that if Glass-Steagall law would still have been in place the pure-play investment banks likeLehman Brothers, Citigroup and the insurance companies that were allowed to deal in securities like theAmerican International Group would not have run into trouble. Sorkin (2009)
In the beginning of 2001, the interest rates were 6 percent when Alan Greenspan, the chairman of US Federal Reserve from August 1987 to February 2006, and his Fed governors saw a slowdown in the economy due to the puncturing of the 'dot com' stock market boom in 2000 and the emergence of accounting scandals of Enron and WorldCom and thus lowered the interest rates Faber (2009, P. 13-19). Due to seven separate cuts, interest rates fell to 3.5 percent by August 2001. Greenspan had to reduce the interest rates aggressively in 2001 due to the devastating events of September 11 which had become a global issue. The interest rates dropped to half, within three months. Borrowing cost had plummeted to levels not seen in 50 years which continued till early 2007 due to the July 2005 bombings in London's transport system. Booth, et. al (2009) & BBC news (2005).
According to Rowley (2009, P. 26-31) and Faber (2009, P. 13-19), Easy money fuelled a house price bubble and a surge in personnel indebtedness. Thus, a debt bubble formed as money became almost free if you could borrow it. Low interest rates led to widespread surge in the indebtedness throughout the US economy. The rise in consumer debt reflected the response of consumers to the low interest rates. In October 2008 consumer debt stood at $2.58 trillion. As the credit terms tightened, following the financial crisis of September 2008, the leveraged impact on household consumption became very sharp. Another reason for cheap credit was the influx of capital from China in the United States. US trade deficit is clearly reflected in China's capital sur. US companies paid lot of money for goods made in China to gain competitive advantage and thus making the government's inability to manage the US trade deficit another major cause for the crisis.
A bank is a place that will lend you money if you can prove that you don't need it. Bob Hope- Quote garden (2010). A large number of unscrupulous realtors encouraged their clients to write liar contracts, in which borrowers were encouraged to overstate their income and net wealth to qualify for higher mortgages leading to increase in Sub-prime lending. The excess of the housing bubble thus reflected a combined failure of private market and government agencies ultimately needing the government and its independent agencies to bailout the undeserving. For e.g., the world's largest insurance company, AIG which had ventured unwisely and extensively into financial markets, was bailed out by the Bush administration on the dubious ground that "it's too big to fail"- Rowley (2009, P. 31-35)
I had a cheque returned earlier. "Insufficient Funds" Mine or the banks ? Pyers Symon- BBC news (2008). Shadow banking system has also been responsiblefor adding to thesubprime mortgage crisisand thus ultimately the globalcredit crunch. According to Davidson (2009, P. 17) theshadow financial systemincludes non-bank financial institutions that has a critical role in helping business by lending money to operate.
The low-wage economies The low-wage economies that fuelled the high-risk finance were another cause- Manson (2009). In the intervening decades, low-paying jobs (service) replaced high-wage jobs (manufacturing) for instance- the most popular job in Michigan was to work in the restaurant or a fast food joint. 155,000 people across the state started earning their living this way. Second in job league table was 150,000 shop assistants and then came 108,000 cashiers. Not one these occupations pay more than $10 an hour. Therefore due to low earnings
Michigan workers have been earning a wage that would not even lift a family of four. Now the question arises if the wages had fallen, how come people were still buying the Ford cars, Sony televisions, Nike shoes etc. as we can't have mass consumption if there are no high paying jobs? Manson (2009) believes that it came from credit, like credit cards, short term payday loans, zero percent car finance, and self certified mortgages etc. Thus lending money to people, who had no possible way to return it on time, turned out to be a bad decision.
The implications of the financial crisis were huge. "Today, there are three kinds of people: the have's, the have-not's, and the have-not-paid-for-what-they-have's" Earl Wilson Quote garden (2010). According to BBC news (2009), the size of the real per capita debt increased in George W. Bush's administration. Deficits had increased less under younger president Bush than they had during Reagan administration. These deficits were also an automatic result of recession and partly the side effect of the war on terror after 9/11. In February 2009, the total US federal debt was $12.35 trillion. Of this around $6.45 was held by the public and $5.9 trillion in the form of intra-governmental holdings. The per capita burden of debt roughly tripled from 1980 to 2008. Rowley and Smith (2009, P. 26-27)
When written in Chinese the word "crisis" is composed of two characters - one represents danger and the other represents opportunity.- John F. Kennedy (1959) - Quotegarden.com. The current financial crisis began in financial markets in the United States and its effects have spread into the real economy around the world. Thus the response must also be a global one, involving all parts of society. The UK government can take the following steps to reduce the danger of another crisis.
According to the analysis of the Organization for Economic Co-operation and Development- OECD (2010), Americans tend to spend more than they save. The UK and US have been marked by a combination of high debt levels and low savings rates in recent years. Thus the people need to realise the importance of the savings culture. The Government should also try to encourage people and address this urgently through the reform of benefits and pensions systems to restore the economic and social benefits of a low time preference culture.
SMEs help in creating jobs, support stability, innovation, macroeconomic growth and act as a growth engine and thus play an integral part of developing and developed nations. In OECD countries [Organisation for Economic Co-operation and Development- OECD is a set of 30 countries who develop and discuss social and economic policy]. 95 % of the enterprises in the OECD countries are SMEs which account for two thirds of total employment and is also the key source of new job creation. In many countries SMEs also play a major role of economic recovery and help to return to sustainable growth. In fact, some of the most innovative and fastest growing companies such as Wal-Mart (1962), Starbucks (1971), Microsoft (1975) and Virgin Atlantic (1982) were started during recessions.
The "the London summit", a recent meeting of the world leaders at the G20 summit hosted by Gordon Brown, will also play an important role in organising and deciding new economic measures to overcome the crisis. The UK government decided to implement the following steps: it will prevent the collapse of the banking sector by providing temporary liquidity which will protect people and their savings. Lower interest rates will also help in increasing consumer's demand which will in return support the economy.
Government will also support investments in low-carbon infrastructure to tackle climate change and create incentives for companies to move to a low-carbon economy. The UK government truly believes in effective transition to a low-carbon economy which includes- a renewable shift, research and development, commercial use of the low-carbon cars and also the skilled people needed to work in these areas. ACCA (2009)
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