The aim of this work is to demonstrate the understanding of financial crisis. The data is taken from WEBCT and covers the time period from Jan 2001 to May 2010. A thorough empirical and theoretical research is carried out to understand the impact of sub-prime mortgage crisis on a developing and developed nation's perspective. All the phases of the crisis along with impacts are understood and a set of strategies or programs that need to be followed by organizations during crisis are explained in here. Real life examples from the past are provided which helps in better understanding of the crisis.
Also when the change strategies are implemented, how did it bring improvement in the market returns is explained. Predictions by various economists about the next generation financial crisis are explained.
Set of success factors are provided for organizations to help minimize loss during crisis. A set of recommendations are given to avoid such a vital phenomenon. Also at the end we conclude that every nation must lay timely regulations in the fiscal systems. As man is a learning animal, we as human beings should learn from our past and must die hard to improve the financial system for the future.
Chapter - 1- Financial Crisis at a glance.
1.1) Introduction
With the growing economic era, nations have close to each other. There has been intense competition among organizations' to hit the market first and eventually become market leaders. (Prahalad&Hamel, 1994) proposed that, those firms at aspire to achieve high economic value should focus on their core competencies than concentrating on its annual sales and profits. Financial crisis has become a vital phenomenon in today's world. (Allen, 2007) noted that fiscal system is very delicate due to powerlessness of its speculators. As per (Kindleberger, 1978) and (Minsky, 1972) financial crisis comprises of undermining of asset prices, disruption in markets, betterment of balance payments, bankruptcy or any combination of them. (Schwartz, 1986) called it as 'Pseudo-financial crises'. As government was unsuccessful in its treatment, it ruined the economy which eventually gave rise to inflation. (Bordo et al, 2001) observed that frequency of crisis had doubled in recent decades. (Friedman & Schwartz, 1963) noted that there was a relation between banking panics and global financial crisis. Banking crisis being one amongst those types are not only observed in developed nations but in developing nations as well.
This phenomenon affected the economy of developing nation in terms of poverty, housing, and rise in food prices to a much greater extent than that of developed nation. (Masson, 1998) noted that there is high probability, that self accomplished crises will be continuous although there were no techniques by which nations' could change others notion. (Kaminsky, 1998) and (Kaminsky&Reinhart, 1999) proposed different ways that depends on signal approach to react to the dynamic nature of the economy.In this technological era thorough knowledge about financial crisis is essential. The need for carrying out empirical research to determine the cause and implement change strategies to avoid it is what that motivates me for writing this paper.
1.2) Purpose
The purpose of this work is to understand financial crisis on a developed and developing country's perspective. Using data available different phases of crisis along with possible factors, impacts and exit strategies are explained in here. Also a few suggestions are provided for readers for understanding the possible implications and take necessary measures to avoid it.
Chapter - 2-Background of financial crisis.
2.1) Origin and overview of 2007-2009 global financial crisis.
The 2007 credit crisis is amongst the latest in the chain of financial crisis that created panic and havoc in economy. (Mckinnon, 2005) noted that the depreciating value of dollar is an evidence of affected economy. It bought ample hazards to the U.S market and the entire world as well. It embarked upon since there was burst in the asset prices that act with different financial innovation which eventually lead to risk. Organizations' were unable to keep abreast with their risk procedures. Supervisors and regulators were not able to limit higher risks. Even though as each crisis is unique in itself it still shares some characteristics in common such as: excessive money in world economy, structural modifications which are useful in decision making and estimating a higher value on the assets.
(Reinhert&Rogoff, 2008a, 2008b) noticed that banking crisis usually precede credit booms. (Reinhart&Rogoff, 2009) observed that financial crisis involves recession to succeed with which usually lasts for a couple of years. Quantity of goods consumed and foreign investments are reduced. Risks and debts being the associate drivers help in reducing the pace of recovery giving rise to unemployment and rises itself with growing economy. The origin of the crisis has become a vital topic for research. Monetarists suggest capitalism as the main reason for crisis whereas others observed that government played a vital role in allowing regulating financial institutions and eventually enhancing returns. According to (Taylor, 2009) weak policies of U.S lead to credit booms, whereas (Elmendorf, 2007) observed that interest rates weren't low and hence a combination of both domestic issues and global imbalances are required.
(Bernanke, 2004) noted a fall in macroeconomic volatility due to changes in structure along with modified policies. Since 1980 as economy of Asian countries grew it helped in accelerated growth in annual salaries of citizens of these nations which eventually lead to increased amount of savings. Usually an individual's main concern is to find a safe place for his savings for future use. Thus many individuals felt U.S as the safest place amongst all. Therefore, as their economies grew at a rapid pace, a huge volume of foreign savings poured into U.S economy. This eventually helped the citizens to borrow excessive cash which was used by entrepreneurs for growing their business. Government borrowed cash for managing the shortcomings of the budget. Families borrowed money for repaying loans. The brutal fact being that, people started purchasing property for making money as they estimated that the property value would increase by almost 200 % during 1994 and 2006.
Fig 1:
http://www.youtube.com/watch?v=WW2IDE4rPCc&p=A1EE4D2263B8691B&playnext=1&index=35
(Beddoes, 2008) observed that, simplified banking procedures in U.S helped them achieve benefits over other nations. Burst in mortgage prices, did not surprise individuals in realizing that it hit U.S economy badly. Economic development is a subset of societal development. (Heng, 2008). Inflow of cash in year 2006 had reduced. Inflation caused Fed and the central bank to decelerate growth of U.S economy. Combination of several actions helped them in removing funds which were used as loans from U.S market. As there was fall in lending of loans to citizens, it eventually reduced the ever increasing rate of property value. Hence people wondered as to why the property prices did not go high in value? Hence their attractiveness towards purchasing property was reduced.
These factors eventually narrowed down the property market leading to a fall in price. With time some individuals were not able to repay their debts. Also less number of individuals was out in search of property; therefore existing property owners were not able to sell their houses. Eventually this ruined the situation for those individuals who owed more cash on mortgage than their property was worth of. Few people went off from the property and mortgage which lead to reducing value of mortgage backed derivative. Thus the condition became worse day by day for an elementary cause.
Banks did not have any assets that act as backbone for supporting their operations. Hence they should possess assets like liquid cash, gold, and stocks of some different companies or financial derivatives. Hence many banks purchased CDOs which were used as assets to support their operations. As value of these assets depreciated at a rapid pace banks failed to have any assets left out for supporting their operations. Hence granting of loans was reduced and therefore less number of citizens could think of purchasing the house.
As the number of citizens purchasing property reduced, the property prices reduced as well. This resulted in a downward cycle. This downward cycle in which we were trapped is called as recession.
2.2) Literature review:
The financial crisis of 2007 is a noticeable phenomenon in the history of crisis. (Brunnermeier, 2008) portrayed it by explaining various consequences that initiated with a fall in U.S financial institutions and eventually turned itself to global crisis. (Gramlich, 2007) proposed that loans in the form of mortgages were innovations that helped lenders to provide loans for individuals of lower income groups and having inadequate credit histories. (Adrian&shin, 2008) noted the structure of crisis was deteriorating. (Wallison, 2009) observed that traditional pattern for credit evaluations was substituted by flexible procedures that eased lending procedure. U.S financial crisis was a worldwide phenomenon. (Nicholson, 2008). Not only in the U.S but also in other nations such as Asia and Europe, stock market had crashed drastically. Nett loss of $ 350 billion was incurred to the U.K and the European stock markets. In Jan-2008 a total drop of stock market until 323 points created panic in the global market. (Times online 2008).
Apart from the capitalist economies like the U.S and U.K it affected socialist economies like Russia as well.
With rising fall in Russian currency a sense of urgency was developed that triggered them to identify new strategies for rescuing themselves from this situation. (Erkkila, 2008) noted that Russian banks started purchasing ruble to protect themselves from continuous fall in value for Euro's and Dollar's. (Bartlett, 2008) proposed that downward growth of U.S mortgage industry caused the recent crisis. Its exhaustive nature caused huge loss, since assets were unavailable to back up operations. (Yilmaz, 2008) pointed out U.S mortgage industry for causing the financial crisis. (Khatiwada, 2008) observed that sub- prime mortgages were never seen on the balance sheets of those lending institutions that initiated them. Since borrowers were unable to repay loans, they had to fund it by drawing its assets on balance sheet eventually giving banks an opportunity to execute their tasks in a shorter time period. (Hyun- Soo, 2008) argued by saying that it was the lack of trust that caused such a global financial issue.
However (DeBoer, 2008) observed that there wasn't any single reason that caused this crisis but it was a resultant of many events. It started from the drastic fall of currency in Asian countries during 1997 which later affected Russia in 1998. The havoc caused in the market affected U.S by leading to a dot-com bubble in 2001.Also drastic fall in the real estate prices in U.S affected many banks leading to a global recession.
(Rasmus, 2008) observed that apart from these, factors like difference in incomes of the citizens, hike in payment to workers had frozen, fall in permanent employees, continuous depreciation in dollar value, inefficiency in financial policies and the reduction of labor unions also triggered the crisis. (Conclusion remaining)
Chapter 3- Sub-prime Mortgage Crisis.
3.1) Understanding financial crisis:
From the start of 19th century until today several forms of crisis affected the global economy. As estimating magnitude of financial crisis was difficult, hence probable fiscal causes were understood. (Herring&Watcher, 2003) noted those financial crises are the outcome of any bubble in property market. Property owners purchased new homes which were out of their reach. Banks offered loans to customers in the form of mortgages which could not be repaid. These loans turned into securities by investment managers which eventually spread across the world which generated ratings that identified risk. Hence repackaging was done which was then sold to financial institutions to achieve high returns. Simultaneously companies started paying insurance to purchasers for the risk associated with securities. This resulted in significant confidence loss and restructuring of the fiscal landscape as well.
3.2) Phases of financial crisis:
Fig: 2
Phase 1: Eruption of the subprime mortgage crisis.
The origin of crisis embarked with an eruption of sub-prime mortgage on 17th Aug 2007. It initiated due to fall in two hedge funds possessed by Bear Stearns that exposed itself to mortgage based securities. (DiMartin et al, 2007) noted that as liquidity in European markets varied, their investments failed to price their assets to subprime mortgages.
Failing to repurchase funds created panic in the market. Therefore on 20th August 2007 there was a drastic fall in TED which caused market to fall around 240 (bps). Prior, during the 1987 crashes it had fallen to 100 (bps). Thus as evidence market fall was only due to subprime loans.
The value of sub-prime mortgages increased gradually after 2001. Lending bodies started lending money to citizens for housing speedily. Eventually market began to flourish as percentage of subprime lending increased by 35.8% each year during 2001-2005.
Total Mortgage Originations
Subprime Originations
Subprime Share in Total Originations
Subprime Mortgage Backed Securities
Percent Subprime Securitized
2001
2,215
190
8.6
95
50.4
2002
2,885
231
8
121
52.7
2003
3,945
335
8.5
202
60.5
2004
2,920
540
18.5
401
74.3
2005
3,120
625
20
507
81.2
2006
2,980
600
20.1
483
80.5
Table 1: Mortgage origination statistics (Billion dollars, %)
Source: Inside mortgage finance, mortgage market statistical annual (Taken from joint economic committee, October 2007.
As loans were granted rapidly it created a bubble in real estate and eventually increased property value. Property value rose at an alarming rate of 13.8% annually from 2001-2005 eventually triggering lenders to issue higher loans speedily, to stand abreast with others. (S&P/Case-Shiller Home Price Indices, June 2008).
(Stiglitz, 1990) noted that as investors hoped their investment would reap high value in future, therefore the amount invested on property went high as skyscrapers.
Since count of underperforming mortgages increased, the value of CDO and MBS reduced leading to a huge loss to its investors. IMF judged that the total loss by Oct-2008 to U.S was $ 1.3 trillion. (IMF, 2008). Therefore firms with enough cash merged with other firms whereas those who fell short of cash to back them up went bankrupt.
Ex: Merrill Lynch, Lehmann Brothers, Bear Stearns, Countrywide financial corporation etc.,
Phase 2: Development of credit risk leading to loss of fiscal bodies.
Fig: 3- The 30 year conventional mortgage rate and the effective federal fund rate.Jan-1990- June-2008.
The next stage began in Dec-2007 until then it was evident that financial crisis had affected other fiscal bodies. During Dec-2007 there was a tremendous fall in the TED spread causing it to hit by 221bps. Whilst the rate at which government issued funds to its citizens lowered, surprisingly it did not weaken the disseminating of crisis. Therefore it was evident that flourishing market and risks pertaining to credit were shaping themselves in to liquidity and other counter risks. This aspect was highly intense for institutions with high exposure to mortgage market. Growth of credit risk meant to extend unfunded derivatives whereas the financed derivatives were reduced. This exhaustive risk incurred heavy loss to traders who dealt with derivatives .Ex. Bear Stearns.
Phase 3: Continuous effect of Bear Stearns lead to high illiquidity in the global market.
Intensive liquidity persisting in market caused Bear Stearns to let it spread its affect on other investment banks that shared some portfolio characteristics in common. Ex: Lehmann Brothers. Therefore the 3rd TED spread contained heavy risks and eventually incurred heavy losses. When a check was made on the liabilities of Bear Stearns during March 2008 it demonstrated that it had fallen by U.S $17 billion. This triggered the spread of TED to 204 bps in 2008. Therefore, it eventually explains how subprime crisis made a wide spread towards other financial bodies.
Hence above factors, make us understand prior stages towards the crisis and eventually targets on capital re-apportionment on goods to identify its future stages.
Phase 4: Increase in commodity prices.
The 4th phase starts from 2008 which explains about the increase in price of goods. As investors incorporated huge loss due to CDOs and stocks of finance firms, they felt the need to reposition themselves by aiming those goods which had future demand .Furthermore they could be commercialized to earn revenue. Below graph reveals that investors recognized crude oil sector amongst others that has a bright future. Therefore investors found out several means by which they could fund them in order to achieve them. Ex., Prices per barrel of NYMEX rose from USD $75 in Oct-2007 to USD$ 147 in July 2008.
Fig 4: Oil Prices per Barrel
Thereafter, due to inaccessibility of timely incentives to investors the future of those goods was demolished resulting in declining of its future prices.
Phase 5: Freezing of markets ensuring safety to investors.
Finally during the later stages we observe a combination of exhaustive volatile market with illiquidity which caused the investors to become safe. The bubble in the asset price moved itself to U.S cash reserves and gold as well. As there was fall in the liquidity in the global market, as evidence we can observe a drastic fall in average of Dow Jones by 778 points giving rise to a new level. This prompted investors to shift their assets in the U.S treasuries. Simultaneously the price of gold rose by 3.3% which helped TED to spread to a newer peak of 464 bps by October2008.Hence the impact of credit crunch and market freeze on the economy ideally did not protect its investors from being safe.
Fig: 5
Chapter-4- Impact of financial crisis on developed and developing countries perspective.
Unemployment and Poverty
Fig 6: Unemployment in developed and developing nations during 2001-2011.
The recent crisis of 2007, created havoc in the global job market which eventually caused panic among the individuals. It affected the nations such as U.S, U.K, China, India, Europe etc. During Dec -2007 to October 2009 U.S civilian rate of unemployment increased. Likewise it increased in India as well but to a less extent as Indian banks and financial institutions had strict laws for lending money. Eventually as industries did not have enough funds to run their business they lost their clients and future projects giving rise to an increase in the rate of unemployment and poverty.
Inflation and GDP
Recession
Fig 7: GDP in developed and developing nations during 2001-2015.
Fig 8: Inflation in developed and developing nations during 2001-2015.
Inflation and GDP are directly related. During March-2008 to Sep-2010 due to credit crunch in the U.S banks and financial institutions, the U.S market went worse eventually reducing the funds to be lent to other nations. Since Oct-2008 as the organizations started implementing exit strategies in order to rescue themselves from this situation there was a sudden increase in the price value of the commodities giving rise to inflation. During 2007-2009 with a fall in the global business the GDP of various nations was severely affected leading to a fall in the overall returns during that period. Market volatility increased as well. As it was a global phenomenon it affected several developed and developing nation by reducing the export of their commodities. The overall growth and inflow of foreign currency was reduced. Credit crunch in the U.S markets made investors aware of the risks and the uncertainty associated with the continuous variations in the stock market. Thus GDP and inflation help in understanding of the overall growth and price economy of a nation.
http://blogs.cgdev.org/globaldevelopment/2008/09/us-financial-crisis-will-mean.php
http://www.imf.org/external/datamapper/?db=WEO&lang=en&indicator1=PCPIPCH&year=2015&geoitem[]=USA&geoitem[]=GBR&geoitem[]=ARE&geoitem[]=RUS&geoitem[]=IND
Impact on financial institutions.
IMF predicted that U.S and European banks lost over U.S $ 1 trillion on faulty assets and improper loans during Jan 2007 to Sep 2009. Forecasters estimated that U.S will hit a loss of $1 trillion which was slightly less in comparison to U.K. For Ex., Northern Rock being highly leveraged nature requested help from Bank of England so as to protect it from going bankrupt.
Initially, firms that had lending and construction as their prime business were badly affected. Impact on investment banks was worse as well. Bear Stearns sold off its business to JP Morgan chase. The crisis raised itself to a higher level when companies such as Lehmann Brothers went bankrupt. Government takeovers and private mergers of banks took place in order to rescue themselves from this situation. Ex. Merrill Lynch, AIG, Washington mutual, Fannie & Freddie and Countrywide financial etc.
http://www.imf.org/external/datamapper/index.php
Wealth effects.
During June -07 to Nov-08 U.S lost more than its figured net value. From Nov-08 the index value of S&P 500 stock market was quiet low. This caused panic and havoc in the stock market. America's primary household asset deteriorated its value by 22% in year 2008. Likewise investments, pensions, savings assets lowered their values as well. Thus the net loss incurred by U.S had gone up to sky scraper levels that were difficult to monitor and control. Furthermore, as the prices for property went down in year 2007 it created a huge loss in wealth for the common people.
European contagion
Financial crisis had affected fiscal bodies across the globe. Recently as the crisis made progress it affected various European banks as well, which caused them to fail and go bankrupt. Therefore, as the price value of assets and equities reduced it eventually affected European stock markets. Investors purchased MBSs & CDOs worldwide. De-leveraging of banks and financial institutions took place since assets had to be sold during the credit crunch period, in order to refinance their business and increase the solvency bringing in reduction of foreign trade.
Security trading effect.
High market volatility triggered firms to improve their trade by modifying their import and export facilities .Therefore in order to attain the foreign currency countries like U.S, India, U.K, Singapore, and China; increased the count of rational traders like hedge funds or arbitrageurs which allowed them to carry out trade securely among various nations.
Health
Nation's such as Afghanistan, Iran, and Iraq that generate low income felt the impact of the crisis by a sudden reduction in capital inflow. Foreign investments and trade had slowed down. This caused unemployment and eventually led to reduction in the annual funds that are to be offered by government to WHO. If there is a reduction in value exchange of currency, important medicines are often expensive. On either side the government makes promises to people that it will offer treatment of AIDS and T.B at a least cost whereas due to such vital phenomenon it is often not possible to keep up to the individual's expectation. Health is planetary fear. Therefore proper investments and pension plans need to be organized by government to help take care of their people.
http://www.who.int/mediacentre/news/statements/2009/financial_crisis_20090401/en/index.html
Reduction in value for foreign exchange.
During March 2008 as there was credit crunch among the global banks and financial institutions, ample supply of funds was not provided by U.S to other countries for business purpose. Hence firms started losing projects due to lack of funds. Therefore market volatility increased as investors reduced the amount of money that usually was invested in U.S markets giving rise to fall in the stock market prices eventually leading to decreasing in foreign exchange value.
Commodities super cycle.
Global food prices had increased during 2007-2009. This created havoc among the nations. The reason for increase in food prices during the end of 2006 was mainly due to draughts in the nations that produced grains. Crude oil prices per barrel, fertilizers, transportation, had also increased due to increase in usage of bio-fuels in advanced nations and increase in variations among diets in people. These factors eventually caused an increase in the commodities super cycle.
http://www.moneyweek.com/investments/commodities/commodities-super-cycle-has-further-to-go.aspx
Mergers and acquisition
Fig 9: Merger markets in U.S worth total number of deals.
In the year 2007 merger markets realized that the market of M&A made mergers of worth US $ 3,600 billion in just 15,700 deals. Likewise during late 2009 this figure will threw to U.S $1,800 billion in almost 9,400 deals. During this period the global crisis caused companies to merge with other companies to rescue themselves but eventually they failed to get the desired value for their merger. As there was almost 40 % reduction in merger value firms embarked on building new strategies. Ex., RBS Group overtook Fortis, and Santander made a bid for Barclays for buying ABN Amro in only $ 96 billion also Altria Group turned out Kraft Foods in just $ 61 billion whereas Enel Acciona purchased Endsea in merely $ 55 million. Due to economic downturn and market volatility, the value attained by any firm during M&A was reduced which eventually struck its wealth creation. However, in spite of these circumstances Morgan Stanley in 2009 managed to make a deal of worth $585.9 billion whereas Goldman Sachs managed to make highest number of deals in the value aspect with 244 deals. They managed to kick off JPMorgan the highest dealmaker with a value of worth $726.4 billion whereas UBS struck itself by making 271 deals during 2008.
http://www.dare.co.in/strategy/business-essentials/mergers-and-acquisitions-in-times-of-financial-crisis.htm
Liquidity injections in the market
Liquidity realizes the potential of any asset to get sold in market speedily with the least amount of loss in value. The 2007-2009 crises emerged due to a shortage of liquidity in the financial bodies because of excessive rating of an asset. Due to high volatility in the market, investors would be in a dubious situation weather is it wise enough to invest in that particular asset or not? Therefore due to continuous fluctuations in the returns, it was hard to analyze which assets will make an earning hence, affecting liquidity of the market.
Advertisements
With the rising number of traders, a need was developed in firms to invest money in order to achieve high returns. Therefore above normal requirement extra funds were required for advertising their commodities to achieve higher economic stability and growth of the market.
Interest rates
Fig 10: Comparison between Conventional Mortgage and Average U.S Banks interest rates.
Due to crisis many nations are confronting with recession. Nations such as U.S, U.K, Europe, etc, have been hit badly. In order to rescue from this situation, government has organized few policies. Borrowing of money was increased whereas interest rates on the money lent was reduced to pull people for developing economy.
Impact of political factors
Politics played a vital role during crisis. On 16th Dec 2003 former President of U.S Mr. Bush signed the American dream Down payment Act which proved useful to several families across U.S. This strengthened the property market. As per the act, capital must be provided to lower and middle class groups and to those families who had very less savings and have a terror in their mind regarding re-payment. Therefore property market was raised during 2002-2007. Since the U.S president wanted to continuously win votes, this strategy was taken by U.S. Therefore during early 2007 there was a burst in these credit prices which eventually gave rise to financial crisis. Hence in order to rescue U.S from the effects caused by financial crisis, Barrack Obama was elected as the new president of U.S in Nov-2008. http://www.moolanomy.com/866/what-caused-the-financial-crisis-of-2008/
Chapter-5- Strategies & Future Work.
5.1) Strategies for avoiding financial crisis
Crisis of 2007-2009 had caused severe threat amongst citizens across the globe. Hence CEO's of various companies felt the urgency and the need to find an exit strategy for rescuing them from this situation. While the company is offensive or defensive, a series of activities are carried out for bringing a change in the organization.
Fig 11: Plan of actions.
These activities are dynamic and differ with companies. Hence firms are divided into 4 clusters based on two degrees such as the available finance and the competitive advantage. Firms that did not require instant funds for running their business are called as financial strong and those firms that felt the urgency of funds are called as financially weak. Competitive advantage relied on 5 dimensions: cost, branding, technology, leadership, influential ability. Those firms that are ahead in >= 3 dimensions are termed as having higher CA whereas the rest were containing lower CA.
Fig: 12 - 4 Clusters of firms
Regardless of whichever sequence of actions the firm's rely on, it is necessary that they should possess a thorough knowledge and understanding of the desired approach for enforcing change. Change is a 3 step process. In the first step the company management should realize the urgent requirements of the company and hence identify their objectives. In second step data model is designed and planning is carried out. Also actions are sorted based on priority. In third step the company management tries to implement this restructuring using communication as a key catalyst. As the procedure is quiet dynamic eventually there will be a lot of time variations.
Fig: 13- Change Process.
Also firms have to determine an area where more concentration is required for restructuring. Following are the list of focus areas, each containing different tools for restructuring.
Fig: 14: Focus Areas.
Apart from the regular organizational change activities, U.S Treasury also carried out programs such as TARP (Trouble asset relief program) with initial fund of $ U.S 700 billion wherein they bought, insured, kept on hold and sold off various assets and shares to banks and other financial institutions in order to protect them. The term troubled assets symbolizes to those assets that were kept as mortgage before 14th March -2008. A user guide for executing TARP was developed by U.S treasury and was looked up by federal agencies. Insurance was provided for those assets and MBSs which were at stake. In order to suffice the total claims there was an increase in the premium price as well. Asset managers were hired to perform this task.
Fig 15:
Economist argued that the principal cause that let crisis go worse was the U.S treasury and the Federal Reserve by, not interfering to help avoid the bankruptcy of Lehmann Brothers. Various events were studied for the complete understanding the exact cause. The graph above explains about the series of events that took place from 1st Sep to mid of October and from then, new policies like TARP embarked eventually improved the economic condition. From the beginning until mid Sep the spread was fluctuating in the range of 50-100 bps. During this time Bank of England was pushed to prevent Northern Rock from going bankrupt. From then on Sep mid, it went a bit high and again poured down slightly on 16th Sep during AIG treatment. The spread continued to grow in the same fashion due to Lehmann Brothers decision. Moreover on Sep 23 Federal Reserve announced TARP to help the banks and financial institutions fund their troubled assets and helped firms avoid from going bankrupt. Thus from 13 October this policy was implemented and thus there was a downfall in Libor-OIS.
Also TALF (Term asset backed securities loan facilities) was established by Fed with a starting amount of U.S $ 20 billion. Fed had made arrangements to purchase securities by Fannie or Freddie with amount of worth ($ 600 billion). This had improved on the public involvement in their rescue in order to proceed with a reduction in ABS. Thus U.S helped in sorting out the liquidity issues in the markets and helped avoid the firms in real estate sector from going bankrupt.
5.2) Change in returns after the change strategy implemented.
Negative Returns during Recession and use of bad Strategy
Positive Returns after change Strategy
Fig 16: Stock Market Volatility in S&P 500 index
5.3) Recommendations:
The credit crisis of 2007 created havoc in the U.S economy. Economist observed that the recovery of crises took the form of V (hits badly and reflects back); U (slow growth) and W (double dip recession) shaped and therefore affected the global economy. Looking at the current economy, economist estimate the next generation crisis may take the shape of X. However it is just estimation and it cannot be assured until we know the current growth of economy. (http://www.theatlantic.com). U.S president Barrack Obama suggested 5 principles for improving U.S economy. Firstly, banks and financial institutions should have enough capital to backup and rescue the troubled assets during the downfall of economy. Secondly, firms must not be permitted to select regulators for themselves. If in case they are allowed to select then the end result will rely on the firms' competency and commitment. Thirdly, financial systems need to be failure proof in order to prevent itself from failure. Ex, Lehman brothers and AIG should have restructured themselves so as to prevent from going bankrupt. Fourthly, large financial organizations that intend to regulate themselves should understand the hazards on other institutions. Ex: unemployment. Lastly, U.S government must identify the urgency for developing an agency to prevent its citizens from any illegal financial malpractices. Therefore U.S president Obama suggested a unified independent consumer financial protection agency which aimed at giving the appropriate financial information to its citizens and helped them from any illegal activities. (http://www.whitehouse.gov).
Although, firms might be different from one another in a variety of aspects, yet there are certain key steps that firms must adopt in order to prevent and sustain themselves from the ill effects caused by the crisis. Firms must not be biased or partial enough while restructuring. It often results to failure. Effective leadership is required for preventing the firms from going bankrupt. An appropriate prioritized decision enhances the success of the firm even in worst conditions. Instead of going bankrupt firms must develop dynamic solutions for themselves by creating an alliance with its partners and also enhance in-sourcing. As uncertainty and risk prevail simultaneously during crisis, it is quiet certain that firms need to be agile and take proactive decision. Co-ordination among teams in different pools along with efficient change managing activities results in determining ideal solutions. Lastly, the government must establish new policies and programs to improve the condition of the stakeholders. (reference)
The above suggested proposals by Obama are considered to be ideal that help prevent U.S and other nations in the downfall of their economy.
5.3) Conclusion:
Financial crisis created a huge impact and gave a blow to the nation's economy. As per Christina.D. Romer, one of the U.S economist described that financial crisis is a doctor- patient phenomenon. We individuals as doctors keeping faith in ourselves are trying to cure the infected economy which acts as a patient. Weakness still prevails in the patient and constant efforts are made by doctors to develop strength and sustainability in itself. Hence we need to start concentrating on the measures for recovering economy rather than it going worse. In other words we need to focus ourselves on developing preventive measures. Likewise if are to treat any serious patient we should not only focus ourselves for getting the patient cured but in spite of that we should alter his way of living. The last few years made us understand the extent to which the effect of crisis could be. Thus in order to rescue from this, nation's must lay timely regulations in the fiscal system. As there is no end to learning, we as citizens must learn from our past and must strive hard to improve the fiscal system for the time to come.
http://www.whitehouse.gov/administration/eop/cea/speeches-testimony/treatment_and_prevention
Bibliography:
Adrian, T and H.Shin (2008). "Liquidity and leverage,"Federal Reserve Bank of New York Working paper 328, May.
Adrian, T. and H. Shin (2009). "Liquidity and Leverage," Journal of Financial Intermediation, forthcoming.
Allen, F.2007. Understanding financial crises .Oxford: Oxford University Press.
Bartlett, D., 2008, "Fallout of the Global Financial Crisis"
Beddoes,Z.M.2008.When fortune frowned .The economist .October 11
Bernanke, B.S. (2004). 'Remarks by Governor Ben S. Bernanke: the Great Moderation', Speech made at the meetings of the Eastern Economic Association, Washington, D.C., February 20, 2004.
Bordo, M., B. Eichengreen, D. Klingebiel and M. Martinez-Peria (2001). "Is the Crisis Problem Growing More Severe?" Economic Policy, April 2001, 53-82 + Web Appendix.
Brunnermeier M. (2008),"Deciphering the 2007-08 Liquidity and credit crunch," Journal of economic perspective, forthcoming.
Dell'Ariccia, G., E. Detragiache, and R. Rajan (2008)."The Real Effects of Banking Crises", Journal of Financial Intermediation 17, 89-112
DeBeers, R.D., 2008, "Understanding the Financial Crisis: Origin and Impact."
Elmendorf, D.W. (2007). 'Was the Fed Too Easy for Too Long?' Unpublished paper,
The Brookings Institution (November 9, 2007), available at: http://www.brookings.edu/~/media/Files/rc/opinions/2007/11_fed_elmendorf/11_fed_e lmendorf.pdf.
Erkkila, M., 2008, "Impact of financial crisis on the Russian economy"
Friedman M, Schwartz AJ (1963) A monetary history of the United States, 1867-1960 .Princeton University Press, Princeton.
Gertler, M. (1988a). "Financial Structure and Aggregate Economic Activity: An Overview", Journal of Money Credit and Banking, Vol. 20, Part 2, pp. 559-88
Gramlich, Edward M. (2007). Booms and busts: The case of subprime mortgages. Paper presented at the symposium "Housing, Housing Finance, and Monetary Policy," organized by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 30-September 1, 2007; www.KansaCityFed.org.
Hamel G. and C.K. Prahalad, (1994) 'Competing for the future', Harvard Business School Press, Boston.
Heng,Siam Heng .2008
.Some remarks on "After development" of Malaysia.Akademika.74:115-72
Herring, R. and S. Wachter (2003). "Bubbles in Real Estate Markets," Asset Price Bubbles: The Implications for Monetary, Regulatory, and International Policies edited by William C. Hunter, George G. Kaufman, and Michael Pomerleano, Cambridge: MIT Press.
Hyun-Soo, P., 2008, "Future Direction of the Global Financial Crisis"
Kaminsky, G.L. Lizondo, S. ñ Reinhart, C.M. (1998) Leading Indicators of Currency Crises. IMF Staff Papers Vol. 45. No. 1
Kaminsky, G. Reinhart (1999) The Twin Crises: the causes of banking crises and balance-of-payments problems. American Economic Review 89, (3), 473ñ500.
Kindleberger, C. (1978). Manias, Panics, and Crashes: A History of Financial Crises, New York: Basic Books
Khatiwada S., McGir E., 2008, "Financial Crisis: a review of some of the consequences, policy actions and recent trends."
Krozner, R., L. Laeven, and D. Klingebiel (2007). "Banking Crises, Financial Dependence, and Growth," Journal of Finacial Economics 84, 187-228.
Masson, P. (1998): "Contagion: Monsoonal Effects, Spillovers, and Jumps between Multiple Equilibria," Working Paper 98-142, International Monetary Fund.
Mayer, C., K. Pence, and S. Sherlund (2009). ''The Rise in Mortgage Defaults'', Journal of Economic Perspectives forthcoming.
McKinnon, Ronald I., 2005, "Trapped by the International Dollar Standard," Journal of Policy Modeling, Vol. 27, pp. 477-485.
Minsky HP (1972) financial stability revisited: the economics of disaster. In: Board of Governors of the Federal Reserve System , Reappraisal of the Federal Reserve Discount Mechanism ,vol.3 .Washington , D.C.: 95-136
Nicholson, R., et al, 2008, "Impact of the Financial Crisis on Technology Spending in the Utility Industry"
Rasmus, J., 2008, 'The Deepening Global Financial Crisis: From Minsky to Marx and Beyond', Journal of Socialist Theory, 36:1, 5 -29
Reinhart, C., and K. Rogoff (2008a). "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," NBER Working Paper 13882.
Reinhart, C., and K. Rogoff (2008b). "Banking Crises: An Equal Opportunity Menace," NBER Working Paper 14587.
Reinhart, C. and K. Rogoff (2009). This Time is Different: Eight Centuries of Financial Folly. Princeton University Press, Princeton and Oxford.
Schwartz AJ (1986) Real and pseudo-financial crises .In: Capie F, Wood GE (Eds) Financial crises and the World Banking System .MacMillan: London 11-31.
Taylor, J.B. (2009). 'The financial crisis and the policy response: an empirical analysis of what went wrong', NBER Working Paper, No. 14631.
Wallison, Peter J. (2009). The true origins of this financial crisis, American Enterprise
Institute for Public Policy Research, February;
http://www.aei.org/publications/filter.all,pubID.29419/pub_detail.asp
Yilmaz, K., 2008, "Global Financial Crisis and the Volatility Spillovers across Stock Markets"
