2008 Financial Crisis Essay

The global economic crisis affects many countries worldwide. It's a period of severe difficulties which financial institutions, markets and consumers experience simultaneously. It started in 2007, the full impact of the crisis wasn’t felt until the bankruptcy of the Lehman Brothers an investment bank in September 2008. Juneja mentioned that in the years to come they were many jobs lost and a decline in GDP of many countries was witnessed. What started as the subprime mortgage crisis quickly morphed into a full-fledged crisis of historic proportion causing many commentators to draw up parallels with the great depressions of the 1930s. It has benefited from many achievements of maturation, thus calling upon new forms of trade barriers. Chappelow (2019) refers to a recession as a significant decline in general economic activity in a region or country prominent to industrial production.

What Triggered the Global Crisis

The 2008 financial crisis started in the United States. It was caused by deregulations in many aspects of the world of finance thus allowing banks to engage in hedge fund trading with derivatives. These profitable derivatives prompted banks such as Lehman Brothers to demand more mortgages opting for only interest loans that were more affordable to subprime borrowers. Kiprop (2017) says cheap mortgages led consumers to rush for houses causing a disequilibrium in the market as more people invested in real estate. Excessive supply of homes in the market resulted in a price drop of houses enabling investors to pay back loans. The value of derivatives ended up drastically falling and later leading to a crumbling.

Elliot (2011) says the crisis had five stages. Phase one began in 9th August 2007 when BNP Paribas announced that it was seizing activity in three hedge funds that specialized in US mortgage debt. No one knew how huge the losses were, and banks stopped doing business with each other as they didn’t trust each other. On commenced on the 15th of September 2008 when the US government allowed Lehman brothers to go bankrupt. At this point it had been assumed that governments could always step in to bail any bank that was in trouble. When the Lehman brothers went down, the view that banks were ‘too big to fail’ was deemed false. Within a month the domino effect through the global financial system forced western governments to imbue a vast amount of capital into banks to prevent them from collapsing. On April 2 2009 at the G20 London summit world leaders committed themselves to a fiscal expansion plus an extra $1.1tn resources to aid the International Monetary Fund to boost growth and jobs. 9th May 2010 marked the point at which the crisis had shifted to the public sector. Budget deficits vastly expanded due to high non-disclosure agreement about how welfare would be spent. August 5th, 2011 was commemorated as the day the US hegemony was lost. Fiscal policies were tightened as tax breaks expired and public spending was reduced.

Lioudis (2019) says Lehman Brothers continuously invested in subprime mortgages, consequently quadrupling their portfolio relative to shareholders equity with belief that risks were properly managed and would impact their earnings slightly. In September of 2008 the situation had aggravated as equity worldwide became highly volatile. When the value of homes plunged, several borrowers had negative assets. Although many believe that the US housing collapse triggered the financial crisis, some experts investigated the past 5 years and found out that if financial system had been better monitored it would have prevented any form of corrupt lending.

Role That Banks Played During the Crise

Banking crisis reflects the exigency of liquidity and insolvency of one or more banks in a financial system. Deficiencies in banking management plus other factors were causes in all 24 studied systematic bank crises. It was mandatory for central banks to lend banks in a colossal scale to prevent the cascade of financial sector bankruptcies bigger than Lehman. Chu (2018) says that bankers developed what was known as sub-prime, loans given to people who can’t afford prime rate loans.

When the central banks raised its interest rates in 2006 many US homeowners started to default, house prices fell, banks started charging high interest rates, lending to other banks and institutions whom they suspected were sitting on large unrecognized losses. This was known as the ‘credit crunch’ phase.

Bank executives pumped up their profits by draining their saved-up capital in order to fund fast growing balance sheets with large amounts of debts.

Role of the Government

The US government failed to bail out the Lehman brothers who were finding it impossible to roll out of their borrowings in the market. Michel (2015) says the truth about the financial crisis lies in the firmly rooted, ill-conceived government policies that allowed lots of people to take out home mortgages.

During the second phase of the global crisis (15th September 2008) it became mandatory for western governments to imbue a large amount of capital into banks due to the domino effect to prevent them from collapsing. Lethbridge (2012) says the introduction of fiscal and monetary stimulus packages obtained from reserves and borrow extensively support the financial sector through the crises appeared to resolve the crisis however it increased overall level of government debt.

However, the government played a positive role during the global crisis by providing major support to the financial institutions such as too big to fail and nonfinancial corporations during the bail out process. Moffatt (2019) says the government planned to strengthen the economy by reducing taxes enabling consumers to spend more encouraging economic growth.

Role of Legislation

In November of 1999 Bill Clinton had signed of a law that partially repeals the glass house of 1993 preventing banks from operating other financial businesses e.g. investment brokerages. Congress passes legislation to government sponsored giants such as Freddie Mae to devote a percentage of their lending to affordable housing. The Commodity Futures Modernization Act of 2000 exempted credit default swaps and other derivates from regulations. This federal legislation overruled the state laws that formally prevented this from gambling, specifically trade in energy derivatives.

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In 1995, reconstruction to the Community Reinvestment Act (RCA) allowed home loan borrowers purchase sub primal securities to satisfy their housing granting priorities. Adding on (Drew/AP) says on April 2004 the securities and exchange commission (SEC) loosened the net capital rule allowing firms with more than $5 billion worth assets to leverage themselves an unlimited number of times. President Barack Obama signed into law a financial reform bill aimed at preventing future financial crises by giving them powers to regulate Wall Street.

Impact of the Global Recession in Developing Countries

Emerging and developing countries were progressively been affected by the slump of revolutionized economies through trade and financial market channels. With diminishing world trade reducing domestic demand and access to external financing, merging market growth is expected to decline sharply by 1.5% in 2009 from 1.6% in 2008.

Trade

This is the major channel of crisis transmission for developing countries. The continuous depletion in investment flows was restraining the development prospects of developing countries. The descriptions are more parlous for foreign trading in developing countries mainly looking at those which have a small private economy which is likely to increase unemployment. Nevertheless, these factors could drag millions of people back to poverty. Developing counties were also affected by a decrease in merchandise trade which fell from 6 to 8 percent in 2009. Adding on their exports could potentially decline 7 to 9 percent in 2009.

Botswana was one of the most heavily impacted countries during the global crisis since it was a highly trade dependent It had several negative consequences in the economy. Overall real GDP contracted by 6% following a revised growth rate of 3.1% in 2008. Although this was less dire, it closed a few businesses triggering job losses, mainly affecting the mining sector at this time period by 9.3% in March of 2009. Deloitte blog (2013) says however as part of rejuvenating the economy, governments decided to continue with its projects during the time of the crisis. The position of the policy combined with decreasing income from the government meant that Botswana had more imports than exports which lead to a trade deficit balance.

Diamonds

The major supplier of diamonds, as Deloitte blog (2013) calls it the ‘diamond giant’, Botswana has been considered a beacon of success in terms of economic management compared with other developing countries. Debswana temporarily closed its mine on April 2009 to conserve cash. Making matters the trading of goods and services to other counties fell by 67%. The prices of diamonds had immensely increased following the global economic crisis. This resulted in minimal profits made from diamond cutters hence the storage facilities became overstocked as the demand for diamonds went down. Kieth Jefferis (2015) says that the imbalance became overwhelming as the sale of unprocessed diamonds plunged drastically along with its prices, this caused Debswana to cut diamond production along with its market feeding through Botswana’s GDP growth.

However, to mitigate the ramification of the global recession on unemployment, the government introduced Ipeleng programs. It’s a long-term program running since April of 2009 targeting people with little or no source of income. It has amassed 234 462 people into employment, 172 686 females and 61776 males to be precise. Botswana also has Safety Nets system which offer financial reliability to elderly citizens by providing people aged 65 years and above with income.

Conclusion

The Lehman brothers was said to be the root cause of the global crisis because they heavily invested in subprime mortgages which were adversely affected by the housing market crash. They delayed getting out the position which precipitated their exposure to the subprime market which later collapsed and given their large size they brought everyone down with them.

The main development pathway of the crisis was trade, more especially from the emerging and developing countries including Botswana amongst many others. These countries experienced declines in trade and investment flaws resulting in stunted development. In 2015 Botswana diamond prices plunged. Conversely, Botswana government sculpted mitigating programs such as Ipelegeng.

Recommendation

In my opinion I believe that during the global recession the government shouldn’t have made it easier to access mortgages as it caused them to imbue lots of money into the financial markets preventing them from subsiding. To add on banks shouldn’t have increased interest rates as everyone had the opportunity to buy a house even those that had a low income or bad credit. This caused what was known as the ‘credit crunch’ phase.

However, under the Dodd frank act, they stated that orderly liquidation authority monitored the safety of investments in major financial firms who negatively impacted the economy. It established liquidations to assist the disassembling of financial companies placed in receivership.

The Volker Rule aids in assisting the way banks invest. Bank were not permitted to not get involved with privately owned companies as it was too risky. To minimize possible conflict of interest, institutions were not allowed to sufficiently trade in secret without ‘skin in the game’.