The global financial crisis threatened to lead to the total breakdown of the global economy. Despite originating from the US subprime market, the global financial crisis affected all sectors of the economy. The sectors affected by the global financial crisis ranged from banking, insurance to tourism.
The global financial crisis had an adverse effect on the healthcare industry. The global financial crisis reduced the funding of that the healthcare facilities received from the government. Lack of funding made hospitals suspend their expansion plans. The global financial crisis reduced peoples income. This reduced the ability of people to access quality healthcare. This is because they could not afford quality healthcare, which is expensive.
The global financial crisis reduced investments in the healthcare industry. Many hospitals delayed their expansion plans during the financial crisis due to lack of funds. Some of the worst affected projects included the expansion of wards and purchase of new diagnostic equipment. The hospitals put on hold projects that would have improved the quality of healthcare. In addition, there was a hiring freeze in most hospitals during the global financial crisis. Therefore, the global financial crisis had a negative effect on the quality of healthcare.
During the financial crisis, there was a significant decline in the number of patients of were admitted in various hospitals. This is because the patients did not have enough funds to seek medical treatment. Patients postponed seeking medical treatment for non-fatal ailments or resorted to cheaper healthcare alternatives.
This reduced the income of healthcare facilities that focused on treatment of non-fatal ailments. During the financial crisis, most hospitals experienced a sharp hike in bad debts. This is because patients could not afford to pay hospital bills despite the fact that they required medical care. Medical facilities have investment portfolios that complement their income. During the global financial income, the financial markets were performing poorly. Therefore, this reduced the income of the healthcare facilities.
The government, individuals, and employers are the principal financiers of healthcare. Most countries have various government-funded medical schemes that finance healthcare. Lack of funds during the global financial crisis necessitated the government to introduce budget cuts. Budget cuts had a negative impact on government-funded healthcare schemes. Companies depend on the availability of revenue to finance employee healthcare schemes.
The global financial crisis reduced the revenue of most employers. This reduced the ability of employers to fund various healthcare schemes. Individuals also have private healthcare insurance schemes. However, the global financial crisis led to a significant reduction in the income of various people. This made it difficult for individuals to purchase healthcare insurance policies.
The global financial crisis had a negative effect on the individual health of various people. People postponed seeking healthcare services for non-fatal conditions. People depended on the public healthcare system. This increased the pressure that the public healthcare system faced. This is despite the fact that the global financial crisis reduced the availability of funds to finance various public healthcare schemes. In addition, the global financial crisis reduced the health status of individuals.
Home foreclosures and other financial problems had a negative effect on the mental and psychological health of various people. The importance of healthcare in a nations well-being necessitated most governments to limit budget cuts on healthcare provision. Most governments strived to ensure that lack of funds during the financial crisis does not lead to deterioration of the health status of people.
Rapid globalization of international markets has given rise to global crisis and emerging markets like that of Bahrain characterized with strong fundamentals attributed from sudden inflows and outflows of foreign investment has not been an exception.
Impacts of financial crisis on the countrys economy have accelerated debate within the mainstream of economics and many market analysts have devised economic stimulus plan to confront the crisis. Global Financial Crisis has provided valuable lessons to both regulators and financial industry hence the need for stronger regulatory frameworks and monetary policies.
Impacts of Financial crisis on Bahrain
Financial crises that usually follow inflation often destroy large volume of wealth causing financial meltdowns. Although GCC countries are endowed with natural resources such as oil and petrochemical products, they are not shielded from the financial crisis. For example, the collapse of Lehman Brothers subjected the economy into unpredictable phase of financial crisis.
There were reports of increase in risk aversion in financial markets, as indicated by rise in risks premiums and steep fall in global stock markets. It is however, important to note that, a continuing period of low risks premiums could mean prolonged downturn of asset price inflation and devastate the economy of a nation which may subsequently reverberate beyond the countrys borders.
Collapse of Lehman brothers led to immediate liquidity in international financial markets and large bank hence deepening the current economic status of the country (AMEinfo 2009, online).
Further research to substantiate the impact of financial crisis on Bahrain suggest that other sectors of the economy such as financial services, tourism and real estate were affected as well. Some of the impacts included loss of sovereign wealth funds, decline in capital inflows, global trade, unstable oil prices and major investments projects were scaled back.
Since majority of Bahrain economic stimulus package was proposed to come from corporate earnings, AME info (2009, online) proposes that in order to mitigate the impacts of financial crisis, banking sectors will be required to recapitalization their funds and offer guarantees on deposits and to maximize exposure by publishing daily, monthly and quarterly reports on their liquidity positions.
Studies have consistently found that impacts of financial crisis are intertwined between there sectors of the economy that include; financial sector stability, key economic sectors and economic performance. The three dimensions are further divided into growth, inflation, external balance and public finance in measuring the extent of financial crisis.
In economic growth aspect of GCC countries, the global recession that hit the countries in 2009 resulted to a decline in real GDP rates by 3%. According to Markaz News (2010, online), Bahrain was anticipated to experience fiscal deficit of -2% of GDP in 2010 since most foreign investors pulled out of the capital markets and there were reports of decline in international reserves.
The Bahrain government however did step up by drawing contribution from reserves and external balance to stimulate the economy. In public finance sector, GCC countries recorded sharp decline in oil revenues which subjected Bahrain to risks of running budget deficit.
AMEinfo (2009, online) reports however indicated that the country high spending prior to the crisis and massive public investment programs depleted the countrys reserves hence making it vulnerable to any fiscal retrenchment.
Other non-financial that reported to be adversely affected by the financial crisis include real estates and tourism sectors. Real estates for instance recorded significant drop in demand and decline in prices during that period and GCC hotels on the other hand reported less revenue and lower occupancy rates.
Amidst the crisis, banks in emerging markets such as Bahrain should implement high standards of risks management offer incentive for adequate self-regulation, corporate governance and internal controls to prevent excess risks taking. The correction of this market margins would require Bahrain to undertake several reformatory measures such as regularity changes, corporate governance and transparency in the monetary system to attract foreign investment (AMEinfo 2009, online).
Impact on financial crisis on financial systems in Bahrain limited its credit growth and the banks inability to lend. On key economic sectors, the country recorded a sharp decline in oil and gases exports and other new investment projects have either been deferred or cancelled.
The upstream projects were reported to put pressure on inflation because of the amount of materials and energy services required to put up the project. The country should try and use its future excessive capital in financing the underway projects such as the construction of energy production firms to increase the production capacity and boost the economy (AMEinfo 2009, online).
Since most Arab economies are dominated by family owned businesses, the financial crisis had huge impacts on these private businesses to their exposure to foreign markets. Azour quoted in AMEinfo (2009) stated that Several family businesses are facing financial difficulties from deterioration in their asset quality, the increase of corporate risks, their lack of focus on core businesses, exposure to hard-hit sectors, and high levels of debt (online).
In order to recover from the global crisis, GCC countries will be required to work together to recover its financial activities in oil demand by strengthening their fiscal policy and external balances.
Stimulus programs and policy actions towards economic diversification, adopt modern fiscal management infrastructures in investment and social reforms such as subsidy programs and labor policies that will encourage macro-financial stability. Azour also encourages GCC countries to prioritize private investments mostly in non-oil industries, service sectors and high-value industrial services to stimulate the economy.
Bahrain overdependence on foreign financing might have subjected to it to global crisis. Findings summarized by International Monetary Fund (2008, online) reported that banks in Bahrain borrowed from foreign banks to support their credit growth and the sudden inflows of cash might have greatly contributed to high rates of inflation in the country.
This is because inflation accelerated the inflow of capital into banks and which was later flushed out due to the global crisis making the economy liquidity strapped. Its equally important to note that economic crises that usually follow inflation often destroy large volume of wealth causing financial meltdowns.
Conclusion
In order for Bahrain economy to mitigate the impacts of financial crisis, economic stimulus plans such as investing in robust government spending and good external demands will be required in order to promote corporate economic growth. The country should also improve its regulatory structure and encourage foreign involvement to boost stability and enhance transparency in the banks monetary activities.
Lastly, banks should be encouraged to publish credible reports on annual, monthly and quarterly basis as a strategy to improve transparency on the flow of capital and attract foreign interest. Potential investors reviewing financial statements of the banks will have well informed knowledge of the company to invest in due to the comprehensive notes provided by the reports.
Reference List
AMEinfo 2009,One year on:the GCC regions post-economic crisis prospects. Web.
The European continent and the world at large are nursing the effects of one of the worst financial downturns in recent history. In efforts to avert such scenarios in the future, European nations are in need of a risk management framework that should not overly depend on the results of external assessments and risk models from rating agencies. Europe has learnt the hard way that risks are interrelated and the correlation may result in an effect that had not been detected earlier.
Consequently, the EU members have adopted frameworks of managing organisational risks that are firm- wide and which addresses the different forms of potential risks that firms may encounter. Central banks have a very essential role to play in risk management during such crises. However, they have to operate in a way such that they are able to strike a balance between their policy making duties and still maintain credibility and independence from other arms of the government or other agencies.
The EU has learnt that risks do not become obsolete with time. Most of the risks that financial institutions ignored or had forgotten about were the same as those that crashed financial systems. Nonetheless, the crisis has reminded nations and institutions to focus more on how to effectively manage risks from an internal perspective that is informed by expert judgement.
Introduction
Most of the firms which were severely hit by the effects of the credit crisis in Europe had put in place various systems of risk management. However, it is important to note that huge losses are not incurred as a result of failed risk management systems only. The amount of losses incurred by corporations and organisations in the western nations has left a mark that will not be forgotten easily in the history of finance and economics.
There are many theories which have been put forth to explain or put into perspective the European credit crisis. Some of them include the various inconsistencies both in the governments and in the private sectors.
However, one of the most obvious causes of the crisis is the inadequate risk management measures in the various organisations. With the crisis is out of the scene- at least momentarily- it is essential to find out what can be learnt from the horrific financial and economic experience and determine how risk management systems can be used to avert future downturns (Higdon & Busch 2010).
In this report, the author makes an attempt to outline the failures in risk management initiatives just before and during the crisis. This is in addition to a critical analysis of the efforts made by the European Union (herein referred to as EU) to reinforce proper management of risks in the future.
Causes and Dynamics of the Crisis
Economists have written and published several papers and books touching on the dynamics and causes of the global financial and economic crisis that began in 2007. Today, most of the reasons why Europe and the United States found themselves in the economic depression seem to be very much obvious. However, that was not the case before the crisis struck. It is very clear that the way many institutions and governments view trade- offs between returns and risks has changed a great deal since 2008 (Higdon & Busch 2010).
Zaharia, Zaharia, Tudorescu & Zaharia (2011) point out the main reason why public authorities, participants in the markets and academics have devoted more resources to the identification and assessment of issues that are related to risks is not because of the challenges and uncertainties facing the financial and economic systems.
They add that it is not even because of the fact that the crisis was one of the most devastating in recent history. On the contrary, the focus on risk has been necessitated by the fact that everything that is related to the crisis- roots, trunks and branches- are correlated to governance aspects and risk management.
In the light of this reality, there are several convincing explanations that have been provided to address the dynamics and causes of the economic and financial crisis. It is clear that risk managers may find these explanations to be very useful because they may hold some truth.
Of most importance is that no single argument can sufficiently explain or account for what happened from late 2007. However, it is equally essential to remain objective in order to distinguish between ideologies and facts. This is as scholars assess the pieces of work, some of which are best- selling (Jourdan, Meier, Pacitto & Soparnot 2012).
Various commentators have made several suggestions in efforts to explain the credit crisis. Some of them include:
The financial and private sectors borrowed heavily and incurred large debts because of the low rates of loans just before the crisis.
the building up of disequilibria in the financial sector and the bubble in asset prices.
the biased offering of incentives which encouraged investors to take excessive financial risks.
the strategic drift that disabled regulators and prevented them from adapting to the evolving financial system.
the conflicts between agents who were needed in secularization.
failures in the markets that were mainly caused by lack of accountability and transparency concerning product characteristics, risks and information asymmetry.
Most of the investors over- relied on economic models and information that was unable to correct project some very important risks and as such they did not conduct themselves with the expected due diligence (Jourdan et al. 2012).
Many scholars agree that after the burst of the United States housing bubble, many people defaulted on their loans, which led to widespread underperformance in the mortgage sector. The resulting financial inadequacies were the spark that ignited the global economic crisis.
In early 2008, many high profile investors decided to unwind their positions so that they can take care of margin calls. As a result of this, the liquidity in fixed- income markets began to dry up rather fast. Losses that were related to the risk in liquidity began to pile up and real estate risks started to manifest in a manner that had not been witnessed before since the end of the 1930s great depression (Polak, Robertson & Lind 2011).
One of the most important lessons that Europe and the world has learnt is that downturns are more frequent than previously thought. The EU is thus bracing itself for new slumps in the future, economic slumps that may be very different from what happened during the recent crisis. Regardless of the cause of such a crisis- whether high prices of food and oil, asset bubbles or geo- political tensions- nations and organisations around the world should have the capacity to react and weather the effects of such shocks.
The lack of asset liquidity and the fact that most of the main players in the financial markets were going through some of the most difficult times- reconciling losses and trying to consolidate and deleverage them- rendered most of the risk management models obsolete.
Over- reliance led to a false increase in the scope of risks that the models were supposed to cover and address. This led to a great deal of uncertainties regarding the real value of the assets that were in the custody of financial institutions. Institutions and governments began to discover the forgotten risks in addition to credit and tail market risks.
Nonetheless, such traits were still not enough to wake them to the fact that the decisions of global investors were misplaced. However, the increased defaulting rates and collapse of large banks both in Europe and in the United States made the concerned parties realise that they had to begin focusing on counterparty risks. These risks were of immense importance to the governments in Europe (Higdon & Busch 2010).
International integration and financial globalisation- which highly determine the prosperity of nations- became shock transmission channels that relayed the effects of the crisis throughout the global economy. With time, systemic risks set in because of the links between global financial systems and the difficulty of isolating problems in the financial institutions and in sectors where the crisis had begun to encroach (Higdon & Busch 2010).
Risk Management and the Crisis
The parties concerned in the crisis abandoned some of the most basic practices of risk management. This is for example the practice of identifying ones counterparties, investing only in services and products you comprehend, not outsourcing risk management by over- relying on external assessments of credit, and not exclusively relying on quantitative risk management models, regardless of their sophistication (Jourdan et al 2012).
Throughout Europe, there was evident overdependence on some aspects that made the situation even worse. This is for example over- dependence on:
the capability of managers to create returns.
the merits of financial innovation in efficiently spreading returns and risks in the market,
the sufficiency of data and models used for risk estimation in the market,
Assumed market efficiency, and
the willingness and ability of authorities in the financial sector to alleviate the effects of slumps in the asset prices (Polak et al 2011)
According to Polak et al (2011), this over- dependence denied capital markets the opportunity to reflect on the price in the culminating risks.
Regardless of how one looks at it, there are many lessons that nations and institutions can learn from the financial crisis regarding the importance of strategic management of risks.
This is the reason why financial markets all over the world are characterised by buzzwords such as sovereign debt, animal- spirits, black- swan, and stress- testing. The experience has made risk managers realise and appreciate the need for the right risk management models at the right time. It has also made portfolio managers realise how risks really manifest themselves.
The market participants are now aware of the compound impacts of risks, crises dynamics, and systemic risk effects that arise from shocks in global economics, courtesy of the recent economic meltdown. The participants are also aware of the various hidden imbalances and contagion effects of such a crisis.
Courtesy of the crisis, practitioners and academics are now able to analyse failure in markets with more emphasis placed on institutional and behavioural aspects. Moreover, investors and their companies have become quite sceptical as they have discovered the need to diversify their operations. They are also aware of the fact that their assets may not be risk free after all (Higdon & Busch 2010).
It is noted that as a result of the recent economic and financial crisis, risk management has emerged as a popular strategy among stakeholders in this industry. For example, the participants reaction to rumours regarding the financial stability of institutions has changed drastically.
Kirkpatrick (2012) notes that generally, the financial industrys capital position has been watered down. In addition to this, some institutions have been forced to go back to processes such as risk downsizing and deleveraging. However, such processes can bring the European capital markets down again if there are no proper check mechanisms. It is thus adversely affecting the way risks are viewed all over the world (Higdon & Busch 2010).
There are two major explanations for the negative feedback that is brought about by financial crisis. One of them is the fundamental point of view where the risks all over the world increased while loss absorption capacity decreased. Another one is the behavioural perspective where confidence waned as the crisis pushed the world towards unchartered territories, far away from presumed comfort.
Higdon (2012) points out that the approach adopted in the management of risks in the financial sectors (by bankers and risk managers) may not be explained by the understanding of the recent risk. On the contrary, it is a reflection of the drastic rise in measures to avert risks.
He adds that such a phenomenon is not fully justifiable on the basis of the learning process. In this regard, it is always important to take into consideration the fact that behavioural factors provide the momentum that drives markets when making decisions and formulating models that support such processes (Jourdan et al 2012).
However, it is advisable to remain optimistic given that individuals, institutions and nations have learned important lessons. It is noted that when reforms are implemented when necessary, the confidence of the financial system is restored. Nonetheless, one major question still persists.
This is the question of whether the European countries have adequately learnt from the effects of the crisis or whether they are simply living in the crisis mode and will forget the lessons as soon as the downturn is in the books of financial history (Higdon & Busch 2010).
Risk Management in the New Environment
In this section, the report will address some of the reactions to these new developments in the global arena. It is noted that nations in Europe have begun to embrace risk management strategies to cope in the developments in the market. Public authorities in the United Kingdom have started to put into practice the lessons learnt from the crisis. Kirkpatrick (2012) is of the view that the EU has adopted various regulatory initiatives in order to protect the region from similar crises. These include:
The promotion of sound practices of risk management and the integration of risk management into the process of making regional financial and economic decisions.
Addressing challenges that are posed by institutions that were previously regarded as too-big-to-fail and the associated moral hazards.
Enhancing the financial infrastructure of the region to make it more tolerant to risks. This is through the promotion of initiatives and instruments to alleviate counterparty risks and limitation of contagion channels of sector or firm- specific shocks.
Making sure that financial statements are standardised, valued fairly, and transparent.
Redesigning capital requirements and regulatory policies to prevent pro- cyclical impacts. This is for example through the introduction of provisioning mechanisms and funding as well as liquidity requirements.
The Basel III Agreement provides guidelines for the changes that should be implemented in the regulatory standards of the banking industry. The effects of the new regulations will be mitigated as countries in Europe begin to slowly adjust to the proposed regulatory framework, taking into consideration their feeble economic and financial position.
In the long run, as these nations transit from the crisis to a framework that is meant to enhance organisational risk management and the capital position of institutions in the financial sector, the publics confidence in credibility of financial systems will be restored (Jourdan et al 2012).
There is need for more intervention measures from the government. This is the reason why the European Central Bank- in association with other key partners in the market- has made the decision to disclose loan by loan level information and data in the European ABS market.
This will definitely go a long way in revitalising the markets and in mitigating the risks related to such products (Higdon & Busch 2010). However, the effectiveness of the ECB initiative will be determined by the diligence of participants in the market. Public institutions will be expected to provide high standards of governance.
The problems faced by financial institutions and governments in the recent past are not solely as a result of measures taken to address risks such as value-at-risks or as a result of adoption of models such as Gaussian copula model or the opinions of credit ratings. On the contrary, the problems have been brought about to a large extent by the failure to elucidate on the limitations of such models and measures (Higdon & Busch 2010).
The EU is currently encouraging financial risk managers not to be too comfortable with established standards and historical risk management regularities. All departments in financial institutions are supposed to make contributions to the organisational function of risk management and come up with effective communication strategies to address this issue.
Europe has gone through economic uncertainties that no institution or person in contemporary society would have predicted. However, although the idea of managing risks has much to do with uncertainty than making forecasts, the placid financial risk management models coupled with myopic inputs could not capture the hazards that plagued the financial systems in the continent and elsewhere in the world (Zaharia et al. 2011).
This notwithstanding, economists continue to wonder how governments and banks could have fallen blindly for the predictions given by the models that were using data collected over a period of ten years. The data was used to erroneously predict that global financial systems were not likely to face a crisis in a period of 100 years.
However, in addition to the economic downturn that materialised from 2008, the world has experienced two global wars over the last one century. This is in addition to the Great Depression of the 1930s and several financial and economic crises that have crippled many sectors of the society and affected virtually all countries in the world. One does not need to be an expert in statistics to realise that governments and financial institutions misused the models that were in place at that time.
The most disturbing question is whether Europe and the world at large can withstand such crises in the future if there is failure to assimilate experiences of the past. Some analysts have pointed out that the standard models of risk management did not have the capacity to effectively capture and address what they are referring to as a black- swan event (Higdon 2012).
This is the reason why stress- testing is regarded as one of the most essential components of a contemporary risk management model. Designing plausible but forward- looking (as well as demanding) stress- tests at the firm- level and at the business level significantly improves the comprehension of causes and effects of risks encountered by financial institutions and such other organisations.
One of the most important lessons that European governments have learnt from the economic crisis is the fact that the various kinds of risks are interrelated. At times, the correlation results in a compounding effect that had not been detected by the tools of risk management used by the organisation.
Therefore, the frameworks used in managing organisational risks and which have been adopted by institutions in the EU are firm- wide and collectively address the various risks encountered by the firms. This explains the current emphasis on both inter- risk and intra- risk interrelations which are aimed at building a diversified portfolio on the two dimensions while at the same time matching the needs of the market and risk- return preferences (Higdon & Busch 2010).
In order to successfully weather such a crisis, it is important to understand the fact that economics and finance are quite different from natural sciences. While such disciplines are based on the discovery of fundamental laws, finance is based on modelling and relating the interactions between people and systems. Such an understanding will be a vital asset for bankers and risk managers operating in the industry (Jourdan et al. 2012).
Controversies Surrounding the Crisis
According to Jourdan et al. (2012), one of the major controversies surrounding this crisis is the bailout plan adopted by several governments in the region. Analysts who are against such measures are of the view that at the end of the day, all they will achieve is shifting the exposure from the financial institutions in the region to the public.
The banks are the ones that stand to benefit from such measures at the expense of the taxpayer. This is given that the managers and directors are likely to walk home with bonuses and other benefits, courtesy of the European taxpayer (Higdon 2012).
It is noted that financial institutions from German have benefited from the bailout plans rolled out by the governments in the region. According to Jourdan et al. (2012), these financial institutions have received a disproportionately huge chunk of the bailout money that has been given to countries such as Greece which are already reeling from the effects of the crisis.
Such developments will hamper efforts to come up with risk management strategies to address such situations in the past. For example, the banks may encourage or fuel such crisis in the future given that they are likely to benefit from the measures that will be put in place by the governments to address it.
Stakeholders Fuelling the Financial and Economic Crisis and Risk Management
Credit Rating Agencies
These are some of the stakeholders that, according to Jourdan et al. (2012), led to the onset of the crisis in the first place. The risk management strategies in these agencies were very poor or non-existent in some cases. Analysts cite organisations such as Moodys and Fitch (Higdon 2012), which have been blamed for the crisis that took place in the US and whose effects persist today.
It is noted that such bodies have continued to provide misleading ratings mainly as a result of conflicts of interests among the management (Jourdan et al. 2012). Such ratings negatively affect the efforts of risk managers in the market.
The Media
As usual, the media has been blamed for the crisis that is taking place in the region. This is especially so in the case of English language media houses. The media is believed to have created tension among members of the public by blowing the situation out of proportion.
This sentiment was captured in the statement released by Papandreou, the Prime Minister of Greece (Jourdan et al. 2012), one of the countries that have been largely affected by the crisis. The leader was of the view that his country will not withdraw from the European Union. He opined that the crisis was a political and financial propaganda propagated by media.
Risk managers may at times make use of information that is availed by the media in making decisions touching on the financial status of their organisation. As such, misleading media statements may lead to erroneous decisions on the part of the risk manager.
Challenges for European Central Banks
The job description of a risk manager is directly related to what happens in a conventional central bank. A central bank is constantly exposed to crisis situations and has to come up with solutions using limited resources at its disposal. The ECB has played a major role in assisting European companies deal with the diverse phases of the downturn.
In order for central banks to effectively undertake such risk management roles, there needs to be an understanding of systemic risks that the economy is exposed to. Risk materialisation may to some extent impact on the financial position of the central bank. In such a context, they are risk takers as well as investment and monetary policy makers (Higdon & Busch 2010).
Central banks are different from other players in the economy. As such, their reaction to a crisis and their operations in such a situation are very different from those adopted by other stakeholders. This is mainly because they have the additional responsibility of managing public funds. That is why they are regarded as conservative investors in the economy.
Such a perception is fairly accurate in defining the risk appetite of a central bank but not in defining its policy making role. They take on risks that the investment banks would not have the capacity to handle. Additionally, in times of economic downturns, they follow the inertial principle because of the nature of their policy making responsibilities. The inertial principle posits that the organisation should not take risk management actions that may deepen the financial markets pro- cyclical behaviour (Higdon & Busch 2010).
As the markets served by the main financial institutions in Europe were reeling from the effects of lack of money, central banks in the continent had to take unconventional measures to supply the economy with credit. This is in order to sustain the process of implementing the various monetary policies in the most dangerous financial environment ever.
All risk managers understand that resorting to such measures means exposing themselves more to such risks. Long- term operations, asset purchases, full- allotment tendering and collateral framework relaxation have one thing in common. This is in times of such crises. However, central banks had to take that responsibility, albeit in a calm and disciplined manner (Higdon 2012).
During crises, the level of risk for central banks always increases. According to Higdon (2012), what makes the situation even worse is that they have to maintain their credibility and independence as they implement the monetary policy.
In light of such a reality, central banks are supposed to constantly monitor and evaluate their frameworks for risk management so that in times of crises, they can easily adapt to the situation at hand and remain credible and independent. This is so that after the downturn, they can continue pursuing their organisational objectives (Higdon & Busch 2010).
Conclusion
The recent global economic crisis has been a wakeup call to the entire world and as such, there are many lessons for all participants in the global market. One of the most disturbing lessons that may not be forgotten any time soon is that there are no risks that become obsolete with time.
The risks that many banks and governments in Europe had forgotten about and which no one could include in a presentation are the same that got revitalised and took the world by storm. One of the few positive effects of the crisis is that, for institutions and persons who are charged with the duty of designing and implementing public policies, there is an increased awareness of the need to have strong internal practices for risk management.
Another important lesson is that, even when risk management initiatives are implemented flawlessly, there is no guarantee that losses will not be made. On the contrary, the organisation may even incur huge losses in such a case. Losses can be caused by other diverse factors such as bad luck or poor business operations.
However, the crisis highlighted some of the most serious flaws in the risk management models adopted by global financial institutions. Some European firms went down courtesy of known unknowns like liquidity risk and model risks.
However, many of the firms were failing in 2008 courtesy of unknown unknowns such as contagion risks and structural as well as regulatory changes in regional and global capital markets. Admittedly, some of such risks could not be formally measured. Nonetheless, there are various effective risk management models that can be used to protect the EU from the effects of a similar crisis in the future. These include stress- tests and scenario analysis.
References
Higdon, P & Busch, N 2010, Corporate treasury risk management- are new approaches now essential? Journal of Corporate Treasury Management, vol. 3 no. 4, pp. 310-319.
Higdon, P 2012, Monitoring, benchmarking and improving treasury performance: the practical application of key performance indicators (KPIs) in treasury, Journal of Corporate Treasury Management, vol. 4 no. 4, pp. 293-310.
Jourdan, P Meier, O Pacitto, J & Soparnot, R 2012, How to emerge from the crisis and from crisis: lessons learned from a European survey, International Business Research, vol. 5 no. 6, pp. 105-11.
Kirkpatrick, G 2012, Corporate governance lessons from the financial crisis, OECD Journal, vol. 1, pp. 61-87.
Polak, P Robertson, D & Lind, M 2011, The new role of the corporate treasurer: emerging trends in response to the financial crisis, International Research Journal of Finance & Economics, vol. 78, pp. 48-69.
Zaharia, C Zaharia, I Tudorescu, N & Zaharia, G 2011, Effects of the financial crisis on the real economy, Economics, Management & Financial Markets, vol. 6 no. 2, pp. 164-169.
Greece faces economic hardships caused by both internal and external factors. There is hope for recovery through various proposals available. Unfortunately, citizens and authorities in Greece do not agree on which method of recovery is suitable. This essay seeks to establish the nature and origin of the crisis, Greeces advantages and disadvantages in the Eurozone, and Greeces fiscal policy.
Nature and Origin of the Financial Crisis
The current financial tragedy has its roots in the Eurozone financial crisis of 2008, which led to a sudden increase in public debt in developed economies. Greece became a victim of this tragedy due to three key factors (Kouretas). First, a weak political structure characterized by corruption and mismanagement of public resources led to a rise in public debt. Greece had the highest public debt in the Eurozone as it went beyond the 100% mark (Kouretas). Secondly, a lack of accurate prediction by financial markets concerning the infamous semi-prime mortgage credit crisis of 2007 in the United States of America led to a downgrading of Greece and other peripheral states and consequent withdrawal of Greece and other states from international bonds market (Kouretas). Lastly, Eurozone governments showed no interest in bailing out Greece, as did the European Central Bank due to lack of political union (Kouretas).
Benefits Greece Derives from Being Part of the Euro Zone
Greece derives several benefits by remaining a member of the European Monetary Union. Embracing Euro enables business people and customers in Greece to compare the value of goods and services among member countries (Simmons). In other words, this would increase integrity in business circles because of transparency in prices of similar commodities. Consequently, it will enhance cross border trade and add to competitive forces among member countries. Consumers are bound to enjoy lower prices, thus increasing consumer welfare (Simmons).
Another related school of thought states that embracing the Euro lowers exchange rate anxiety, which would, in turn, result in a lower cost of doing business for corporations and tourists. This leads to increased profits by corporations leading to high dividends for shareholders and increased revenues for Greece government (Makris). Reduced cost of doing business translates to increased trade in Greece and enhances competition for products and financial services (Indiana University). Increased competition would force corporations to invest in research and development, leading to better goods and services and increased productivity. In the end, member countries would certainly encourage specialization and a further rise in production (Indiana University).
Adopting a common currency makes it easier to secure foreign funding, especially within the Eurozone. This would cushion Greece from the further financial crisis and encourage foreign investors to establish multinational corporations in Greece (Tavlas). Such local and international investments in Greece would lead to increased job opportunities for the largely unemployed citizenry coupled with improved salaries and wages. In the end, savings levels would increase, thus providing financial companies with funds for issuance of credit to investors and Greece government as well (Tavlas).
Effects of Leaving Eurozone on Monetary Policy, Fiscal Policy, and Debt Financing
Leaving the Eurozone and reverting to Greek currency, the drachma, would force Greece to devalue the drachma. This would increase liability on the part of the government since the current debt is set in terms of Euros. Devaluation of a currency leads to high inflation levels in a country and probable civil strikes. Debt already owed to foreign countries and institutions would be too large in terms of local currency (Makris). Since the government needs revenue to fund programs, the government of Greece will impose more taxes on citizens and cut down its yearly budgets. Further, reverting to the drachma would probably force the government to default on local loans leading to financial losses by the financial service providers in Greece (Makris). Other than the default, the government would over-rely on internal funding leading to increased credit rates and lack of economic growth since common people would find it hard to borrow from banks.
Works Cited
Indiana University. The Euro and Greece Explained. 2011. Web.
Nowadays, it became a commonplace practice among many American economists and politicians to suggest that it is specifically the Federal governments failure to introduce regulatory measures, as the mean of preventing banks from providing financially non-credible citizens with mortgage loans, which created objective preconditions for the outbreak of 2007 financial crisis. The close analysis of such an idea, however, reveals it being essentially deprived of a rationale.
The reason for this is quite apparent it was namely the Democrats preoccupation with combating poverty (under Carter and Clintons administrations) that resulted in passing of the infamous Community Reinvestment Act (CRA) and in reinforcing its provisions through the course of late nineties, which in turn gave banks a green light to qualify socially-unproductive Americans for mortgage loans (Wallison, 2011).
Moreover, the Federal government is being simply in no position to regulate dynamics on the American financial market de facto, since it has long ago delegated its monopoly on designing monetary emission-policies to the privately owned Federal Reserve System.
Therefore, the suggestions that the government should pass additional bylaws, in order for the financial markets dynamics to be more predictable, cannot be referred to as anything but the part of Democrats sophistically sounding but essentially meaningless rhetoric. In this paper, I will aim to substantiate the validity of this statement at length. Let us elaborate on the actual causes of the most recent financial crisis first.
By the year 2006, the volume of so-called non-standard and alternative mortgage loans, provided by banks to Americans, accounted for 40%. In other words, almost a good half of mortgage loans were given to people that would not normally be qualified to receive them.
Yet, even though that this particular financial policy did not make any rational sense, whatsoever, through years 2003-2006 American banks strived their best to cease the opportunity to simply give away money to those citizens that were simply in no position to be able to afford repaying annual interest rates. Why was it the case? This was because, prior to the outbreak of 2007 financial crisis, the real estate market in America was experiencing a particularly dramatic growth.
In its turn, this caused more and more Americans to realize that they could make utterly lucrative profits by the mean of buying houses with bank-loans, waiting for a year or two, without even being required to pay interest on the received loans, and then selling these houses for often twice as much.
Thus, as time went on, a growing number of Americans were beginning to perceive mortgage loans not in terms of an opportunity to buy otherwise non-affordable real estate per se, but rather in terms of an opportunity to indulge in financial speculations. This, of course, caused the growth of the real estate market in America to attain an exponential momentum.
Eventually, American bankers concluded that non-standard and alternative mortgage loans could also be provided to citizens for investment purposes. That is, banks started to sell mortgage agreements and potential profits (which were yet to be obtained in the future) to each other.
It is needless to mention, of course, that banks were not financing these types of loans with their own assets, but with largely virtual assets of some third parties. In other words, non-financially sustainable citizens were receiving personal mortgage loans from organizations that were simultaneously applying for corporate monetary loans, in order to have these loans simply given away to as many people as possible.
One debt was generating another debt, which in turn was backed by another debt, and so on. Yet, there was an artificially maintained respectability to all of this, as the reselling of debts became a widespread practice. The mechanics of how the proper functioning of American economy was being undermined from within were quite simple.
The likelihood of a particular mortgage loan not to be returned was evaluated by credit rating agencies, which used to result in security equities being rated according to the extent of their perceived riskiness. Loan agreements, considered most secure, were easily sold. Yet, given the continuous boom of the real estate market, even clearly risky loan agreements could be successfully resold to investors.
As a result, all the involved parties were able to benefit from participating in the scheme banks could get rid of legally bounding agreements with private citizens, investors could benefit from making almost instantaneous profits, and private borrowers could close their mortgage loans hence, qualifying to apply for new ones.
This situation lasted for seven years, while resulting in the rapid growth of Americas GDP. Millions of citizens were making huge money out of the thin air, without being required to contribute to the de facto growth of the American economy.
Nevertheless, the sustainability of the earlier described debt-pyramid was maintained solely by the continual but thoroughly artificial growth of the real estate market, which was attracting more and more investors. In its turn, this growth came because, as of 2003, Federal Reserve System reduced interest rates down to 1%.
This poses us with the question given the fact that the cause of financial crises has always been the lack of financial liquidy, what caused the lack of financial liquidy in 2007? The answer to this question is simple it was the FRSs decision to dramatically increase interest rates through 2006- 2007.
In essence, FRS simply followed the classical recipe of making a financial crisis, which it had already resorted to during the time of Great Depression. The consequential guidelines for making a financial crisis are as follows:
Increase the moneys physical volume as much as possible,
Create loan-agitation by the mean of qualifying even jobless people to apply for loans,
Drastically reduce the amount of money in circulation and demand borrowers to immediately return their debts.
What it means is that, far from being spontaneous, the financial crisis of 2007 was intentional and thoroughly regulated, with its foremost goal having been the elimination (due to banks bankruptcies) of trillions of excessive dollars, printed by FRS without bothering to back up their actual value with any material assets, whatsoever.
Therefore, the suggestions that this crisis came because of the Americas financial system having been deregulated simply do not stand much ground. Quite on the contrary it is specifically because, ever since 1913, FRS exercises a complete regulatory control over monetary emissions in this country, that the financial crisis of 2007 was bound to occur. In this respect, the Federal governments regulations simply assisted FRS.
The validity of this statement can be well explored in regards to the passing of enforcing bylaws to the earlier mentioned Community Reinvestment Act of 1977, Bill Clinton& passed laws to enforce the original (CRA) bill.
The purpose of the CRA is to force banks to make risky loans to people who cant afford to repay those loans (Knight, para. 1). In other words, the governments meddling in financial affairs, as the part of governmental officials pursuing its ideologically driven and clearly utopian agenda of eliminating poverty, contributed substantially to the outbreak of 2007 financial crisis.
Apparently, left-wing politicians simply do not understand a simple fact that the proper functioning of the free-market economy cannot be regulated and that if it nevertheless becomes the subject of regulations (especially if these regulations are being ideologically motivated), this necessarily results in the economys functioning becoming susceptible to crises.
There is another aspect to the earlier argument as of today, the Federal government simply does not have instruments to regulate the functioning of FRS. This is because, contrary to the provisions of U.S. Constitution, which endows U.S. Congress with the exclusive right to exercise a unilateral control over the process of designing this countrys financial policies, this right has been delegated to FRS a private financial organization, over which the government does not have any control.
After all, it is FRS that lands money to the Federal government and not vice versa. Can borrowers control a money-lending organization? President Kennedy did believe that it was in fact the case, which is why under his Presidency, the U.S. Ministry of Finances issued $2 and $5 banknotes, backed by silver from the National Treasury. This, however, had sealed the Kennedys eventual fate.
Therefore, the suggestions that the functioning of the Americas financial sector could be regulated by governmental decrees appear utterly fallacious. As the example of CRAs passing points out to, the governments attempts to regulate this functioning simply create yet additional preconditions for the countrys richest bankers, who own FRS, to act on behalf of their sense of greed, at the expense of undermining the economys vitality from within.
As Randazzo noted it, Ironically, it was government action (the enforcement of CRAs provisions) that created incentives for financial firms to be less risk adverse, not a lack of regulation (2009, para. 6). Thus, we can well conclude that the more a particular progressive politician talks about introducing more regulations, meant to apply to the Americas financial sector, the more he or she is being in cahoots with those greed-driven bankers, who are supposed to suffer from these regulations enactment pure and simple.
After all, as the history indicates, recently passed regulatory measures (such as CRA), originally conceived to work on behalf of ensuring the American economys stability and the underprivileged citizens well-being , did not only fail at that but they actually strengthened the acuteness of the ongoing financial recession. As the famous saying goes the road to hell is made out of good intentions.
Therefore, it will only be logical, on our part, to conclude this paper by reinstating once again that the introduction of new regulatory bylaws, designed to prevent the outbreaks of financial crises, such as the one of 2007, will not possibly change the situation for better. The reason for this is simple the periodic outbreaks of these crises can be well seen as the very purpose of the FRSs existence.
However, since the functioning of FRS cannot be regulated by governmental decrees de facto, it means that the government cannot effectively regulate the financial markets dynamics either. I believe that this conclusion is being thoroughly consistent with the papers initial thesis.
The global financial crisis that broke out in 2007 continues to attract the attention of economists, lawyers, and policy-makers. One of their main tasks is to identify the main lessons of this event and develop strategies that can minimize the possibility of such threats in the future. This essay is aimed at discussing the laws that could have contributed to this event. In particular, one should focus on regulations and legislative acts that could have encouraged or at least allowed unscrupulous practices of financial institutions and their extreme risk-taking.
Furthermore, these regulations did not ensure complete transparency of the organizations that were involved in financial transactions. These are some of the main aspects that can be identified. Nevertheless, one should not assume that the absence of legal safeguards is the only factor that led to this crisis since it is necessary to consider the development of the economy and lack of internal controls in many institutions. These are the main questions that should be examined in greater detail.
Laws and policies that increased the fragility of the financial system
It is possible to mention several important laws that are closely related to this crisis. In particular, one can refer to the Gramm-Leach Bliley Act adopted in 1999 because it enabled the integration of commercial and investment banks (Stowell 32). It should be taken into account that investment banks are usually more tolerant to risk (Stowell 32). They are more likely to put capital into projects which can yield higher returns, but at the same time, these investments are more likely to fail. One should take into account that the clients of these organizations are aware of these dangers, and they can withstand the impact of possible failures.
This is one of the main issues that should be considered. In contrast, commercial banks are averse to risks since deposit holders expect bankers to avoid aggressive investment. These clients want the management to minimize the risk to their assets. The integration of commercial and investment banks was prohibited according to the Glass-Steagall Act implemented in 1933. The risk management strategies in these organizations were not consistent with one another. In turn, the Gramm-Leach Bliley Act eliminated this restriction (Stowell 32).
More importantly, this law resulted in the creation of institutions that were described as too big to fail (Stem and Feldman 7). In this case, one should speak about various financial organizations that are very interconnected and large, and they are supposed to be supported by the government if they experience difficulties (Stem and Feldman 7). Among such institutions, one can distinguish Lehman Brothers or AIG. In many cases, the managers of these organizations pursued risky policies that were based on the assumption that the state would not let them go bankrupt. This case indicates that this crisis could have been caused by imperfect legislation, and its negative impact cannot be overlooked.
There are other important laws that could have lead to the financial crisis. For example, one can mention the Commodity Futures Modernization Act that was signed in 2000. This legal act decreased the regulation of credit default swaps or CDS (Kolb 33). It should be taken into account that a CDS is an obligation of a certain organization, usually an insurance company, to compensate the buyer of the CDS in case of a default (Kolb 33). One can argue that CDS is a useful tool that can minimize the risks of inventors (Kolb 33).
Yet, many financial institutions misused this financial instrument, and as a result, they became exposed to many liabilities. For instance, one can mention such an insurance agency as AIG that had to be bailed out by the government because it gave a great number of credit default swaps (Kolb 33). Moreover, the total market of these financial instruments equaled approximately $35 trillion (Kolb 33). Certainly, one cannot say that the Commodity Futures Modernization Act was the only factor that intensified the risk.
Such a statement can hardly be called accurate. Much attention should be paid to the reckless policies of the senior executives who did not properly evaluate the risks of selling CDS in such quantities. This aspect is also vital for discussing this financial crisis. However, the absence of regulations prevented the government from intervening in the activities of companies that misused credit default swaps. Overall, this aspect is also vital for understanding the origins of this financial crisis and its long-term effects.
It is also necessary to discuss the deregulation of rating agencies that also played an important role in the financial market. These organizations were responsible for providing accurate information about the value of securities (Friedman and Craus 33). A great number of investors relied on the data provided by these institutions. They believed that in this way, they could make informed purchasing decisions.
Nevertheless, rating agencies did not cope with their duties effectively. For example, many securities received a triple-A rating from these agencies, and this assessment affected the choices of the investors (Friedman and Craus 33). In turn, one can say that the activities of rating agencies were not closely monitored by the government. Thus, one can say that laisser-faire policies were not efficient. One should take into account that the failure of rating agencies might not produce devastating effects if investing companies adopted appropriate risk management strategies. Nevertheless, this aspect was often disregarded by individual and corporate investors.
Apart from that, one should remember the role of the Sarbanes-Oxley Act. This law was designed to ensure that companies provided accurate about their financial performance. This regulation was supposed to reduce the risk of corporate fraud (Prentice and Bredeson, 54). Certainly, this law did bring some improvements, but it did not include specific provisions about mortgage lending (Tressel, Mishra, and Igan 17). There are other areas that were not properly covered in the Sarbanes-Oxley Act.
For example, one can mention excessive leverage of investment banks, the real estate market, and mortgage obligations (Prentice and Bredeson 54). These are the main drawbacks that can be identified, and they could have contributed to this financial crisis. Nevertheless, possible deficiencies of this legal action should not be viewed as the main cause of environmental crisis because regulations and laws cannot be the only safeguards against a financial crisis (Tressel, Mishra, and Igan 17). One should not forget about the absence of internal controls that could minimize the risk of losses. This is one of the main points that should be taken into account.
Discussion
Again, it is important to mention that policies and regulations should not be viewed as the only force that could have brought the crisis. One should keep in mind that these laws cannot explain the irresponsibility of many senior executives and the lack of concern for various stakeholders such as investors or employees. Moreover, these legal acts could not shape the development of the global economy. This is one of the main aspects that are vital for discussing the origins of the crisis.
Nevertheless, one can still argue that legislators and policy-makers failed to provide a system of checks and balances that could minimize the possibility of risks. To some degree, the laws which existed during that period were based on the premise that the players in the financial market could always act in a rational way. Yet, this assumption proved to be wrong. This is one of the main arguments that can be made. It should be one of the main lessons for legislators who should eliminate the drawbacks of existing policies.
Conclusion
On the whole, the discussion of the financial crisis suggests that it is not possible to focus only on a single factor or aspect. Such an approach cannot capture the complexity of this event. The examples presented in this paper indicate that the absence of adequate policies and laws could have increased the impact of various risks, especially the inefficiencies of internal controls used in different financial organizations. It is possible to identify several aspects that were not properly addressed in the legislation and policies existing during the period. Close attention should be paid to risk-taking in financial institutions, their transparency, and the disclosure of information to various stakeholders. Yet, the inefficiencies of laws were only one of the factors contributing to the crisis.
Works Cited
Friedman, Jeffrey and Wladimir, Craus. Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation, Philadelphia: University of Pennsylvania Press, 2011. Print.
Kolb, Robert. Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future, New York: John Wiley & Sons, 2010. Print.
Prentice, Robert, and Dean Bredeson. Student Guide to the Sarbanes-Oxley Act: What Business Needs to Know Now That It Is Implemented, Boston: Cengage Learning, 2010. Print.
Stem, Gary, and Ron Feldman. Too Big to Fail: The Hazards of Bank Bailouts, New York: Brookings Institution Press, 2004.
Stowell, David. An Introduction to Investment Banks, Hedge Funds, and Private Equity, New York: 2010. Print.
Tressel, Thierry, Prachi, Mishra, and Deniz, Igan. A Fistful of Dollars: Lobbying and the Financial Crisis, New York: International Monetary Fund, 2009. Print.
Despite wining only two games last season, Carolina Panthers illustrated an increase in revenue, a stark difference from the rest of the leagues. While it was expected that the team could lose its operating income because of the losses it went through last season, the team emerged as one of the teams that profited greatly in the 2010/2011 fiscal period. According to Forbes, Carolina Panthers are ranked in the 15th position, down from the 12th position held by the team last year (1).
The drop in the teams ranking is alleged to be a reflection of its economic status but this is not true. This is because over the last one year, the company has managed to increase its operating income from a low of $15 million to $31.2 million in one year (Forbes 1).
The increase in the operating income comes at a time when the league experienced financial difficulties. Therefore, it was unpredicted that Carolina Panthers could have made such an impact. In addition, the spending by the owner on new players this year is also perceived to have contributed to the increased operating income.
Despite the seemingly increased spending on new players at the beginning of 2011, the players expenses were lesser than the ones experienced in the year 2010. In fact, the players expenses had been increasing over the years, only to drop this year to $124 million from the previous value of $148 million in 2010.
The operating income rise was very steep, since it doubled the previous value that was recorded in 2010 (Forbes 1). The increase in operating cost has made the owner to show appreciation to the fans by hiring new and experienced players.
The team has lost its market value although by a small margin. This is because the market value share dropped from 1,037 million dollars in 2010 to 1,002 million dollars this year. The reason for the reduced market share can be attributed to the significant drop in the wins-to-player ratio, from 88 to 26 in the year 2011 (Forbes 1).
From this reduction in the performance of the team, there has been decreased support that has eventually led to a decline in the support. The differences in the market share have however not affected the revenue that is generated by the company.
The major corporate sponsors are PepsiCo, Carolinas Medical Center, US Airways and Anheuser-Bush InBev, while the naming rights sponsor is the Bank of America. According to Forbes report, the company has revenue per fan of $55 (1). There have been several transfers in the team and these have been focused on making the fans to make increased contribution to the team.
According to the valuation breakdown the team has under sports are equivalent to $637 million, with a market equivalent of $162 million, stadium equivalent of $144 million and a brand equivalent of $60 million (Forbes 1). These revenues have impacted on the operating income generated by the company.
Due to the current financial crisis, the league has had trouble and the team was therefore not expected to generate as much operating income as it did. The increase in the operating income did not however influence the team to increase its rankings among the most profitable teams in the football league.
The most valuable teams are ranked according to revenue and market share and Carolina Panthers are expected to increase the performance in order to rise up the rankings.
The team is therefore expected to hire more experienced players that will ensure the performance is enhanced and ensure that last years performance is not reflected this coming season. There is great expectation among the fans for the team to increase the quality of its players by hiring individuals who are more experienced and qualified.
The global financial crisis started in the year 2008, and it is set to continue unleashing devastating effects on the global economy. The magnitude and the level of disruption of the global economies have led to speculation of various causes that has contributed to its occurrence. The major factor that explains the occurrence of this crisis are the loose monetary policies (Bean, 2008).
John Taylor argues that interest rates were well below the ones implied by Taylors rule. In addition, large current accounts surpluses in emerging economies with underdeveloped financial markets. For instance, China has largely driven the interest rates up (Caballero & Gourinchas, 2008).
The last, but not the least is the loose financial regulation which has led to the increase in risks and investments in poorly understood new financial products (Borio 2008). This paper seeks to describe global economic crisis and its impact on global finance currently and over a couple of years to come.
The global crisis has crucial dimensions which includes buildup of both corporate and household debts (Brunnermeir, 2009). As the main concern, these bad debts have caused confusion to the UK government on how to deal with loan defaulters. These ever increasing bad debts have been threatening the solvency of banks.
Also, the apparent change in bailing out policy from the earlier rescue approach, created a panic in the interbank lending rates, thus worsening the situation further. However, the uncertainty of banks future has seen them as ceasing lending causing to stagnate the system as a whole. Moreover, stock market investors panic has led bank shares to perform poorly in the stock market.
Nevertheless, bank regulations are pegged on the notion that loans forms have a significant percentage of bank capital, and since decline in stocks has reduced capital to a great extent; this has, in turn, led to massive decline in the bank lending. This further threatens the stability of the global financial system (Morris, 2008).
In addition, there has been an abrupt change in policy towards bailing out banks whereby the UK government is buying shares from the banks with intent of restoring the profitability, and then sell its shareholding to investors (Taylor, 2008). The significant effect of recognizing bad debt is that, the idea of recovering large amounts of capital lent as housing loans is no longer worth (Taylor, 2008a).
This has made the financial sector to shift the cost of the crisis to the public to the extent of using taxpayers money in order to survive. Banks are rebuilding the profit base by declining to reduce interest rates on funds borrowed which leads to reduction in rate of return to depositors and savers, thus causing a conflict between the government and banks (Morris, 2008).
This has led to serious implications to both current and future pensioners. Furthermore, there has been massive loss of jobs, as various firms succumb to the effects of credit crunch.
To remedy this situation, the government has been encouraging mergers to help in curbing the effects of global economic crisis. However, this bail-out approach has resulted in a considerable ideological cost, both in terms of reputation and increased legitimacy of regulation.
The effects of global economic crisis will continue to have serious effects on many firms around the globe overtime. This is because firms are being forced to downsize their operations, as a result of difficulties in obtaining finances from the banks (Adalid & Detken, 2009). Banks are raising the interest rates as one of the measures to correct the effects of global credit crunch.
Also, debts, owed to the firms, have proved not forthcoming and, instead, firms are writing them off. Therefore, the profits which could otherwise be utilized in expanding the businesses are now utilized in writing off bad debts. However, the problem of declining job opportunities will persist overtime, leading to increased poverty levels amongst the households.
To correct the global economic crisis, governments across the world are taking measures on places that will see the economic growth of their respective countries back to normal, though this is a process that might take quite longer.
References
Adalid, R., & Detken, C. (2009). Liquidity shocks and asset price boom/bust cycles. Working paper, 732(2), 5-56
Bean, C. (2008). Some Lessons for Monetary Policy from the Recent Financial Turmoil. Remarks given at a conference on Globalisation, Inflation and Monetary. New York: SAGE
Borio, C. (2008). The financial turmoil of 2007-? A preliminary assessment and some policy considerations. Bank of International Settlements Working Paper, 251, 56- 89
Brunnermeir, M. (2009). Deciphering the Liquidity and Credit Crunch 2007-08. Journal of Economic Perspectives, 23, 77-100.
Caballero, R., E. Fahri, H., & Gourinchas, P. (2008). An equilibrium model of global imbalances and low interest rates. American Economic Review, 98, 358-393.
Morris, C. (2008). Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash. London: Public Affairs Books.
Taylor, J. (2008). Monetary Policy and the State of the Economy. Testimony to the US House of Representatives. New York: SAGE
Taylor, J. (2008a). The financial crisis and the policy responses: an empirical analysis of what went wrong. NBER Working Paper, 14631, 56-78
For a period of three consecutive decades, the world has witnessed numerous changes in the financial market, which has further disintegrated into global financial crises. The situation grew even worse in the past five years from the year 2007, leading to the global economic recession in 2008 (Goonatilake & Herath 2007).
Globally, people witnessed falling of stock markets and collapsing of commercial businesses dealing with finance and governments, even the richest ones shivered. Developing countries largely blamed the wealthiest countries for their engagement in risky financial businesses with research revealing that these countries had committed themselves to financial business markets targeting huge profits (Malkiel 2003).
Changes in financial market have consequently affected the economic growth, thus distressing the governments efforts in dealing with the continued employment crises in developed countries and down turning the economic growth in developing countries (Krishnamurthy 2010). Due to the above reason, this study seeks to examine the reasons behind the changes in financial markets during the last 30 years and the role of these changes in the recent financial crisis.
Overview of Financial Market
Financial market describes the commercial economic centres where people or companies can trade on stocks or shares, commodities, bills of exchange, foreign exchange and financial securities, which work as financial business units for capital or credit (Dick 2009). Financial markets aim at acquiring funds from shareholders and incorporating them into corporations.
Typically, financial markets come in different forms such as capital markets, stock markets, money markets, insurance markets, commodity markets, foreign exchange markets, and future markets. Each type of markets deals with different forms of financial engagements. According to Nier (2009), financial market is largely responsible for controlling financial lending and borrowing activities, which provide room for lenders and borrowers to interact through financial deals.
These markets are renowned for their responsibility in regulating the economical situations of nearly every country through enhancing investment, saving funds mobilisation, industrial development, entrepreneurship, and national growth. Conventionally, financial markets are responsible for regulating funds throughout nations and the entire globe.
Financial markets across the globe have been shaking for over three decades with its prime impact felt in the last five years (2007-2012) throughout the globe, but the climax was in 2008. Down turning in the financial market consequently led to world financial meltdowns or financial crises with people coming to acknowledge important financial terms such as inflation .
According to research by (Krishnamurthy 2010), each country in the world underwent this experience ranging from wealthiest to poorest. For instance, there were cases such as the US stock market crash, savings and loan collapse, and credit crunch in the early 1990s, 1994 Mexican peso devaluation, the Asian financial crises in 1997, and the Russian Long Term Capital Management implosion in 1998 (Lee 2012, p.41).
The financial crunch was also eminent in developing countries within Africa, Latin America, and some countries in the Middle East, which faced this financial misfortune. However, lessons were unlearnt from these crises until the year 2006 to 2009, when the US and other renowned economic influential countries in the world triggered a global financial crisis.
Changes in Financial Market
The world financial centres at this moment witnessed numerous changes in the financial market. According to Lee (2012), involvement of superior countries in financial crises in the last three decades shook the world with subsequent changes ranging from financial engagements to technological bumbling.
Research carried out during this moment identified changes in equity prices in global markets, deprecation and fluctuations in the value of main currencies, increased financial crisis, changes in commodity prices, volatility in exchanges rates, changes in the taxation system in the US, changes in lending processes, and increased liquidity in financial markets (United Nation 2012).
Both developed and developing countries significantly contributed to changes in the financial markets. In developed countries, the contribution was mainly through various unconventional policy measures that led to inflation and liquidity. On the other hand, persistent and high unemployment in developing countries is responsible for causing crushes in wage growth, consumer demands, and increasing delinquency on mortgages.
Changes in lending policies
Changes in lending policies, as characterised by credibility of fiscal policies, are the definite changes that took place during the error of global financial crisis.
During the three consecutive decades, international banks governing the global finances and central banks controlling financial regulations and lending entered into world records for engaging in poor management practices (Ocaya 2012). At this moment, the international bank lending systems adjusted their policies and increased lending to emerging and developing economies started. This move served as a malicious deal for the interest of the banks to manipulate profit margins.
Ocaya (2012) asserts, Reckless loans extended by financial institutions without proper adherence to the code of lending, ability to pay, guarantees and profitability considerations (p.167). The poor lending system led to easy access of funds by unstable and non-realistic businesses and companies that consequently operated in loses, allowed over-accumulation of bad debts left to banks, and engaged malpractices including retrenchment programmes.
Volatility in exchanges rates
During the practicing of credibility, the international exchange rates remained significantly low. In major developed economies, exchanges rates went down due to the high demand of lending practice as endorsed by the international banks and central banks.
Exchange rate instability consequently led to large fluctuations among major international reserve currencies responsible for major economic boost, including the Euro, Japanese Yen, and the United States dollar (United Nations 2012). Among these currencies and the great sterling pound which traded fairly by then, are the world international reserve currencies commonly used in international trading.
The United Nations (2012) further points out, Fluctuations in the value of the United States dollar and unpredictable trends in financial derivatives trading in commodity markets (p.15). Instability of the exchange rates especially the major currency, that is, the dollar led to poor exchange rates and fluctuations in other currencies that increasingly resulted in economic stagnation that further affected the social and political menaces.
Instability in commodity prices
As defined in the meaning of financial market, commodity markets are key elements of financial market, including trading in physical products like food products and precious materials. Shooting of prices in these primary products was worse between the years 2008 and currently in the year 2012.
Krishnamurthy (2010), states that during this period, prices of essential commodities including oil continuously went up. This aspect thus reduced the consumption rate of such products and in turn reduced the financial expectation of the world financial markets through reduced international trading.
In his study, Ocaya (2012) affirms, The export earnings have been hit hard due to reduced demand and lower prices for resources and other commodities (p.172). Private business tycoons and other business intermediaries with alternative sources of financing, excellent stability of spending positions, and international investments became advantageous of the prevailing situation and exploited the commodity market, thus worsening the financial market crisis.
Change in the stock market
Changes in the stock market exhibited changes in the financial market. A stock market is an important component in the financial market deals with stocks trading, also commonly known as share, and derivatives at agreeable prices and terms. The stock market relates relatively well with the Gross Domestic Product (GDP) in developed economies over time.
GDP simply means the official market value of services or goods produced in the country in a given duration. According to Duca (2007), during this moment when the global financial crisis stood at its peak, stock markets experienced rapidly falling prices in the market. Therefore, at a certain moment, the stock prices are quite important as they determine the GDP of a given country.
Duca (2007) posits, During such moments in the U.S. stock price movements cause movements in GDP (p.6). The same situation happened in the UK, where the lending stock, commonly known as the FTSE 100, caused a similar trend in the stock market, thus hampering the sustainability of the stock market.
Impact of the changes on financial crisis (in developed countries)
Changes in the financial market consequently influenced the events that unfold within a financial crisis moment. Given the above changes in the financial market, one can quickly conclude that these changes heavily influenced the financial instability worldwide.
Beginning with the developed economies, which suffered the greatest blow, changes in the financial market triggered the several financial problems. Krishnamurthy (2012) asserts that due to poor lending strategies commonly described as credibility, the national financial system suffered from liquidity characterised by excess accumulation of bad debts, broadened gap between the rich and the poor, turn down in consumer profits, and commercial profits that led to layoffs and bankruptcies.
Ocaya (2012) asserts, The crisis played a significant role in the failure of key businesses, declines in consumer wealth, and a downturn in economic activity leading to the current global recession and contributing to the European (p.168). This scenario sent a huge blow to the entire economical system in the developed economies, especially in the United States, the United Kingdom, and Japan, among other commercialised countries.
Changes in the financial market in this period have continuously proved dangerous to the later. During this moment, customers involved in the money and stock markets retreated due to fear of losses that were eminent during that period (Helleiner & Pagliari 2010).
From that moment of financial crisis, very few people can afford to invest in financial markets due to the fears of running at losses or even due to bankruptcy after securing employment in non-viable businesses that depended on loans from lending institutions and later shut down due to bankruptcy.
Due to fear and unemployment that resulted from global collapse of financial market, the world social and financial order strained, causing the global financial disorder. Miles (2002) asserts that several companies and Business Corporation could no longer support themselves financially and thus they operated in large debts. The international banks and central banks tried to recover from the financial crisis by developing financial policies that further result in poverty, economical instabilities, and increased financial crises.
In a bid to restore the economical situation, governments in developed economies like the United States came up with policies and strategies to stabilise the financial condition.
According to Ocaya (2012), some of these measures included the attempt of American International Group (AIG) and other major American banks including the Bank of America to rescue the situation through bailouts and government policies including strained lending. These bailouts aimed at providing financial support to individuals as well as businesses and other corporations.
In contrary, instead of improving the financial crisis, they made it even worse because they kept the government into risks of incurring deficits. According to Duca (2007), the situation gave room for exploiters in the private sector to increase the housing rates in a bid to improve their business portfolios. Characterised by high employment rates and fiscal austerity measures among citizens in the United States, the population is at risk of maintaining the national economic recession.
Impact of the changes on financial crisis (in developing countries)
In the context of developing countries, including the worst poverty-stricken sub-Saharan Africa, impacts of the financial market changes were eminent.
Given the fact that the financial institutions of these emerging economies are generally tiny and centralised within basic centres with interest in the banking system, the financial crisis was unavoidable (Zaki Bah & Rao 2012). Developing economies and the Sub-Saharan Africa largely depend on the economies of the developed countries and thus the financial crisis impact projected into these countries.
Ocaya (2012) claims, Many economies of Sub-Sahara Africa have witnessed depressed commodity prices, reduced external transfers and remittances, declined donor aid and tourism as well as declined investment and consumption, which has resulted in the overall contraction of GDP growth (p.169). This aspect further constrained the government finances as the situation forced the governments to increase funding to its projects and programmes due to reduced financial revenues obtained through taxes.
Developing nations largely depend on funds in the form of foreign exchange, donations, or import duties. Changes in the financial markets consequently led to financial instabilities within these nations. Tourism, being the backbone of many developing countries, especially in Africa, suffered a serious blow.
Commercial businesses supported by international donors in developing countries faced a challenge. According to the United Nations (2012), since the beginning of the global financial crisis, the tourism turnover reduced due to the crisis since tourists could no longer afford their leisure expenses during holidays. People in developed countries could no longer offer loans with an aim of cutting down their operational costs.
Another shortfall of the changes in the financial markets included reduced foreign investments and strained financial support from international donors and well-wishers. The existing and new investments initiated by foreigners slowed down due to lack of adequate support. This element, in turn, forced the governments to strain in their budgets to accommodate the accomplishment of such projects that remained underdeveloped.
Among the changes practised in the financial markets included changes in the stock markets. Despite the fact that the stock markets propel economies of many nations, the stock markets in developed countries suffered and thus the situation worsened in developing countries, including Africa. The majority of developing countries have unreliable and underdeveloped stock markets, which were unable to survive the crises, and the majority of them collapsed, hitting the economical belt.
Inflations in the international reserve currencies and increased prices in essential commodities influenced the financial crisis in these countries. Due to what happened in these nations because of changes in the financial market, government expenditures increased in a bid to accommodate the situation. Research reveals that some countries in developing economies had to incur huge losses that affected the social, economical, and even political establishments.
Conclusion
Changes in the global financial market initiated by developed economies, including the United States, the United Kingdom, and other European countries triggered numerous financial tensions. Changes in the financial markets within the last three decades involved changes in the lending/loaning policies, changes in the stock markets, as well as changes in the commodity prices resulted in a subsequent financial crisis (United Nations 2012).
Globally, the developed economies were the first to encounter this menace with superior financial countries, including the United States facing economical challenges. Illegitimate businesses bloomed exponentially through loans granted under low rates; regrettably, these businesses later failed to pay back the leaving the government to incur losses. The stock markets suffered a downturn and since they influence the Gross Domestic Product (GDP), financial institutions underwent a huge financial crisis.
The developing nations were not exclusion since the trade between them and their fellow developed counterpart was constrained. According to the United Nations (2012), the tourism industry that provides a wide range of financial assistance to such countries felt the blow since most tourists come from the developed nations and could no longer support their holiday trips as banks in the European countries strained financial access to these people in order to recover from the crisis.
Despite facing such crises in the global financial markets, several governments are still engaging in malpractices. Therefore, there is likelihood that the financial market will continue shaking if governments do not change their financial practices in the financial market.
References
Dick, N. 2009, Global Financial Crisis: Foreign and Trade Policy Effects, DIANE Publishing, New York.
Duca, G. 2007, The relationship between the stock market and the economy: experience from international financial markets, Bank of Valletta Review. Web.
Goonatilake, R. & Herath, S. 2007, The volatility of the stock Market and News, International research journal of finance and economics, no.11, pp.53-64. Web.
Helleiner, E. & Pagliari, S. 2010, Global Finance in Crisis: The Politics of International Regulatory Change, Taylor & Francis, New York.
Krishnamurthy A., 2010, How Debt Markets Have Malfunctioned in the Crisis, Journal of Economic Perspectives, vol. 24 no.1, pp.3-28. Web.
Lee H., 2012, Contagion in International Stock Markets during the Sub Prime Mortgage Crisis, International Journal of Economics and Financial Issues, vol. 2 no.1, pp.41-53. Web.
Ocaya M., The Current Global Credit Crunch: A Review of its Causes, Effects and Responses, Online Journal of Social Sciences Research, vol.1 no.6, pp.166-177. Web.
United Nations 2012, World Economic Situation and Prospects 2012-2013: Global economic outlook. Web.
Zaki, E., Bah, R. & Rao, A. 2012, Analysis of Financial Crisis in UAE Financial Markets, International Research Journal of Finance and Economics, no. 83, pp.121-133. Web.
The international political economy is one of the important phenomena in international relations. Issues in international economics have a huge impact on the relations at the international stage. One of the most important issues in international economics is the forces in the international business cycles resulting to economic crises.
International financial crises have been prevalent in international economics occurring in different regions at different times. The first major financial crisis in the world occurred during the post WW1 era in what is famously known as the great depression of 1930s. Other crises in international economies have been occurring including the recent financial crisis that directly affected the United States and the European Union.
There is also the least known financial crisis that affected East Asia in a span of one year 1997-1998. This had devastating consequences on the East Asian economy. However, the quick actives responses by the states in the region helped in the quick aversion of the crisis and its impacts on the regions economy (Heo & Horowitz, 2000). This essay discusses the developments of the financial crisis in East Asia financial crisis.
The effects of the crisis on the affected states have been analysed. In addition, the paper discusses measurers applied by states in averting the crisis. This essay centres on two benchmark states: Singapore and Australia. In this article, it has been be demonstrated that the economic crisis has a spill over effect especially when applied to regional economic blocs.
Origin and development of the financial crisis in East Asia
Most research findings point at a number of aspects as being behind the financial turmoil that was witnessed in East Asian States between the year 1997 and 1998. Weak macroeconomic policies and foundations by East Asian countries have been found to dominate the argument about the causes of the financial crisis.
This argument was made by both financial institutions such as the International Monetary Fund and economists. However, there is another argument holding that the presumed causes of the crisis do not wholesomely apply to all nations in the region. In most cases, the economic analyses of the causes are generalized.
This relates to political settings of these countries, economic structures, social environment and the relations between these countries. However, diversity exists in the internal economic and political structures of these countries, and this point to different inclinations causes, responses and results of the crisis to individual countries (Hasan, 2002, p. 1).
Radelet and Sachs (1998) observed that the financial crisis in East Asia emanated from liquidity flight in Thailand and the subsequent depreciation of the Thai currency. The baht recorded a big percentage of depreciation over 50 per cent in the year 1997. This depreciation had effects on the currencies of other countries because of the participation of the country in regional trade.
The Indonesian currency was the second one to respond. Eventually, all countries within the economies of East Asia followed in progression. Indonesia and Thailand in which the crisis emanated were the hardest hit by the crisis. Inflation became very high with a lot of cutbacks and crunches being witnessed in these economies. Inflation rose by 58 per cent in Indonesia within a period of less than a year (Reisen, 1999).
Inflationary pressures were also recorded in the entire states of East Asia. There were notable different economic abilities in handling the crisis. In this case, the most devastated countries were those states that had weak economic structures. The East Asian countries had different liberalization patterns, which aided them differently in mitigating the effects of the crisis.
Countries with strong economic structures such as Malaysia are argued to have suffered regional economic contagion. Political pressures of the 1970s and 1980s had forced most nations in the region to embrace the liberalization of their financial systems.
This was also done in order to give countries some power to respond to the external market with a lot of ease. Therefore, it was evident that the economies of the countries in the regions were closely knit in the sense that individual countries could not easily resist economic falls in one country (Baek and Jun, 2011).
The Asian financial crisis can be looked at from both the micro and microeconomic policies that were being pursued by the countries, which resulted to currency speculations. Speculation and the pursuance of hard monetary policies are argued to be the genesis points of the Asian financial crisis.
Prior to the crisis, most Asian countries had for close to two decades executed economic strategies that had put them on a clear lane of economic development. This crisis led to lapses and destruction of the flow of economic development for most countries in this region.
On the other hand, it is argued to have been a pointer to economic re-examination by most countries in the region. A number of countries such as Singapore, Malaysia and Korea recovered from the crisis and have attained great economic achievements that surpass the achievements made in the US and Europe.
Some countries have found it strenuous while trying to recover from the crisis because of the policy lanes that they followed. However, other emergent issues combine to hinder the countries from full recovery and the attaining of strong, sustainable economies (Denis, 2002).
Among the factors that economies of East Asia is the 2007 economic turmoil that originated in the United States and Europe. This signifies the fragility of international economies (Jeon, 2010).
Response and effectiveness of response to the crisis
In history, whenever countries have been faced with financial crises, they have often resorted to certain policy response mechanisms. One of the most common policy responses is the search for funds from international financial institutions to help in cushioning the financial crunch.
International financial institutions such as the International Monetary Fund in most cases attend to the needs of the states by providing funds to bail the countries affected by the crisis. However, this response is not often immediate or rapid as countries have to fulfil the conditions of the international financial institutions, which may include ensuring that there is economic transparency.
The East Asian financial crisis was responded to by the affected countries that were in search of ways of revitalizing their monetary systems. Malaysia is among nations that were hard hit by the crisis which threatened to sway the country from the rapid economic path that was being pursued (Sundaram, 2006).
According to Hasan (2001), Malaysia took a different response path to the crisis. Malaysia did not choose to approach the IMF for financial support. However, the country chose to go as per the prescriptions of the IMF. Malaysia adopted a tight monetary policy for a period of one year. This was one of the prescriptions that was made by the international financial institutions and entailed the raising of the interest rates.
However, this policy lane did not seem to be favourable to the Malaysian economy. The economy began to shrink because of the inability of business institutions to access finance due to unsustainable interest rates. Many projects that were running had to be either put on hold or progress at a very slow pace due to deep cuts in public expenditure. The employees suffered from cutbacks in their work benefits.
In short, the economic impacts of the monetary policy adopted by Malaysia during the first year were not favourable to the economy. The tight monetary policy led to a series of activities that included cutbacks in the economy.
This resuted to more than 6 per cent drop in the real gross domestic product of the country. In spite of this, Malaysia still remained adamant to approach IMF for funding to bail the economy and stabilize the currency (Dornbusch, 2001).
Since the economic fundamentals of Malaysia were strong, the country chose to impose control on capital outflows in order to eliminate the speculative demand for the Australian currency and prevent its internationalization. Thus, the country pegged its currency on the US dollar that helped in devaluing the currency and eliminating the speculative demand.
This was a replica of international economic behaviour since most countries suffering from economic shrinks opt to strict regulation of foreign capital flows. However, this was done in a more liberalized and open way, as opposed to the pre-crisis period.
The controls were implemented in a selective manner leaving the foreign investments intact. The current accounts were also not affected (Sundaram, 2006). In addition, the country replaced the pursuance of a tight monetary policy with the prescription made in Keynes economics.
A cheap monetary policy was adopted, and this resulted to a drastic fall in the rate of interests. Effective demand was increased, and banking institutions were encouraged to lend considerable finances to the industry. All this translated to a clear path towards the regaining of performance and financial stability of the Malaysian economy (Choudhry, Lu and Peng, 2007).
The avoidance of assistance from the IMF and the adoption of a Keynes economy accompanied by liberalized restructuring programs helped in putting the Malaysian economy back on track. The gross domestic product of the country regained its strength by the end of the year 1998 registering over 6 per cent growth.
The countrys economy has been operating on quite a stable path since then. Rejecting to approach the IMF for funding is argued to have helped Malaysia to recover from the crisis quickly (Huston and Kearney, 1999).
Being among the countries that had adopted a strong development path, Singapore was also devastated by the East Asian financial crisis. The effects of the financial crunch in the region fell on Singapore with a thud. This is because Singapore had strong roots of investment in the neighbouring countries.
This resulted to major economic shocks such as the shrinking of prices on the stock and securities market of Singapore. In general, the country is argued to have been a victim of the crisis (Choudhry, Lu and Peng, 2007). It suffered from the spill over effects of the crisis due to strong economic roots in the East Asian trading region.
Singapore is argued to be one of the benchmarks in dealing with the financial crisis that occurred in East Asia. Singapore took an independent or internal approach to avert the crisis and its effects to the economy following the footsteps of Malaysia. The country chose to concentrate on wage instruments and control of exchange rates in an effective way.
Despite the rise in the speculative demand for the Singapore dollar, the country used strict controls to manage and check its exchange rate system. Therefore, the Singapore dollar was quickly depreciated as a response to the loss of competitiveness in exports due to the collapse of the currencies of the neighbouring countries. Direct cost cutting approach was used by the country to maintain competitiveness.
Wage and operating costs were cut. Singapore continued withholding to the liberalization of its currency on a long-term basis thus ensuring competitiveness of the economy. This enabled the country to maintain a strong currency as compared to other currencies of the region like rupiah, the baht, the ringgit and the won.
This happened despite the drop in the value of the Singapore dollar to major international currencies such as the US dollar, European currencies, and the Japanese yen (Choudhry, Lu and Peng, 2007).
Despite the effect of the financial crisis, Singapore, which is the economic hub of Southeast Asia, had strong economic foundations that sailed it through the crisis. These include the maintenance of strong fundamental in the economy such as strong financial institutions and the continued use of a well managed exchange rate system.
Others included the well established wage system and strong controls on bank lending in Singapore currency (Baek and Jun, 2011). The country had to respond to the loss of competitiveness in international trade by making adjustments to the long withheld economic policies. The country applied the strategy of cost reduction to improve the profits made by businesses.
This was implemented by enhancing the capacity of all industries and improving on the labour efficiency. All these were pursued with the aim of cushioning the Singapore economy amidst the crisis and maintaining the sustainability of the economy. The country managed to devalue the currency through the combination of exchange rate depreciation and application of cost-cut measures.
In addition, the Singapore economy has been significantly diversified with the development of many industries and reduction of dependence on a few industries (Jin, 2000). In this case, it can be said that Singapore gained economic grounds after the shocks of the Asian financial crisis and has continued to grow by continuing to embrace sound economic policies (Choudhry, Lu and Peng, 2007).
Conclusion
It has been demonstrated that financial crises are a common phenomena that often result from the economic policies that are pursued by states. Countries that fall within a common economic block or region can easily be affected by a financial meltdown occurring in a single country.
This is evident in the East Asian financial crisis and resonates from the fact that economies are interconnected in the sense of bilateral and multilateral trade relations. While some states opted for external financial support from IMF, others like Malaysia chose to pursue independent economic policies that helped them to recover from the crisis immediately.
Countries that sought for international funding took quite long to recover such as Indonesia and Thailand. Notably, the implications of the crisis cannot be said to have been completely eliminated. This is because many gaps still remain in the regional economic policies exposing countries to economic shocks.
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