Category: Financial Crisis

Main Causes and Effects of the 2008 Financial Crisis

The issue of liquidity is going to be my main focus point when looking at the 2008 financial crisis and it will constantly crop up. Liquidity refers to the ease with which an asset, or security can be turned into cash without affecting its market price. In the period leading up to the Great Recession there was a massive increase in the availability of credit for banks and loan providers which in addition lead to an increase for consumers, in the US aided by Freddie Mac and Fanny Mae (government backed loan providers). In this essay I am going to try and discuss and link together the many historical and economic factors that lead to the credit crunch and as a result the Great Recession. I will then dive into the effects of the Great Recession and look at what steps were made to make the banking institutions less vulnerable/likely to fail, and also look at the policies implemented to help the UK out of a recession.

My hypothesis on why there was a financial crisis in 2008 going to be an extreme version of what is common practice in the modern financial system “holding a mixture of long-term, illiquid assets financed by short-term liabilities”, now it’s not that practice alone, but I believe the Great Recession was a result of banks having an over reliance on market liquidity.

The first example of this over reliance on liquidity in financial markets comes from the British bank Northern Rock, which hit financial trouble in mid-2007. Its assets were long term and very illiquid (securitized mortgage notes and its liabilities were short term). Banks in this time would rely on constant short-term financing, to pay off the recent maturing liabilities, and to fund the acquisition of new assets (leverage). But what lead banks to be in such a condition where they could borrow with such excessive leverage. To do this I am going to look back at historical factors which lead to this explosion in liquidity. First, I would like to look at the changes in in the ease of capital flows, I believe that after the collapse of the Bretton Woods System, which had a slow decline over the years, 1968-73, and then the slow move for the UK to a floating exchange rate in 1992 which massively increased the ease of flow of money as countries are no longer trying to maintain exchange rates through restrictive policies, because floating exchange rates are automatically adjusting. In the period from 1970 – 2007 there is a huge increase in capital mobility. This saw a huge increase in capital flows and helped grow the UK banking sector from 300% of GDP in 1997 to 500% in 2007. This led to banks raising funds globally increasing the global interconnectedness of the financial system. But even with the increase in liquidity it is hard to trace why banks such as northern rock taking excessive leverage. Since 1939 in the UK there had been wide scale financial repression, banks had to hold large amounts of capital in the form of government binds and they were limited in their deployment of it, that was until 1980 where the repression was lifted and few capital controls were brought in, with the Bank of England as a lender of last resort banks had little incentive not to take excessive risk, creating a huge morale hazard. This led to a situation where there was high liquidity and banks had limited controls their capital deployment, couple this with an exploding US housing market and the creation of profitable derivates in terms of the mortgage-backed securities. With the collapse of the housing market in the US following the fall in house prices in 2006. What this leads to is a vicious cycle with house pricing falling, people then have negative equity (900,000 UK homeowners pushed into negative equity), then owners foreclose or default, then the supply of houses increase and the price of houses (assets). This effects banks in the following ways: when the mortgage payments decline and the fees fall, then the value of the mortgage bonds fall, then the banks’ assets reduce and as a result they can loan less; so, they do, this results in a contraction in the economy as there is a fall in the availability of credit, which reduces investment which is part of aggregate demand. The contraction in the availability off credit creates problems for banks who in light of the worsening circumstances want to reduce exposure by selling assets and reducing liabilities but in a collapsing market it doesn’t make sense to sell, long term illiquid and the markets are illiquid as well and the amount of leverage allowed is lower to raise funds (lower proportion of debt required) as seen with Northern Rock. As well as Northern Rock the government had to bail out Lloyds, RBS, HBOS and Bradford & Bingley with a bill that roughly amounted to 20% of GDP. We can see because of banks over reliance on liquidity to maintain their operation, they failed.

In terms of the effects of the 2008 financial crisis I am going to split them into two sections. The first will cover the effects of the recession and the resulting government policy used to curb those effects. The second will be about the preventative measures brought in to stop a similar banking collapse happening again. The recession of 2008 was a demand side collapse. The reduced availability of credit creates problems for banks that the reduced availability of credit creates problems for banks that and one of the main things this resulted in was the collapse in the derived demand for labor. Where the demand for goods and services in the economy is jointly linked to the labor which helps generate the supply of those goods. This has an adverse effect on youth unemployment. “Unemployment is especially prevalent among those aged 16-24”. One of the surprising knock-on effects is the increase in the number of people applying to university there was an increase of “11.6 percent” in people applying to university through UCAS in 2010. This is because when there is a time of economic downturn the opportunity cost of going to university is dramatically reduced because of the fall in potential earnings if you had not gone to university. In the aftermath of government sponsored bailouts of UK banks. There are many fiscal changes, in order to recover from the increase in debt. The budget will have been affected by a fall in: tax receipts from stamp duty (in a housing crisis funny that); VAT as a result of reduced expenditure, wide spread unemployment and a loss of equity for many and also increased spending on unemployment benefits. One of the main aims of the coalition government was to “to create the most competitive tax system in the G20, to make the UK one of the best places in Europe to start, finance and grow a business”. This can be seen through a reduction in corporation tax (a reduction of 5.5% in the average marginal rate of tax) and also greater implementation of EIS (enterprise investment scheme) with capital gains relief on new British business if the investment is held for longer than three years. The reasons for this increase in tax incentives is because the governments want businesses to be incentivized to set up or increase production and thus in the process hire more people, to give more people income and have more money going round the economy and therefore have appositive multiplier effect. As a result of these the unemployment rate started to fall in 2012. The government also embarked on other supply side policies, through investing in R&D infrastructure (construction workers were disproportionally hit by the crash) and investment this is on one side to help provide some form of employment and also increase the productive capacity of the UK economy.

In light of the financial crash there obviously would be research and action taken to come up with more precautionary measures. I am looking at two sources, the Vickers Report and the Basel III recommendations. The Vickers Report suggested the ‘ring-fencing’ of retail banking from the investment and commercial side of banks. This only became mandatory on the 1st of January 2019. The implementation of higher reserve asset ratios, forcing banks to hold more high-quality liquid assets as a proportion of liabilities proportion of liabilities as recommended by both the Vickers Report and the Basel III recommendations.

Referring back to my hypothesis we can see that the main cause of the 2008 financial crisis was banks over reliance on liquidity in financial markets and as we can see from the finding and recommendations shown above the main stressor, other than the ring-fencing of banks, is to implement regulations that force banks to hold liquidity themselves. This would help reduce the damage done to these incredibly large ‘too big to fail’ institutions (banks so large that their demise would place systemic risk on the economy). The increase in the mobility of capital as a result of the fall of the Breton Woods exchange rate system and also the forgoing of many capital controls in 1980 are two of the biggest historical factors leading to huge liquidity link that with the position of the Bank of England as a lender of last resort and there is the perfect recipe for banks to take excessive risk.

Bibliography

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Essay on the Financial Crisis in Greece

Everyone knows that Greece is famous for its rich history, mythology, and architecture. But they cannot rely solely on tourism to keep their economy afloat. There were some key mistakes and mismanagements from their government threw them into a deep, deep hole.

When Greece joined into Europe, they were doing well financially. In 1981, the party that rose to power was the Panhellenic Socialist Movement, spearheaded by Andreas Papandreou. They stayed in power due to what some would call bribing the voters, with a very liberal welfare policy. They also created policies that sound great on paper, but do not actually work in real life. Many programs such as the annual increase in salary for workers in the public sector, or their retirement programs. These all sound outstanding, and will attract voters to keep the party in power, but it does very little to help the economy. The increase in salaries did not take into account that a certain level of production would be needed to obtain the increase, but instead everyone received it annually. Also, the retirement programs were very generous. Once reaching thirty-five years of service in the public sector, a man was allowed to retire. For women, however, in certain situations, were able to retire as young as 50 years old. As absurd as it may sound, it is known that in December Greece also paid employees additional monthly payments. They said it was to help with holiday expenses and then in March they would receive an additional half-yearly allowance to help pay for holiday expenses. All of these factors, including others, was leading Greece into a major financial crisis. As stated in an article by Elvis Picado, “As a result of low productivity, eroding competitiveness, and rampant tax evasion, the government had to resort to a massive debt binge to keep the party going” (Picado 2018). This quote essentially states that the working force in Greece had no desire to exert much effort into their work because they would receive lavish benefits every year even without a certain level of performance. So yes, this made the people happy, and it kept the PASOK in power, but it did nothing to help stimulate the economy.

In 2001, when Greece was admitted into the eurozone, it helped Greece borrow money from other countries to help their own shortcomings economically. The euro was considered to be better because it was stable, it had been proven to work for other nations, and it did solve Greece’s problem for a short time. Since they were now using an accepted, stable, and proven currency, many banks and investors saw this as Greece being a stable place to invest their money. The investments made helped to sustain and balance Greece’s economy for most of the early 2000s. Things were looking up for Greece. The graph shows all of the interest rates across Germany, Italy, France, Greece, Ireland, Spain, and the ECB. The interest rate that was being seen were nearly identical to that of other countries such as Germany. This let Greece have some leeway when they borrowed because firms were more trusting of them. This borrowing led to a sharp increase in spending, which seems like it would be the cause of the economic downfall, but it was not. As stated above, Greece is small. They are made up of multiple islands, and do not have the land for booming corporations to compete with countries such as China, or the United States of America. Nor do they have as great of a population as other countries. They spent a lot of money, but their biggest problem came from a lack of income into the country. It does not matter how much is spent, if no money is being brought in to the country, then it will automatically lead to a very hefty debt. The country also faced another problem: tax evasion. Most self-employed people would fudge their income, while raising their debt payments. With so many businesses considering this to be accepted, there was little that the government did to try to put a stop to it.

With all of the struggles facing Greece, they could do something to try and counteract the ever-growing debt: devalue their currency. The only problem that they face with this is that Greece lost its individuality when they became part of the eurozone. If they were to devalue their currency, every other nation who uses the euro would also see their currency devalued. This move would not fly for many obvious reasons, but the biggest would be screwing other countries who were not struggling. They also could not afford to leave the eurozone because that in turn would bring on its own set of challenges. Greece would lose financial help from other nations, it would be forced to bear the weight of all of its struggles alone, which was virtually impossible.

Another cause for this sharp fall was its relationship with Germany. German goods were much cheaper than those made in Greece, so they were imported into Greece regularly. With more goods being imported from Germany, this meant that Greece itself was not producing as much as it used to. This led to an even bigger decrease in productivity which lowered the amount of revenue being made. However, the amount being spent stayed the same. The demand for goods was still as high as it was before, but now Greece saw more and more goods being shipped in. Although, as long as the country was stable and everyone was happy, nothing was done to solve this problem, because what could go wrong?

In 2007, Greece’s problems came to light. The global financial crisis weakened Greece’s economy even further, and caused them to look for banks to help bail them out. The International Monetary Fund, or the IMF, along with other agencies came to the rescue, with certain conditions to be upheld. Greece was to perform actions such as cutting their budget, raising taxes, and others. This would not be accepted well in Greece however, because its people are used to living lavishly, retiring early, and not paying taxes. By making this move, many people would likely turn against the party in power, causing political uncertainty in a time where absolute leadership was imperative. With such sharp changes happening in the country, tragedy struck its people. The economy went into a deep recession, causing unemployment to spike to an all-time high in 2012. Because of the unemployment reaching over 24%, this caused homelessness to increase. This spiraled out of control then for Greek people with a jump in suicides nationwide and also the nation’s overall health of its people went down dramatically. Greece was in turmoil, and there was not much they could do to try and supplement their economy due to all of the limitations placed on them by the International Monetary Fund.

Greece was in such a bad position that they had no choice but to rise from where they stood financially. What it actually did, and what is its policy of recent years aimed at.

The Financial Crisis: An Essay on Its Causes and Consequences

A financial crisis is a situation when businesses and consumers are unable to pay their debts, asset prices depreciate, and financial institutions go through a shortage of liquidity. There are several types of crises, including stock market crash, financial bubble or a currency crisis (Dabla-Norris et al., 2015). All these crises have similar causes, and the consequences are much more alike.

Among the most common causes of the financial crisis include a mismatch in liquidity. On rare occasions, financial institutions have asset-liability mismatch. In this scenario, the association of risks and the institution’s assets and debts are not aligned appropriately. The institution is left unable to pay off its debts. For instance, a bank with deposit accounts that can be withdrawn at any time, but uses the proceeds to offer long term loans. This leaves the business at a disadvantage when the reports are removed, thus, crisis.

As business goes on, often investors and business owners make rash decisions. And there is the tendency of individual choices and trends to spark uncertainty among the investors (Claessens et al., 2014). And in odd herd behavior, several investors make a move that turns out to be a mistake and harmful to them, their businesses, and the economy at large. Such causes a financial bubble, which is often a result of new economic and technical innovations that seemingly present the investors with opportunities like the dot com bubble of 2001.

Another concern when it comes to the financial crisis is the governance and regulations in play in a state. Finance affects the citizens and as such, governments seek to regulate the financial sector. Critical for management is transparency and helping commercial outfits have enough assets to support their operations. With this in mind crises arise from insufficient regulations and changing regulations without basis.

There are other causes for financial crises, but all lead to the inability of a commercial outfit to perform and meet its obligations. When this happens, the first public response often is panic (Claessens et al., 2014). Investors and clients alike fear which leads to withdrawal of funds and assets from businesses. It leads to falling of markets and loss of jobs, which also reduces a society’s productivity.

With jobs reducing and lost incomes, social lives are affected as well. There grows acute inequality among people, which contributes to the poverty levels. It is either you have something or not, and gives rise to social tensions with those considered poor worrying over their future while the rich scrambling over the safety of their assets.

Thankfully, financial institutions have measures and policies in place for handling crisis events. Unfortunately, however brief the crisis was, there always will be the long-term consequences. With panic and fear still fresh in the minds of business owners and public in general post-crisis, there is always the pressure for economic reform. This is an effort to avoid any future loses and protect investments. For those that last longer there is the fear of having a legacy of debt or the adoption of protectionism which limits the economic growth and development of a nation (Dabla-Norris et al., 2015).

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.

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’.

Coming New Financial Crisis in Italy

Italy’s presidents have been in conflict with Europe because of their problems ever since they achieved power in the year 2018. They say that various European countries’ technocratic rules have caused economic trouble and they blame Europe’s rigidness for the country’s downturn after the 2008 financial crisis. Since then, Italy’s growth has slowly moved along at just barely below 1 percent, behind most other European economies, and the amount of youth in Italy is at a staggering 30 percent, surpassed only by Spain and Greece, currently. Rome seeks more money for it to spend, which it says will boost, productivity within the city, growth in population and tourists, and employment for the future generations to come and, in turn, make paying off their enormous debt easier in the years ahead of them. Meanwhile, the government’s loaning costs are rising. Government bond yields—a check of how much the government pays to keep track of/pay off debt—have nearly doubled since the month of May to their highest in four years. This undoubtedly means that current investors of Italy may and probably will see this as a forthcoming risk.

Recently, the European Central Bank has been thinking about purchasing the crippling Italian bonds, but that idea is being shut down (another cause of friction between Italy and Europe’s institutions). If the banks’ holdings (Italian bonds) become of no value, then the banks (as a result), become valueless. If the Italian banks get into trouble, then the Italian government has to find a way and try to help them out. Rescuing the entire system is beyond the means of Europe and the countries within it.

Italy’s slow-growing economy has a very basic and radical explanation to it. It’s Italy’s youth demographic; it has way too many young people and way too many older, retired citizens of Italy. In favor of Italy, migration would really benefit them to sort of balance the horrid demographical problem of the country. Though it’s extremely disliked and to add onto this, other Europe partners also disavow the allowance of migrants.

Considering the outcome of what will probably happen to Italy, it’s better off leaving the EU and starting its own currency. Though even though they’re better off doing that, they won’t. Unlike Italy, the United Kingdom was actually thinking of doing that. Italy is for some reason not willing to stand up for their actions and find a clever solution to pay for all of its debts. Instead, they’re getting ready to face yet another financial crisis and letting the EU do their dirty work for them.

Essay on the Economic Crisis in Greece

Greece is a country in South Eastern Europe consisting of 2 mainland peninsulas and thousands of islands throughout the Aegean and Ionian Seas. It is 15th largest economy among the 27 Europe Union. Greece is a developed country with high standards of living and high human development index. Participation in the European Monetary Union was a landmark development for Greece. It bestowed on its government and private sectors a rare historical privilege: the ability to borrow in open financial markets on the same terms as other Union members, without the encumbrance of exchange risk. The Greek financial sector (stock exchange, mutual funds and commercial banks) flourished. Domestic financial flows (credit, savings and stockholding) boomed. Investment and growth accelerated. On the eve of EMU membership, Greece was nothing less than a star performer in Europe. But by the year 2009, as a result of international and local factors, Greek economy faced its most severe crisis. On June 30, 2015, Greece became the first developed country to fail to make an IMF loan repayment. At that time, debt levels had reached €323bn or some €30,000 per capita. Debt relief has been a contentious issue for creditors, with the IMF and EU lining up on opposite sides. Greece became the center of Europe’s debt crisis after Wall Street imploded in 2008. With global financial market still reeling, Greece, in October 2009, announced that it had been understating its deficit figures for years raising alarms about the financial soundness of Greece. The IMF has insisted that Greece cannot meet its budget goals without easing its debts. The two weeks since June 26th, when Alexis Tsipras, the Greek prime minister, abandoned talks with the EU and IMF on a further bail-out and called a referendum on their terms.

This essay shall go in detail of how the Greece, country having 38th rank in the world for nominal GDP, became 1st developed country to be a bad-debt. The study also analyses why there still has been crisis even if it received billions of bailouts. Most eurozone leaders now believe Greece has no place in the euro. Even those genuinely supportive concede that things may not go their way. At the heights of debt crisis, many experts worried that Greece’s problems would spill over to the rest of world. If Greece defaulted on its debt and exited the eurozone, they argued, it might create global financial shocks big collapse for the whole world. The essay also deals with the effects of introduction of euro in 2001 among the eurozone countries and how this introduction increased the labor costs in Greece relative to other countries like Germany.

From Privilege to Curse

Participation in the European Monetary Union was a landmark development for Greece. It bestowed on its government and private sectors a rare historical privilege: the ability to borrow in open market on the same terms as others union members, without the encumbrance of exchange risk. To gain that status, Greece had undertaken successful stabilization policies in 1996-2000, bringing under control the long-standing public deficits, domestic inflation and the drachma exchange rate. The Greek financial sector flourished. Domestic financial flows boomed. Investment and growth accelerated. On the eve of EMU membership, Greece was nothing less than a star performer in the Europe. Nine years later the privilege became the curse. In October 2009, Greece announced that it had been understating its deficit figures for years raising alarms about the financial soundness of Greece.

Greece’ Economy from 1997-2010

For the years 1999-2010, a number of observations can be made. First, there were periods during which the private debt increased substantially whereas there were other periods during which the private debt has been reduced with a great speed. Second, during periods of economic booms, private debt has risen by an accelerating rate. Third, for the whole period the increase in private debt was higher than percentage increase in public debt. Forth, during 2005-07 there was an average increase in private debt of eurozone countries of approximately 35% of GDP. In contrast during the years of economic recession 2008-09, private debt slows down and public debt accelerates. “Greece is likely to default over the next three years because budget-cuts would not be enough to reduce the nation’s tax burden”, – Pacific Investment Management CEO Mohamed A. El- Erian said on 27 October 2010. “It is Greece’s interest to default as long as you can contain the contagion to other countries and it is done through orderly restructuring and reprising to retain competitiveness”, – he added.

Excessive Borrowing

Despite Papandreou’s governance often being criticized for building the foundations for the crisis during the 1980’s, the government has also been heavily criticized for excessively borrowing at low interest rates made available to Greece as a result of the accession to the eurozone, which allowed Greece to borrow at sharply reduced interest rates. In response to the announcement that Greece was to join the eurozone, the nominal interest rate declined from 20% in 1994 to less than 3.5% in 2005.

The accession of Greece in the eurozone imposed an analogous effect upon the interest rate mechanism. As a result of minimized risk upon accession to the single currency, along with high liquidity in the credit market, both the public and private sector found themselves in a prominent position to secure finance at low interest rates which were applicable to all eurozone economies, regardless of concerns relating to a particular economy’s indebtedness.

The accession of Greece to the eurozone and the implementation of the currency peg in Argentina had the initial effect of increasing economic confidence and resulted in the considerably lower interest rates observed in both countries. The situations observed in both countries as a result of the loss of national monetary policy bears great similarity, with both countries experiencing high levels of debt, uncompetitive economies and the implementation of severe austerity measures reinforces this by stating that: “Argentina in the 1990s and Greece in the 2000s were able to access serious amounts of hard currency on the open markets, the results should have been predictable. In each case, there was a decade-long consumer and public sector spending boom, followed by a cataclysmic economic crash”. The effective loss of national monetary policy in both countries resulted in overconfidence in both country’s abilities to pay back debts. Subsequently, this led to increased accessibility to lending at low interest rates that led to increased borrowing in both the public and private sector. Furthermore, competitiveness was severely affected by the irresponsible overspending.

Bailouts by Troika

Greece has been receiving financial support from euro area members states and International Monetary Fund (IMF) to cope up the financial difficulties and challenges since May, 2010. The international aid package, negotiated with so called Troika (European Commission, European Central Bank and International Monetary Fund), was 110 billion euros over three years. Of the overall amount 80 billion euros was made through euro area members in 2010. In 2012, after months of tortuous tense negotiations, second bailout for Greece finally became a reality when euro area members formally authorized the first instalment of 39.4 billion euros where the worth of total bailout was 130 billion euros. In mid of August 2015, Greece receiving much needed funding from third eurozone bailout worth about 85 billion euros. As previous bailouts, Greece’s UE partners set tough conditions, demanding more austerity. It must fulfil the MoU in the name of bailout. The MoU demanded ‘prior actions’ aimed at boosting revenue and call on the government to:

• End fuel tax benefit for farmers;
• Scrap a range of tax exemption;
• Clarify who is eligible for minimum guaranteed pension at age of 67 and start phasing out most early retirement;
• Overhaul social welfare to achieve savings of 0.5% of GDP;
• Deregulate the natural gas market;
• Open up restricted professions;
• Reduce travel allowances and perk for state administration staff.

In 2016, Greece had agreed a deal to unlock a further 10.3 billion euros in loans from its international creditors. The bailout aims to: put privatization back on track, modernize and slim down the state administration, tackle tax evasion and fraud, open up regulated professions to competition, and cut pension costs to make the welfare system sustainable. Greece’s banks remain in a fragile state – they depend on emergency ECB funding and cannot borrow in capital markets. Strict capital controls remain in force – Greeks are limited to withdrawing €420 a week from their accounts. The banks were closed for three weeks in June-July, to prevent a bank run by anxious customers, who feared economic meltdown and ‘Grexit’ – exit from the eurozone. The controls put a severe brake on economic activity. With regard to Fund involvement, the view expressed by the IMF in its report was that it would have been better if the crisis could have been resolved within the eurozone, but neither the authorities nor the EC or ECB had the required program experience.

Why Has Still There Been Crisis?

But the question arises if Greece had received Billions in bailouts, why there still has been a crisis. The money was supposed to buy Greece time to stabilize its finances and quell market fears that the EU itself could break up. While it has helped, Greece’s problems have not gone away. The economy has shrunk by a quarter in five years and unemployment is about 25 percent. The bailout money mainly went towards paying off the international loans, rather than making its way into the economy. And the government still has a staggering debt load that it cannot begin to pay down unless recovery took hold. The government would then need to continue putting in place deep economic overhauls required by the bailout deal Prime Minister Alexis Tsipras brokered in August, as well as unwinding of capital controls introduced after political upheaval prompted a run on Greek banks. Greece’s relations with Europe are in fragile state, and several of its leaders are showing impatience, unlikely to tolerate the foot-dragging of past administrations. Under the terms of bailout, Greece must continue to pass deep-reaching overhauls, many of them that were supposed to have been passed years ago.

The Global Effect

Now what can be the effect of crisis on the global financial system? In the European Union, most real decision-making power, particularly on matters involving politically delicate things like money and migrants, rests with 28 national governments, each one beholden to its voters and taxpayers. This tension has grown only more acute since the January 1999 introduction of the euro, which binds 19 nations into a single currency zone watched over by the European Central Bank but leaves budget and tax policy in the hands of each country, an arrangement that some economists believe was doomed from the start. Since Greece’s debt crisis began in 2010, most international banks and foreign investors have sold their Greek bonds and other holdings, so they are no longer vulnerable to what happens in Greece. Some private investors, who subsequently ploughed back into Greek bonds, betting on a comeback, regret that decision.

Effects of Global Financial Crisis on Greece Economy

It is possible to say that the current situation of Greece is a possible result of wrong policies applied in the last 25–30 years. This process is closely related with financial extravagancy and insufficiency of Greece government, unfair and infertile taxation system, unsustainable retirement, low competitive power, populist practices of political parties and organizational and political problems in EU and eurozone. Greece became tenth member of the European Community in 1981 and launched the euro as local currency (Clarke & Claire, 2010). The passage was thought to be more beneficial and to accelerate the modernization of economy. However, although the passage to the euro, at first, had such positive effects as development, high inflation and credibility of economy policies, it was seen that it brought about some negative causes as well (Kouretas, 2012). Remarkable increases in public spending, together with wrong political choices, caused serious problems in competitive power of country and big financial instability.

For many years, Greece managed to contract debts with low interest rates by playing on basic economic indicators thanks to accountancy support provided by Goldman Sachs. When the process before the crisis is taken into consideration, it is seen that the rate of Greece debts to its GDP is one of the highest in Europe.

This rate particularly increased after 2000 and surpassed 160% and far beyond Maastricht criterion (60% of GDP). When compared to Spain, Portugal, Italy and Ireland, the situation can be seen clearly. The international competition power of the country significantly eroded. In addition to all these, probably the most attention-grabbing elements which ignited the wick of the crisis are the government’s approach and statements that increased the uncertainties and raised worries about the low reliability of financial statistics and the real extend of financial problems and their possible financial results. It can be said that the EU countries were late to read the indicators and failed to support Greece as the crisis escalated in the country.

Before the crisis and in the process of the crisis while most loses were expropriated, most revenues were privatized. It can be said that tax payers are responsible for more than 80% of Greece’s debt. High-cost measures with regard to public debt stock led to large fiscal deficits. The rate of public deficit to GDP in Greece has always been higher than averages in European area since its entrance into the eurozone. One of the most important problems Greece has experienced in recent years is decrease in tax revenues of the government. Tax revenues have perpetually been lower than expectations. When budget income and outcome of Greece and EU are compared, budget income in Greece is seen to be lower than the average of EU27 and EU17 and budget deficit is seen to be high. It is argued that there are serious levels of tax evasions due to inadequacy of pressures and deterrent measures created by the high wage costs and heavy social security load.

Quite a big part of foreign debt of Greece is public debt. In the last two decades, a dramatic increase is seen in Greece’s foreign debt. Greece loaned foreign debt at the rate of 4.1% of GDP every year during 1990s. This increased to 10.2 % during 2000s. However, the state could not effectively use the financial resources coming from foreign debts to increase the production capacity and nor could it realize the structural reforms to increase competitiveness. While Greece was at 83rd place in Global Competitiveness Index in 2010, it declined to 96th place in 2013. The erosion in competitiveness as well as chronic weakness of Greek economy explains the structure of current deficit and why the export performance is lower than the other European countries. Greece imports more than it exports; in other words, it consumes more than it produces. The state provides some of its financing with foreign debt. The current account balance, which was in the rate of –7% of GDP in 2001 with the effect of decline in competitiveness, realized as the level of –15% of GDP in 2008. In the following period, this rate was about –10%. In 2001, current account balance of Greece was about –29.3 billion dollars, that is –9.8% of GDP, which is threefold of Maastricht Criteria. In the same period, this rate was 1.1% in Ireland, –3.2% in Italy and – 6.4% in Portugal.

When compared to previous periods, although the inflation rates were low in Greece between 2001 and 2009, they were at relatively high levels according to the EU criteria. In Greece, both prices and high increases in wages in comparison with the eurozone have reduced the competitiveness of the country. In Greece, the inflationary pressure strengthened during 2010. The increases in VAT rates and the special consumption tax led to the realization of the inflation rate in 2010 as 4.7%. In 2011, there was a decline and the inflation rate was 3, 3% power. An important portion of foreign debt is used for import directed at consumption.

Between 2000 and 2007, Greece had one of the fastest growing economies in the eurozone. In this period, the country’s economy increased more than 4% on average. Greece’s economy entered a serious constriction period, especially after 2007. It can be said that the negative effects of the crisis were seriously felt in the European Union and the eurozone experienced the greatest recession of its history in 2009. Afterwards, although this rate turned to positive, it has not exceeded the level of 2s%. After 2007, the Nominal GDP rate in Greece has continuously been negative value.

While the debt crisis continues its pressure on the real economy, layoffs and the number of unemployed as well as the cuts in public expenditures have increased as a result of severe austerity measures (Sesric Reports, 2011). Thus, this constriction brought up the unemployment problem seriously, the unemployment rate which was 7.6% in 2008 increased rapidly and it reached the level of 17.3% in 2011. This rate is estimated to be 23.8% in 2012. It is predicted that there will be an increase in employment and the unemployment rate will decrease if the reforms concerning economic structure and labor market are practiced as planned.

Analysis

In response to extensive analysis, it is clear that substantial evidence is presented which gives credibility to both sides of the argument. However, after considering the evidence, it is a credible possibility that Greece could seriously consider a default on its debts and exit from the eurozone. It is apparent that a restructuring of unsustainable debt and reforms are necessary in order for an effective recovery to take place. The analysis uncovers the extent of the crises experienced by both countries, which demonstrates that although many similarities and trends are evident, the situation in Greece is incomparably worse.

The analysis has also demonstrated the complexity of both cases, with a number of individual, complex issues, which have inevitably contributed to the occurrence of events that took place. The circumstances that Greece faces are further complicated as a result of external pressures, which forms the main distinction between Greece and Argentina. For this reason, it has been proven difficult to reach a conclusion as to the most suitable solution to the crisis.

In order for it to be possible for Greece to eventually pay its debts, a number of issues needs to be addressed. Primarily, efforts to reform the structure of the Greek government needs to be considered further. Measures to improve competitiveness in Greece and entice foreign direct investment should be high on the agenda. In its current state, it is almost impossible for Greece to be able to repay its debt and recover from years of recession. The evidence suggests that an exit from the eurozone would be catastrophic for Greece, and the short-term negative implications would last longer than they did in Argentina, despite this Greece could pursue this option and eventually recover from the crisis, just as Argentina did.

Equally, the fundamental structural failings of the EU need to be addressed if Greece and other peripheral countries are to recover while retaining the single currency.

Conclusion

Greece became the center of Europe’s debt crisis after Wall Street imploded in 2008. With global financial markets still reeling, Greece announced in October 2009 that it had been understating its deficit figures for years, raising alarms about the soundness of Greek finances. Suddenly, Greece was shut out from borrowing in the financial markets. By the spring of 2010, it was veering toward bankruptcy, which threatened to set off a new financial crisis. To avert calamity, the so-called Troika — the International Monetary Fund, the European Central Bank and the European Commission — issued the international bailouts for Greece. The bailouts came with conditions. Lenders imposed harsh austerity terms, requiring deep budget cuts and steep tax increases. They also required Greece to overhaul its economy by streamlining the government, ending tax evasion and making Greece an easier place to do business.

At the height of the debt crisis a few years ago, many experts worried that Greece’s problems would spill over to the rest of the world. If Greece defaulted on its debt and exited the eurozone, they argued, it might create global financial shocks bigger than the collapse of Lehman Brothers did. Now, however, some people believe that if Greece were to leave the currency union, in what is known as a ‘Grexit’, it would not be such a catastrophe. Europe has put up safeguards to limit the so-called financial contagion, in an effort to keep the problems from spreading to other countries. Greece, just a tiny part of the eurozone economy, could regain financial autonomy by leaving, these people contend — and the eurozone would actually be better off without a country that seems to constantly need its neighbors’ support. Greece does hold some leverage, however. European leaders are keen to avoid a new Greek crisis before a British referendum on membership to the European Union in June, and will most likely need Greece’s help in tackling the Continent’s continuing migration crisis, which has been concentrated in the Aegean Sea. Since 2007, world economy has lived one of the biggest crises ever. The financial crisis began in USA and spread to the world and affected many both developed and developing countries. One of these countries is Greece. The combination of high rates of public deficit and debts to GDP, shrinking tax base and dysfunctional tax collection system increased fragility and liquidity crunch in Greece economy. The crisis not only accelerated the corruption in economy but it also revealed the chronic weaknesses in it.

It is clear that the discussion about the exclusion of Greece from the common European currency should have been made in 2001, when Greece adopted the euro as its local currency. The support, Europe gave to save Greece, is a price it should pay and it will go on paying. Greece is also aware of it. In fact, Greece is just the visible tip of the iceberg (Roubini, 2013). In the EU area, only the Greek economy or several countries such as Ireland or Portugal should not be regarded as problem. Unless a determined and extensive solution policy is established, other several European countries including France will be exposed to public debt crisis and economic crisis afterwards. This is an important element that threatens the integrity and future of the European Union. To solve the problems in Greece in a short time, there is a need for a structural reform about the sustainability, competitiveness and transparency of economy. This must not only be a change in economy but also in politics and society, and this change must be supported. In fact, this is not an economic problem but a loss of prestige. It will not be easy to regain this prestige.

Essay About the Causes of the 2008 Financial Crisis

In 2008 the world’s economy had its biggest crisis since the Great Depression in 1930. According to Britannica, this epidemic “began in 2007 when sky-high home prices in the United States finally turned decisively downward, spread quickly, first to the entire U.S. financial sector and then to financial markets overseas” (para. 1). The individuals and firms associated with this were commercial banks, savings and loans lender, mortgage offices, insurance companies, and the entire banking investment industry. It affected many other industries such as the auto industry, making this “the longest recession since World War III’ (Brittanica, para.1). The 2008 financial crisis resulted in a 10 percent unemployment rate in 2009 (Bureau of Labor Statistics, 2012, 2). $8.8 million jobs were lost, and $19.2 trillion were lost in household wealth (Department of the Treasury, 2012). Real GDP fell more than 5 percent from the pre-recession peak (Department of the Treasury, 2012). This paper is going to outline and explain all the factors that acted as a cause to this situation. The factors that caused this crisis are securitization, growth on subprime mortgage and housing initiatives and other policy factors.

Subprime Mortgages

Subprime mortgages, mortgages that are normally issued to borrowers with low credit ratings, were a vital part of the 2008 financial crisis. The banks took advantage of relaxed regulations to look for new ways to generate profits. The troubles began with the changing role of banks. The bank’s profits came from interest rates, but they weren’t enough. Therefore, higher profits motivated them to come up with new ways to make a profit. These banks decided to create new mortgage products, and instead of protecting borrowers from risk, they increased risks and made new fees. There are several innovative mortgages that the banks gave during the housing boom (Stiglitz, 2010, 85). The 100 percent loan had banks’ lending “100 percent, or more, of the value of the house” (Stiglitz, 2010, 85). The problem with 100 percent loans was that it was “what an economist calls an option”, and this means that the borrower receives a profit if the price of the home goes up and has the option to walk away if the price happens to go down (Stiglitz, 2010, 85). If the borrower could not pay the mortgage payment, they could foreclose and leave the bank holding both the mortgage and the home, and the borrower lost nothing.

Also, ARMs were introduced. An adjustable-rate mortgage is a mortgage where interest rates can change during the time they are being paid. Banks would tease a low rate, and then increase it drastically after a period of time. For example, you may apply and get a mortgage worth $150,000 with a 2.4% interest in 2008. Suddenly, the rate may increase to 9%, now you have to pay more than triple the amount you pay toward interest. Teaser rate mortgages had temporary low rates and increased dramatically after a few years, and balloon payment mortgages took advantage of the low interest rates at the time but had to be refinanced when interest rates went up or the time of the balloon occurred (Stiglitz, 2010, 85). Mortgages required the borrower to repeatedly refinance their mortgages, and the lenders profited from this because each refinancing required the borrower to pay a new set of fees (Stiglitz, 2010, 85).

The teaser period would end, and families would have a very challenging time making payments. This cycle would continue repeatedly. The lenders would assure them not to worry about this due to the fact that their home price would increase and allow them to easily refinance and have money left over for a vacation or a car (Stiglitz, 2010, 85). The lenders encouraged the borrowers to take a gamble on their mortgages and increase their debt because the lenders had the incentive to do so regardless of how it affected the borrowers in the long run. Lenders had the incentive to originate mortgages in order to sell them off, and once they were sold off, the lenders did not have to deal with how the borrowers were affected by their increasing debt.

Negative amortization mortgages are another innovation of subprime mortgages. Lenders utilized these “mortgages that allowed the borrower to choose how much he paid back”, and there was not even a requirement “to pay the full amount of interest he owed each month” (Stiglitz, 2010, 86). By the end of the year, the borrower would end up owing more than at the beginning, but the lenders persuaded the borrowers by using the increasing house prices as justification (Stiglitz, 2010, 86). Regulators and investors should have been suspicious of all of these new “mortgages that left the borrower increasingly in debt and those that forced him to refinance and refinance” (Stiglitz, 2010, 86). Liar loans “were the most peculiar of the new products” because many borrowers were encouraged to lie and 7 exaggerate their income; there were also times when loan officers lied about the borrower’s income (Stiglitz, 2010, 86). The lenders allowed for these innovative subprime mortgages to be made because they had only one thing in mind and that was that larger mortgages would give them higher fees (Stiglitz, 2010, 86). The lenders would receive fees from the borrower for refinancing. The initial fee that the lender charges on a mortgage is a point, and each point equals one percent of the loan. The charge can be one point or multiple points. The lenders did not think of any of the problems they were causing for the future (Stiglitz, 2010, 86).

Ben S. Bernanke (2013) argues that the increase house prices and the deterioration in the quality of mortgage standards are two key events that led to the 2008 financial crisis (41-42). Housing prices were increasing and feeding the bubble while mortgage underwriting standards became worse and worse (Bernanke, 2013, 42). Before the 2000s, borrowers had to provide detailed documents of their finances to convince the bank to give them a loan, but as housing prices increased, the lenders began giving mortgages to borrowers that were less qualified (Bernanke, 2013, 42-43). These mortgages are called “nonprime” mortgages because there were mortgages that were above subprime and below prime that were not up to the traditional standard and “often required little or no down payment and little or no documentation” (Bernanke, 2013, 43). Mortgage quality was declining because lenders were “lending to more and more people whose credit was less than stellar” (Bernanke, 2013, 43). The overall mortgage deterioration can be seen in 2007 where 60 percent of all “nonprime loans had little or no documentation of the creditworthiness of the borrower” (Bernanke, 2013, 43).

The deterioration of mortgage standards became a problem as house prices began to decrease. As house prices increased, “the share of borrowers’ incomes being spent on their monthly mortgage payments went up”, and the increasing costs of homeownership decreased the demand for new houses (Bernanke, 2013, 43-44). The earlier increase in house prices caused an excess in the supply market. Therefore, “the bubble burst and house prices fell” (Bernanke, 2013, 45). Bernanke (2013) argues that “the decline in house prices and the mortgage losses were a trigger”, and they “set afire” the “vulnerabilities in the economy and in the financial system” (48). The borrowers and lenders in the private sector “took on too much debt, too much leverage”, and the banks and other financial institutions were not able to keep up with monitoring the risk of the innovative and complex transactions (Bernanke, 2013, 48-49). Financial firms were also relying “very heavily on short-term funding such as commercial paper”, and their short-term and “liquid form of liability” became “subject to runs in the same way deposits were subject to runs in the nineteenth century” (Bernanke, 2013, 49). The vulnerabilities in the public sector include an outdated regulatory structure that “did not keep up with the changes in the structure of the financial system” (Bernanke, 2013, 50). The Federal Reserve also created vulnerabilities in the economy by providing poor supervision of banks and poor consumer protection because “the Fed has authority to provide some protections to mortgage borrowers 9 that, if used effectively, would have reduced at least some of the bad lending” (Bernanke, 2013, 51). Bernanke (2013) makes the final point that the structure of the regulatory system caused weaknesses because there was not much attention paid to problems affecting the entire system due to having many different regulatory institutions being responsible for different, specific financial institutions (51). Bernanke argues that the deterioration of mortgage standards coupled with the decrease in house prices exposed the vulnerabilities in both the private and public sector, leading to the 2008 financial crisis. The amount of subprime mortgages increased from $35 billion (5 percent of all originations) in 1994 to $625 billion (20 percent of all originations) in 2005 (Blinder, 2013, 70). People previously purchased homes with a 20 percent down payment, but this all changed because of the real estate boom due to the “can’t lose” mentality developed towards real estate (Blinder, 2013, 47). Mortgages that required only 5 percent or less down payment became common, and there were times when the down payment for the house was borrowed (Blinder, 2013, 47). Banks were making risky mortgages and quickly passing them on before they could bear the consequences (Blinder, 2013, 69). Specific subprime mortgages are highlighted, and they are “low doc” mortgages, “no doc” mortgages, “liar loans”, “option ARMs,” and “negative amortization mortgages” (Blinder, 2013, 70-71). No doc and low-doc mortgages were about one-third of the total of all subprime 10 mortgages (Blinder, 2013, 70). NINJA loans were loans “granted to people with no income, no jobs, and no assets”, and “no one seems to know how many NINJA loans were actually granted” (Blinder, 2013, 70). These are all “risky mortgages that should never have been created” (Blinder, 2013, 68). The option ARMs gave the borrower a choice each month of whether to pay the contractual payment, the interest, or pay less than the interest and add the rest to the principle (Blinder, 2013, 71). It is, however, important to note that these risky mortgages were only risky because of the people they were offered to (Blinder, 2013, 71). Subprime mortgages can be a good risk for people that can afford to gamble with their money, but banks offered these mortgages to people who could not afford a loss (Blinder, 2013, 71). There is a clear difference between “almost qualified” borrowers who would like to own homes and banks looking for anyone who would sign a mortgage document (Blinder, 2013, 69-70). Banks should not have offered loans that were “designed to default” to “unsophisticated borrowers” because it “violates the principle of sound banking” (Blinder, 2013, 71).

Securitization

Securitization is another cause of the financial crisis that occurred in 2008. Initially, the purpose of securitization was to reduce risks and make mortgages more liquid. It seemed perfect because it gave the bank the ability to sell mortgages and use the money for other purposes. However, the process of securitization severed the relationship between the lender and the borrower and worsened problems caused from imperfect information (Stiglitz, 2010, 14). In the past, banks would originate loans and hold onto them, so they had an incentive to ensure that the borrower had the means and the incentive to repay the loan over time (30 years). They would bear the consequences of the borrower defaulting because each mortgage the banks made was held by them (Stiglitz, 2010, 90). Holding onto the loans forced the banks to be held accountable for their loan decisions, so they had to make sure the loan was good. Borrowing was a personal process in the past before securitization, and the bank would know when it was worth it to extend credit and be able help out a borrower that had trouble paying because the bankers had the opportunity to know the borrowers (Stiglitz, 2010, 90). Foreclosure only happened when it was absolutely necessary, and banks could judge this situation because they had a more personal relationship with the borrower (Stiglitz, 2010, 90). Securitization put distance between the lender and the borrower because the lender became an investor that was completely separated from the borrower (Stiglitz, 2010, 90). The shift to lenders becoming the investors put the borrowers at a disadvantage because investors could potentially be very removed from the community and less understanding of hardships. Investors often put restrictions on the loans and made it more difficult for the borrower to refinance if any problems arose (Stiglitz, 2010, 96). The understanding friendly banker no 13 longer existed because of the new distance between the lender and the borrower put there by securitization (Stiglitz, 2010, 96). Securitization did not begin as a dangerous innovation, but it became one.

Securitization allowed banks to produce bad mortgages and then pass them on as quickly as possible (Stiglitz, 2010, 14). A bad mortgage is one that is made to either a person with bad credit, does not have the income to pay the mortgage back, or the terms of the mortgage are too risky for the borrower. A good mortgage is one that is made to a person with good credit, the income to pay the mortgage back, and a borrower that can withstand the risk involved. The securitization process had banks making subprime mortgages and knowing they should find a buyer for them while they were still good (Blinder, 2013, 72). Investment banks paid cash for the mortgages, bundled them with mortgages from all over the country, packaged them into “well-diversified mortgage-backed securities”, and sold them to investors around the world (Blinder, 2013, 73). The mortgages were pooled like mutual funds and therefore, less risky to invest in because the investment was no longer in an individual mortgage (Blinder, 2013, 73- 74). The complexity of securitization does not end there.

Securitization became even more complex with tranching, and tranching was done in order to decrease the risk of the upper tranches to achieve higher credit ratings. Banks had the opportunity to “tranche” the mortgage pools (Blinder, 2013, 74). To do this, the bank sliced up the pool into different tranches. For example, there would be three different tranches: the “toxic waste” tranche, the “mezzanine” tranche, and the “senior” tranche (Blinder, 2013, 74). The tranche bundle of 14 securities is now a collateralized debt obligation (CDO), and most CDOs had seven or eight tranches (Blinder, 2013, 74). The “toxic waste” tranche was the most junior tranche, and it would absorb the first percentage of losses in the pool (Blinder, 2013, 74). The “mezzanine” tranche was the middle tranche and would absorb the next percentage of losses, and the “senior” tranche was the top-rated tranche and was vulnerable only to losses above the other tranches’ combined percentages (Blinder, 2013, 74). The complexity of securitization, unfortunately, still does not end with these CDOs. Wall Street engineers began to combine the junior tranches of securities into a new CDO and tranche that “CDO of CDOs” (Blinder, 2013, 75). The lowest tranche of the new CDO protected the other four tranches from risk by absorbing the first percentage of losses that accumulated across all of the underlying mortgage pools involved (Blinder, 2013, 75). The securitization process became extremely complex. Each link in the chain of this process added risk, complexity, and confusion (Blinder, 2013, 76). “The mortgage originators knew something about their local markets and the creditworthiness of their borrowers”, and “the investment banks that did the securitizing knew less” than the mortgage originators (Blinder, 2013, 76). Those on Wall Street “who created the CDOs and the CDO2s were performing mathematical exercises with complex securities; they had no clue about – and little interest in – what was inside” (Blinder, 2013, 76). “The ultimate investors, ranging from sophisticated portfolio managers to treasurers of small towns in Norway, were essentially clueless” (Blinder, 2013, 76).

The bankers did not realize that a rise in the interest rate or unemployment rate could have effects on multiple parts of the country (Stiglitz, 2009, 141). The banks failed to assess the risks associated with the new financial products such as the low-documentation loans that were the underlying loans for some of the mortgage-backed securities (Stiglitz, 2009, 141). Bankers also did not correctly 16 predict the risk of a decline in real-estate price or the effect the decline would have in many parts of the country (Stiglitz, 2009, 141). Focusing the main cause of the crisis on securitization disregards the legislation passed to initially allow banks to be involved with securitization. For example, the passing of the Gramm-Leach-Bliley Act allowed for the conflict of interest that securitization caused (Stiglitz, 2009, 143). Gramm-Leach-Bliley Act “transmitted the risk-taking culture of investment banking to commercial banks” (Stiglitz, 2009, 143). However, securitization alone is not the main cause of the crisis. The following figure explains how often securitization was taking place

Housing Initiatives and Other Policy Factors

Housing initiatives from the government along with monetary policy is possibly the main cause of the 2008 financial crisis. John B. Taylor (2009) claims that monetary excesses were the main cause of the crisis (150). The Federal Reserve did not follow the typical structure of interest rate decisions because “actual interest rate decisions fell below what historical experience would suggest policy should be and thus provides an empirical measure that monetary policy was too easy” (Taylor, 2009, 152). Taylor (2009) uses regression techniques to measure “a model of the empirical relationship between the interest rate and housing starts” (152). The results from the regression show, according to Taylor (2009), that there would not have been as large of a boom and bust had the “interest rates followed the rule”, and that the “unusually low interest rate policy was a factor in the housing boom” (153). Taylor (2009) uses this to establish “Taylor rule”, and it “shows what the interest rate would have been if the Fed had followed the kind of policy that had worked well during the historical experience of the ‘Great Moderation’ that began in the early 1980s” (151). The regulatory agencies and the financial markets let the low interest rates feed the bubble instead of using their power to stop it (Stiglitz, 2009, 145). The financial markets had the choice to use the funds in productive ways, but they chose not to (Stiglitz, 2009, 145). Financial markets and regulatory authorities had the tools to stop the low interest rates from feeding the bubble, but they did not use any of the tools they could have (Stiglitz, 2009, 145). The Federal Reserve could have used open market operations, reserve requirements, or the federal funds rate target in order to slow down the economy. Furthermore, the housing bubble was a major cause. As housing prices rose, the share of income spent on monthly mortgage payments increased (Bernanke, 2013, 43-44). People felt rich during the bubble because the increasing prices of their homes, so they borrowed more than they could afford (Bernanke, 2013, 46-47). After the bubble burst, mortgage 26 delinquencies increased, people were not paying on time, and banks were taking over properties to resell (Bernanke, 2013, 47). The bursting of the housing bubble caused banks and other holders of mortgage related securities to suffer sizable losses becoming a cause of the 2008 financial crisis (Bernanke, 2013).

Conclusion

In summary, banks increased the rate of mortgages and interests to create more profit. This increased the risk for borrowers and made them unable to pay in full. Also, securitization took away the personal relationship between the borrower and the banker, making it worse for the borrower. The lenders were now investors and they weren’t so understanding of hard times in one’s life. Moreover, the government and the fed had opportunities to stop the expansion of the bubble, but chose not to, so eventually it busted. All of these caused borrowers to be unable to pay mortgages, resulting in millions of dollars lost. This is the 2008 financial crisis.

References

1. Blinder, A.S. (2013). After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead. New York, NY: The Penguin Group.
2. Finder-Wustil, C (2018). How We Can Prevent Another Financial Crisis. Futurity. Retrieved from https://www.futurity.org/financial-crises-regulation-insolvency-1712122/
3. Stiglitz, J. E. (2009). The Anatomy of a Murder: Who Killed America’s Economy? ln J. Friedman (Ed.). What Caused the Financial Crisis? (pp. 139-149). Philadelphia, PA: University of Pennsylvania Press.
4. Stiglitz, J.E. (2010). Freefall: America, Free Markets, and the Sinking of the World Economy. New York, NY: W.W. Norton & Company.
5. Taylor, J. B. (2008). The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong. November. Retrieved from https://web.stanford.edu/~johntayl/FCPR.pdf
6. Taylor, J. B. (2009). Monetary Policy, Economic Policy, and the Financial Crisis: An Empirical Analysis of What Went Wrong. ln J. Friedman (Ed.). What Caused the Financial Crisis? (pp. 150-171). Philadelphia, PA: University of Pennsylvania Press US.
7. Bureau of Labor Statistics. (2012). The Recession of 2007-2009. BLS Spotlight on Statistics, February. Retrieved from http://www.bls.gov/spotlight/2012/recession/pdf/recession_bls_spotlight.pdf

Essay on Italian Crisis of 2018

The Italian economy has been hit by a deep-seated political and economic stir which has led to an unprecedented financial crisis. Italy is the only eurozone country to enter recession in 2018 after two consecutive quarters of contraction in the business cycle. Alongside the 2010 debt crisis of Greece and 2018 currency crisis of Turkey, Italy stands alone to be the only eurozone nation to experience recession for the third time in the past decade.

The Italian Economy: A Background

Italy has been a ground for political and economic turmoil ever since the financial crisis in the United States sprung up. The effects of this breakdown could be observed in other real economies, especially in Europe. The markets and other indices began to slide officiating to a crash after March 2008. The euro area was able to withstand the pressure of the downfall for a little longer than the US. However, post-crash, production fell by 20 percent in the euro area between the first quarter of 2008 and the second quarter of 2009 and exports by 21 percent between the third quarter of 2008 and the second quarter of 2009. Furthermore, gross fixed capital formation declined by 11 percent.

In the context of Italy, both industrial production and exports fell more rapidly than in other European economies. The production declined by 24 percent and the total exports by 25 percent between the first quarter of 2008 and the second quarter of 2009. This was anticipated because of the significance of Italy’s trade position in the eurozone and the effects of the devaluation of the dollar.

The unemployment rate has risen by approximately 1 percent. Despite the statement given by the 2009 World Economic Outlook of the International Monetary Fund (IMF) on the progressive decline of unemployment, the unemployment rate in Italy has increased by approximately 1 percent. Although the recovery can be felt, the course that these economies follow is uncertain and conditional to policy changes.

Contemporary Situation of the Modern Italian Economy

In the present times, Italy is trapped in a downward debt-growth cycle. The weak fundamentals of Italy evince the substandard condition of the economy. With a debt of 2.3 trillion euros, which accounts for roughly 131.2 percent of gross domestic product (GDP), it reckons a debt more than double the eurozone limit. Unlike other recessions faced by the members of the European Union since the Second World War, this situation has proved to be the most profound. Moreover, an unemployment rate of 10.7 percent in the year 2019 and a GDP of 1.93 lakh crores (in USD), less than that of 2005 inflicts the grave condition of the economy.

Genesis: Determinants of the Issue

The damage caused to the economy is due to self-inflicted reasons such as the formation of an erratic coalition government, weak banking system, intrinsic and adventitious factors.

Political Stir-Polity

The growing instability due to political chaos has caused turmoil for the European Union. The inefficacy to form a stable government dates back from the March 2018 Italian general elections that resulted in a hung assembly and a need for snap elections. The two populist parties namely, the Five Star Movement and the Lega secured a majority (with 32.7% and 17.4% respectively) in the parliament, thus leading to the formation of a coalition government. Due to the sudden resignation of the proposed prime ministerial candidate, Giuseppe Conte, an opposition amongst the coalition stirred. They refused to offer another choice for finance minister, discarding the coalition. This steered President Mattarella to appoint Carlo Cottarelli, former International Monetary Fund official, as an interim Prime Minister until another round of elections were conducted. This decision taken by the President did not comply with the coalition. While one party favored tax cuts that were business-friendly, the other focused more on expensive welfare programs as a means to extricating the economy from the collapse. Nevertheless, the Keynesian approach does not fit in the situation due to the excessive amount of national debt. This disagreement of the alliances on fiscal priorities caused a conflict of interest.

Proposed Budget

The recent elections represented a blowback directing to the fall of the Italian economy. The coalition had promised the masses money that could not be retrieved unless it was to ask European Union officials, asserting a weak sense of governance and decision-making. The agenda of the government stated a deficit equal to 2.4 percent of the GDP, contrary to the previous government that had called for a 0.8 percent deficit. The statistics show the inadequate funds both the parties have in order to comply with their endorsed campaigns for schemes like the pension reform or the citizen’s wage. The divide between the cost of fulfilling promises by implementing policy changes and the aim to minimize public debt was a major predicament that the coalition government had to face.

The Propaganda of an Anti-Brussel Idea

It is a well-noted fact that the populists at power have followed an anti-Brussel and anti-euro idea for the Italian economy despite the immense assistance that the European Union has provided it with to put Italy back on its feet. Regardless of the damage, it can do to do the market and the economy, their actions to join hands with Portugal and Spain manifest contradicting beliefs for the European Union and the euro. Brussels nearly accused the coalition of infringement of their agreement by excessive spending as highlighted in the 2019 Budget Law. Matteo Salvini, an influential politician released a statement emphasizing on the grave situation between Europe and Brussels and triggering anti-Brussel ideas.

Weak Banking System

The number of questionable loans is on a surge implying a frail banking system in Italy. The banks in Italy hold a huge amount of domestic government debt. European financial leading group, UniCredit, holds large volumes of debt. When production increases, the number of bonds and their value held by UniCredit reduces, deteriorating their capital. A huge collapse has been noticed when it comes to UniCredit shares from €18 to €12. There is an urge for the banks to become a bit more cautious with regards to lending. They raise interest rates or deny the consumers to borrow money. This would lead to a prolonged economic growth and a rise in unemployment. This worsens the situation of the economy and the financial situation of the government. This calls for a higher risk premium on Italian bonds from investors directing to an economy-wide doom loop.

Government Blame on Extrinsic Factors

The populist government of Italy put the blame on extrinsic factors such as global economic slowdown or the limiting amount of spending policy imposed by the EU. Prime Minister Giuseppe Conte has been criticizing the US-China trade war and slow global trade for the challenges faced by the Italian economy. The narrative of the populist government seems to be in conflict with data released as the net trade was found out to be positive. Cultural and historical factors limit an economy’s productivity growth. Corruption, inflexible labor market and shrinking labor force will only add up to the issues of the Italian economy. Given the weak access to capital and credit in Italy, the economy needs a two-fold measure to regulate the economy.

Consequences

It is anticipated that Italian consumer demand remains moderate and expects the investment to decline for the second consecutive quarter in the fourth quarter due to lower business confidence, greater uncertainty and lower credit supply. The stock market in Italy has been deeply affected by this recession. The benchmark stock market index of the Italian stock market, FTSE MIB dropped by 0.7% recently, worsening its condition as a European index. The currency of Italy and the other 18 members, the euro, dropped to an all-time low of $1.153 for 10 months. Global markets were shaken with a drop of industrial average by 1.58% while the investors shifted money into a safe haven of US bonds, resulting in pressure on bank shares. According to Nicola Nobile, an analyst at Oxford Economics, based in Milan, “The government will most likely miss the fiscal targets agreed with the European Commission at the end of last year (2% of GDP for 2019 and 1.8% for 2020)”. Moreover, it is extremely unlikely for Italy to default out of the Euro-One because of the repayment of the heavy sum of debt. The populist parties, the Five Star Movement and the League did not call an off for the euro membership, given the majority of Italians who do not want to leave the European Union or the euro currency. The two parties hope to win by an even more mandate in the snap elections. In April 2019, the league expected to win by 37%, however, the party support seems to have reduced. The European political leaders are likely to enforce sanctions by cutting off EU funds for the Italian economy. However, if the recession continues to exist even by the end of 2019, any measure of government spending will be unsustainable.

Conclusion

The autumn budget could prove to be the best opportunity to make rational decisions and keep the faith of investors intact. The country’s deficit could also be kept under the standard limits by introducing a raise in value added tax. An injunction of the pro-EU group will likely keep things stable and restrain Italy to become the epicenter of another financial crisis. In order to keep the euro from collapse and get the Italian economy out of the debt-trap, Mario Draghi, President of the European Central Bank, suggested bond-buying, hence, establishing credibility and a strong faithful relationship with its eurozone partners.

The Big Short’: Movie Summary Essay

Introduction:

The Big Short was a comedy-drama film that was conducted by Adam McKay and written by Charles Randolph and Adam McKay. The Big Short movie is based on a book from 2010 written by Michael Lewis. This film had a limited release starting December 11, 2015, and then fully released on December 23, 2015. The Big Short is a 2015 Oscar-winning film. The film explains the financial crisis that happened from 2007 to 2008. This financial crisis was a huge issue while everything was crashing down because of home mortgages with people purchasing homes just as an investment. The Big Short really focuses on the people who were predicting the crisis before anything really even happened. Watching this movie was very eye-opening for me and expanded my knowledge on home mortgages and what could go wrong in the future that is sometimes out of your hand you can’t control it.

Backstory:

The financial crisis started in February of 2007 when the housing industry asset “bubble burst” was caused by the subprime mortgage crisis. With years past the increase in home values and low mortgage rates, people were basically buying houses to buy them and not using the home as a place to live, but more as an investment. In March 2007 the stock markets rebounded. The Feds decided to ignore the “warning signs” and they were more worried about inflation. The home sales decreased from 6.48 million sold in 2006 to 6.18 million in 2007. Later on, in 2007 the Feds decided to lower rates to 4.75% and foreclosure rates doubled at the beginning of 2008 when the financial crisis began. The financial crisis that happened in 2007 through 2008 led to millions in the United State being unemployed and many without homes. This crisis spread to the worldwide financial and economic crisis as well. The main players in the movie The Big Short are individuals, mortgage lenders, big banks, collateralized debt obligations (CDOs), rating agencies, and investors. These main players were the main focus of the movie because it was a large part of the financial crisis that started in 2007.

Who is to blame?

Individuals, some people want to blame the homeowners for the financial crisis because people were buying homes not even to live just as an investment. Mortgage lenders get blamed for this because people are claiming someone had to know that this could possibly happen. Banks are also getting blamed for the financial crisis as well because they were accepting applications for second homes for investment when they could have not accepted so many applications and maybe the financial crisis wouldn’t have happened.

Mortgage Loan:

A mortgage is a loan that a bank or mortgage lender approves of the finance to assist you when you can purchase a house either a primary residence, a secondary residence, or an investment residence. A home mortgage is one of the many forms of debt and most mortgages have lower interest rates than other loans. A home mortgage can have a fixed or floating interest rate depending on what the individual would like.

A subprime mortgage is a mortgage loan made for an individual with a very low credit score and limited income to get a conventional mortgage loan. Commonly, subprime borrowers are likely to be unable to complete the payment on their mortgages. A mortgage-backed security (MBS) is a package of mortgages that are sold and traded similarly to a bond. How does the mortgage industry work? There are many steps in the process of the mortgage industry: a range of lenders, lead generation services, working together with a broker, loan application processing, competition, and assisting the borrower.

What are CDOs?

CDOs represent collateralized debt obligations and are a “financial tool that many banks use for individual loans into a product sold to investors on the aftermarket.” This consists of loans such as credit card debt, mortgages, auto loans, and corporate debt. Why are they called “collateralized because the repayments of the loans are collateral that gives the CDOs their own value.” There is also an alternate name that some people use known as Collateralized Loan Obligations (CLOs). A credit default swap is an insurance program that pays off if the CDO defaults. This is how The Big Short people “bet against the real estate market.”

Definitions:

What are regulators? A regulator is someone or something that regulates something. Banking is the business of accepting lending or investment, deposits of money from people repayable on demand or withdrawable. Banking is one of the most important things worldwide. Rating agencies are a company that provides investors with an estimate of an investment’s risk. A mortgage broker is an intermediary who gets mortgage borrowers and mortgage lenders together to meet and discuss further information. Homeowners are people that own a home or homes. Speculators can be a person who invests in stocks or property and possibly make a profit.

In 1977 Congress passed the Community Reinvestment Act (CRA) which “requires the federal banking regulators to encourage financial institutions to help meet the credit needs of many communities that are low and moderate income.” There are only three federal banking agencies that are accountable for CRA such as “The Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board (FRB), and Office of the Comptroller of the Currency (OCC).” The purpose of the Community Reinvestment Act (CRA) is to exemplify that the bank is working to meet the credit needs of different incomes and people.

Ethics and Law:

The concepts of ethics and law can be different in many ways. Law refers to a systematic body of rules that governs the entire society and the actions of its individual people. What is law? Law is a set of rules and regulations that people have to abide by and it is governed by the government. Law is established with the purpose to sustain social order and peace in the environment and supplying protection to citizens. Ethics is a branch of moral philosophy that explains to people basic human conduct. What is ethics? Ethics is a set of guidelines that have to be followed properly. With ethics, there is no punishment for violating the guidelines while violating the law there is punishment such as imprisonment and/or a fine. Ethics is made to assist people to make a decision about what is right and what is wrong. Law and Ethics are very different; one consists of what a person must do while the other one consists of what a person should do.

Conclusion:

The financial crisis started in 2007 throughout 2008 because people were purchasing homes as an investment while there were low mortgage rates. People were going insane purchasing secondary homes for investment and then the housing industry asset bubble burst. Unfortunately, the bubble burst and many financial organizations were left to deal with trillions of dollars of investments. The financial crisis affected the entire world leaving people without homes or jobs. Many of the people that purchased homes during this time found out that they owe more on their mortgages than their home was really worth. The federal reserves were getting warning signs and hints that the financial crash could potentially happen but they just kept ignoring the signals. In 2009, the economy was starting to get back to “normal”. This movie was very interesting. I enjoy watching movies that are educational and that can allow me to expand my knowledge of business topics. I can definitely say that I have learned a lot from watching this movie and researching other information as well.