Category: Financial Crisis

The principles of PPP, its merits and demerits

One of the principles of PPPs is to have the public sector gain access to private sector resources. The resources are in the form of expertise and finance (Public-private partnerships, 2013). The private sector has more innovative ways of raising a large amount of capital without causing inflationary pressure on the local currency. The private sector has experience in running facilities efficiently and profitably.

The size of capital required is one of the reasons for PPPs. The public sector client has more needs. It becomes unreasonable to put a large number of funds on one project when other projects are lacking. The private sector provides the largest amount of capital by pulling resources from several large organizations. Yescombe (2007, p. 30) explains that a PPP has to be of a bigger size to avoid a situation where procurement costs become a large proportion of the project.

Another principle of PPPs is that projects are expected to be operated for a long period of time. It should be about 25 to 30 years. During this period, the project is designed, built, and operated by the private sector. The private sector is able to pay back loans, interest, equity, and dividends.

A service charge becomes another principle of PPPs. The income streams are also used to operate and maintain the facility.

The PPPs are started on the basis of capital costs not incurred by the public immediately. It enables the public to use the facilities that they could have waited for a much longer time before the public sector could have found revenues and expertise to make the services available. It allows the public to use what the public was unable to afford due to a long list of priorities.

Merits

PPPs allow the public sector to gain access to a high level of expertise and finance that the public sector lacks (Public-private partnerships, 2013).

The strong relationship built enhances problem-solving and innovation capabilities. PPPs are recognized for the sharing of risk and developing solutions together between the public sector and the private sector (Greve and Hodge 2013, p. 2). They are also recognized for the timely completion of projects.

Large debts by the private sector do not have a negative impact on economic growth. Economic growth supported by a large public debt ratio to GDP destabilizes the growth rate (Greiner & Fincke 2009, p. 83). A period of high growth may be followed by a recession. Large public debt has pressure on inflation and affects economic stability.

Demerits

The private sector has experienced some difficulty in raising capital after the global financial crisis. Firms are more cautious about the use of innovative securities. Shendy, Martin & Mousley (2013, p. 7) explain that interest rates were pushed further after the global financial crisis by the withdrawal of large insurance companies from the financial market. As a result, the risk posed by holding financial assets has increased. The private sector accesses the funds at a much higher rate of interest than the public sector client. It may be less costly when the public sector client provides finance and the private sector provides expertise.

The private sector may require a speedy completion of the project which may compromise the design of the facility and quality of service.

The private sector is driven by profit motive which may cause financial manipulation. The private sector may inflate the costs of the facility to increase its returns. The public may be charged a higher service charge which may reduce the accessibility of services (Public-private partnerships, 2013).

PPPs are being reviewed in Portugal and Hungary because the unitary charges constitute a large proportion of the government expenditure. The governments entered into PPP agreements before the financial crisis. They did not accurately evaluate their impact on future budgets (Shendy, Martin & Mousley 2013, p. 10). Many PPPs may limit future cash flow.

Format of PPP for a public health facility

Build-Operate-Transfer (BOT) appears to provide the best option for healthcare facilities. Immediately after the health facility has been built, the public sector may not have enough medical practitioners to work in the facility. The private sector may use its experience to access more human resources to run the facility. The public sector may be able to run the facility after 25 to 30 years when the service term comes to an end.

If the project uses the Build-Transfer (BT) format, it may lack experience in running a new large healthcare facility profitably. New equipment and terms of service may also need the expertise of the private sector. In the BT format, the government may lack funds to operate the facility. BOT spreads the operations and maintenance costs over a long period of time.

Build-Transfer-Operate (BTO) may have an impact similar to the Build-Operate-Transfer. The BTO may be used strategically to control the level of service charge if the government makes unitary charges that subsidize user-fee. The private sector acts as a management contract. The use of BOT and BTO will rely on the one which lowers costs without reducing the quality of service. Quality in BOT is likely to be higher because of the profit motive of the SPVs. Service charges are also likely to be higher in BOT than BTO.

Build-Lease-Transfer (BLT) makes the public sector incur the cost of capital much earlier than in BOT and BTO. In BTO and BOT, the cost is transferred to many people and for a longer period. It reduces the impact of capital cost.

Build-Own-Operate-Transfer and Build-Own-Operate may make the health services available but may limit accessibility due to the possibility of a higher service charge. They are closer to a private sector business venture than to a PPP.

Evaluation of PFI and PPP

PFI focuses on service delivery which increases the chances of meeting project objectives. It reduces the risk posed by basic procurement routes. The three common risks include higher asset costs, lower-quality service, and delays in providing the facility. PFI charges the public for the service and an additional unitary charge from the government. The government and individuals share costs that increase affordability. There is a quality service specification that increases performance. The public sector has the ability to reduce payment when the quality does not match the specification.

There is a reduced risk on the side of the public. Asset depreciation costs and interest on loans are incorporated on the side of the private sector. PFI provides a viable route in offering health care services. However, at the end of the term, it may cost the public more than traditional procurement routes (Greve & Hodge 2013, p. 214). The SPVs acquire loans at a higher interest rate than Treasury bonds. Moreover, the SPVs may seek high profitability levels. When the government uses other basic routes, it may operate the facility as a non-profit making organization.

PPPs lack the service focus of PFIs. The public may incur costs of an asset whose useful life may end at the time of the service period. However, PPPs may provide the public sector with the benefit of ownership. The public sector may run the facility to increase accessibility after asset transfer using any suitable program. Service charges may be lowered after the transfer of assets.

In both cases, PPPs and PFIs provide the public with an opportunity to access services that the public sector was unable to afford. The cost of the project is spread over many years increasing the affordability of service.

PPPs and PFI allow the government to divert resources on other projects. When resources are spread over many projects, a shortage of funds may occur. It may leave projects incomplete which is more costly than the opportunity cost of unavailable services. Levy (2011, p. 57) explains that many of the companies involved in PPPs have multiple projects in different countries. Having multiple projects may increase the cost of raising capital and may affect project quality.

Healthcare costs are expensive which match those in the UK such that a hip replacement surgery averages £14,000 (Pallot 2010, para. 28). The high cost of medical services may make the PPP viable despite the high cost of raising capital. If the mandatory healthcare insurance policy is implemented, there will be reduced cash flow risk for the PPP.

There is a need for more hospitals in Dubai because of the high ratio between the numbers of hospitals/clinics and the population. Clinics and hospitals are estimated to be about 20 in Dubai. It gives a ratio of 1:78,000 clinics/hospitals to patients (Healthcare in Dubai, 2013). There is an emerging high demand for medical services in Dubai. It is attributed to a high population growth rate and emerging unhealthy lifestyles (Oxford Business Group 2008, p. 180).

There are delays and cancellations of projects that involve PPPs after the 2008 global financial crisis. The delays in raising funds are caused by the withdrawal of large financial institutions from large debts. Large banks that provided adequate finance have become more risk-averse. It causes SPVs to seek many medium-sized companies to generate funds through equity (International Trade Forum 2009, para. 8). The interest charged is much higher sometimes resulting in the cancellation of projects.

Shendy, Martin & Mousley (2013, p. 13) explain that a PPP framework that evaluates a value for money is necessary for its successful completion. The high cost of debt after the global financial crisis has made many PPPs unviable as they provide an expensive option for the public sector client.

Governments are working together with the private sector to raise funds in PPPs to make them viable. Co-funding is emerging as a new strategy in making PPPs viable. In the UK, the government has established a fund from which PPPs can borrow as a measure of last resort. The UK government has lent £2 billion to the private sector (Clements 2010, p. 17). Other countries that are using co-funding include India, France, and Colombia.

The public is reshaping its collaboration with the private sector through non-profit organizations as another innovative strategy. Greve & Hodge (2013, p. 214) discuss that the public sector is rethinking cooperating with the non-profit sector in the form of PPPs.

Walshe & Smith (2011, p. 308) discuss that PPPs should provide a legal framework to allow changes in the future. The Karolinska Solna (Stockholm) Hospital Project is an example that has undergone functional changes to increase service accessibility. The project has adopted an approach known as population capitation. The performance of the facility will be based on the number of patients among other factors. Unitary payment will also be based on the number of patients served among other factors. The Karolinska Solna Scheme is considered the largest healthcare project in Europe valued at 1.42 billion Euros using 2007 prices (Walshe & Smith 2011, p. 308).

Alternative basic procurement routes

Two of the basic procurement routes that match the Build-Transfer found in PPPs are the traditional route and the design-build route. The risk involved with these procurement routes is accommodated by the public sector. The private sector assumes less risk. The quality of structure may be reduced because maintenance and operations are transferred to the public sector client. The overall cost of the project to the public may be lower than in PPPs when the government raises capital instead of the private sector. Service charges may also be lower than in PPPs.

The government may also decide to make the facility a free-service facility under BT or design-build route. However, setting up free-service facilities is discouraged in health economics. They increase unnecessary out-patient visits which may create congestion. Changes in 2001 have made it necessary for foreigners working in Dubai to pay for their health care costs. Foreigners working in Dubai used to make up 75% of the number of patients in public hospitals (Healthcare in Dubai 2013, para. 9). There was congestion in Dubai hospitals. Only life-threatening conditions may be treated free of charge after changes made in 2004. Subsidies may cover room rates for those admitted to hospitals. BT is not completely a PPP scheme.

Management contracting may also be used to complete the healthcare project. The period of the contract may be extended to the operation and maintenance phase of the project for the route to match BOT or BTO. In management contracting, the healthcare facility would be built according to the expertise of the private sector. Funds are raised by the government. Management contracting is able to pull together a group of organizations similar to an SPV. Management contractors are able to provide the experience of the private sector in managing the factors of production.

PPPs are more beneficial than management contracting because PPPs raise capital on behalf of the public sector client. PPPs will operate and maintain the facility. PPPs will also share the risk of completing the project according to objectives in a timely manner. The disadvantage of PPPs over management contracts is the profit motive of the private sector in PPPs. They may not be interested in controlling costs because it is passed over to the public sector (Public-private partnerships, 2013).

Examples of PPPs

The government entered into a PPP worth US$1.8 billion with the Tatweer Group in 2002 (IBP USA 2007, p. 79). It is a scheme based in the Dubai Healthcare City (DHC) formed by specialists from different areas in medical training and research. They provide services as well as training students. It provides medical learning resources for students. It includes a post-graduate learning facility. It is affiliated with the Harvard Medical School for more experience. There are links to allow students to access the Harvard Medical School online library (Oxford Business Group 2008, p. 182).

In India, the use of PPPs in healthcare has been successful in the BT format. When the format involves the private sector operating and maintaining the health care facility for a service charge, there has been strong resistance from the public. Politicians, healthcare officers, and the general public consider such schemes as privatization of public health care.

In the Municipal Corporation of Delhi (MCD) and Arpana Swasthya Kendra case, patients agree that the PPP provides high-quality services that the usual public sector health care services. However, they dislike the user fee. Public health officers are also resistant to the requirement of reporting to the private sector management (Raman & Bjorkman 2009, p. 56). Poverty levels in India may not match those in Dubai. The success of PPP in Dubai may be based on consumers who are already used to paying service charges. Dubai is mainly formed of expatriates who may be happy to receive health care at a lower cost.

Another PPP scheme in India is the Karnataka Integrated Telemedicine and Tele-Health Project. The scheme involves specialist doctors working through information technology to give consultations on patients situated in further areas. They use the assistance of local doctors and digitized information. Only patients who need surgery are transferred to the specialist hospital. The objective was to reduce patient traveling costs. The project was criticized for its high cost of acquiring assets which makes it unviable if it were to be replicated in many parts of the country (Raman & Bjorkman 2009, p. 60).

Another example of PPP can be found in the construction of Abu Dhabis 327-km Mafraq-Ghweifat highway. The project was bid by three consortium organizations. The Irtibaat Consortium was composed of Macquarie Capital Group and its equity partners, Abu Dhabi Commercial Bank and Construtora Norberto Odebretch, alongside contractors NV Besix and Al Jaber Transport and General Contracting (Oxford Business Group 2010, p. 119). The other bidders were the Mafraq Motorway Group, and the MTD-CSCEC Consortium all of which consisted of several organizations each adding special resources. The main point, in this case, is the large number of organizations that form a consortium.

The road project was supposed to take 25 years. The Abu Dhabi government is supposed to make payments annually to the consortium that built the highway. The performance indicators used by the government are quality construction, and reduction in the number of road accidents. The project was expected to cost US$2.72 billion (DH 10 billion) (Oxford Business Group 2010, p. 119).

Conclusion

The increasing demand for healthcare services needs to be addressed with additional healthcare facilities. Dubai may not experience public resistance to user-fee-based services because patients, apart from UAE nationals, are already used to incurring the cost of the healthcare services. The government is subsidizing Medicare costs which may make it easier to incorporate unitary charges to subsidize service charges in the PPP facility. There are delays in projects that are financed by PFIs and PPPs after the global financial crisis. Firms and individuals are more risk-averse to holding financial assets. They demand higher interest rates for securities that are not guaranteed by the government. Delay in raising capital causes delays in building facilities and offering services. Co-funding may be used to increase the viability of the project.

References

Clements, B 2010, The impact of the global financial crisis on public-private partnerships, OECD, Paris. Web.

Greiner, A & Fincke, B 2009, Public debt and economic growth, Springer, Dordrecht.

Greve, C & Hodge, G 2013, Rethinking public-private partnerships: strategies for turbulent times, Routlegde, New York.

Healthcare in Dubai 2013. Web.

IBP USA 2007, Doing business and investing in United Arab Emirates Guide, International Business Publications, Washington, DC.

International Trade Forum 2009, The impact of the global financial crisis on public-private partnerships. Web.

Levy, S 2011, Public-private partnerships: case studies on infrastructure development, ASCE Press, Reston.

Oxford Business Group 2010, The report: Abu Dhabi 2010, Oxford Business Group, Istanbul.

Oxford Business Group 2008, The report: Dubai 2008, Oxford Business Group, Istanbul.

Pallot, P 2010, Expat guide to the UAE: health care, media release. Web.

Public-private partnerships, 2013, Unit 04, lecture notes.

Raman, A & Bjorkman, J 2009, Public-private partnerships in healthcare in India: lessons for developing countries, Routledge, New York.

Shendy, R, Martin, H & Mousley, P 2013, An operational framework for managing fiscal commitments from public-private partnerships: the case of Ghana, World Bank, Washington, DC.

Walshe, K & Smith, J 2011, Healthcare management (2^nd ed.), McGrawa-Hill, Berkshire.

Yescombe, E 2007, Public-private partnerships: principles of policy and finance, Butterworth-Heinemann, Oxford.

In 2008, the global financial crisis took place. It had started with the financial meltdown in the US financial markets. It is considered that the crisiss emergence is caused by multiple factors: the overall cyclic recurrence of the economy, the overload of the credit and the stock markets, the high commodity costs, etc. By fall 2008, the US government faced significant problems and had to make many tough decisions to save the economy. The contradictory consequences of these decisions indicate that the government wasnt fully aware of the situation on the financial markets and neglected some issues that had led the economy to instability and collapse.

The meltdown started when one of the biggest US investment banks, the Bear Stearn, cracked down. The bank had multiple debts and was interconnected with the organizations worldwide. Thus, the banks bankruptcy could provoke a wave of collapses. One of the primary reasons for the Bears financial crack was instability in the subprime mortgage market, which was caused by the excess liquidity and the careless attitude towards the lenders.

The financial markets had a lack of transparency and regulation. The market was overabundant with lucrative financial products, which had a short lifespan. These factors led to the point where the stocks plunged.

To avoid the evolvement of the Bear Stearn difficult situation and to prevent the dragging down the rest of the financial sector with it, the federal officials made a tough decision to bail out the bank with 30 billion dollars from of Federal Reserve (Money, Power & Wall Street 2012). The bailout induced the emergence of the moral hazard, about which the Treasury Secretary, Hank Paulson, reminded Wall Street in his interviews. He considered that the Bears bailout might cause the other banks officials to avoid responsibility for the mistakes they had made.

The actions towards the financial problems resolving were decided by the government case by case. The organizations that faced the threads of the financial collapse were numerous. The Lehman Brothers bank was one of the most powerful financial institutions in the USA. Nevertheless, it wasnt bailed out by the government. The Lehman Brothers bank went bankrupt, and it was the biggest bankruptcy case in US history. The consequence of this bankruptcy was the stock market freezing.

The injections of capitals were a frequently used solution during the crisis period (Breaking the bank 2009). The government invested the capital in the banks obtaining the ownership stakes or merging with the organization. For instance, the Bank of America-Merrill Merger. The merger prevented the Merrill bank from financial failure. All the banks affiliates and the vast number of employees were saved.

The 2008 financial meltdowns created a significant threat to the global economy. The officials, Hank Paulson, Ben Bernake, and Timothy Geithner, are those who were in charge of the decision making during this tough period. They regarded the meltdowns as the systemic risk to the economy (Inside the Meltdown 2009). The crisis indicated that the economy has a very subtle and complex structure, and it showed the interdependence of the financial institutions not only within the country but also beyond the borders. The importance of the governments control over the situation on the stock markets was recognized by Barack Obama in his public speeches (Money, Power & Wall Street 2012). Since the crisis took place mainly because of the lack of transparency in the banks financial transactions and the absence of the governments involvement in the financial markets, the further regulations of Wall Street are a necessity for the prevention of future economic disasters on the global scale.

References

Breaking the bank [Video file]. (2009).

Inside the Meltdown [Video file]. (2009).

Money, power & Wall Street [Video file]. (2012). Web.

Introduction

The word Financial Crisis is a term that many economies, large or small, are in fear of. It is a situation which occurs when a country which was once doing well in the financial sector is suddenly faced with huge amounts of debts as well as inflation due to ignorance of the managerial teams in financial matters (Baker 1998).

Analysis

Financial crises are bound to hit major economies at one time or the other. Countries which thought they would never face financial challenges often make a mistake along the way and plunge the whole countrys economy into mayhem (Neave, 1998). Such can be said of Russia. Of the Soviet Union, Russia was among the largest republic consisting of 60% and above Gross Domestic Product (GDP).

With the development of financial crisis all over the world, there have been major shifts which have created huge impacts on Russias economy in the world market (Carr, 1966). This has in turn led to loss of confidence of Kremlin leaders who held the belief that despite having suffered devastation as well as chaos during post-Soviet years, Russia was slowly recovering and had to some extent achieved economic invincibility (Gaïdar 2003). Russias financial crisis also revealed the nature of class held by the existing Russian government. The population was not even provided with relevant answers as to whom this burden of financial crisis would be laid upon (Smith & Ingo, 1997).

Russias financial collapse was not a mere accident. It was caused by a distortion of the economy which was as a result of neo-liberalism produced in Russia (Carr, 1966). Neo-liberalism is the modern manifestation of an old belief that affirms the superiority of the free market system (Ibid, 1966). For several years, Russia had financed its budget insufficiency through the sale of short-term bonds. But after a while it was no longer able to do so and an increase in the deficit occurred (Baker, 1998). Collection of tax also followed suit and rapidly declined. Russia was now forced to depend on borrowed funds which led to a 40% rise on its monthly interest debt payment (Steve & Lars, 1993).

In 1998, Russia suffered a meltdown which led to several consequences. These included the spreading of panic all over financial systems. It created doubt all around the world as to whether neo-liberalism model actually worked (Twigg & Schecter, 2003). Russias meltdown also caused a major slip of the U.S. stock market which was experiencing accelerated and rapid increases over the decade. Investors panicked and left all kinds of private corporate bonds as well as stocks and turned to the United States government securities for safety (Geisst, 1995). This move made it even more difficult for corporations to rely on borrowed funds.

Russias financial crisis in the 1990s was so severe that it brought down the government of former Prime Minister, Mr. Sergei Kiriyenko, as well as shook financial markets all around the world including Wall Street (Steve & Lars, 1993).

Soviets downfall in 1991 was viewed as a final vindication of neoliberalism (Carr 1966). Analysts argued that Soviets downfall only further proved that it was almost impossible to form a more just economy by application of collective action since this would only result in the stagnation and eventual collapse of the economy (Twigg & Schecter, 2003).

Due to its massive size, Russia had come to inherit quite a number of regional economies from the Soviet. But when the Soviet Union collapsed and economic ties which it had acquire broke, there was a rapid decline in production that was almost 50% (Aslund, 1995). This in turn led to corporations laying off employees thus creating an issue of under-employment as well as much unemployment in the population.

In addition, Russia had not had the priviledge of inheriting a system of state welfare as well as social security from the Union of Soviet Socialist Republics (USSR) (Carr, 1966). Thus it was largely dependent on companies for functions such as management of health, provision of educational facilities, building and maintenance of workforce houses as well as provision of recreational facilities (Neave, 1998). Employers became heavily reliant on their companies and this made it difficult for maintenance of the social welfare. Local governments could no longer take up the responsibility for the various functions (Ibid, 1998).

The population of the former Soviet Union possessed some degree of literacy and its state enterprise managers had acquired skills to cope with demands of production targets laid upon them (Baker, 1998). However, the motivation system formed within industries as well as state institutions emphasised on skills to cope with the planned economy which was run by the state rather than concentrating more on the behaviour of the risk-and-reward free enterprise (Steve & Lars, 1993). Among the Soviet enterprise managers, efficiency as well as profitability was not considered as major priorities. Hence, no manager or employee possessed skilled experience of decision-making when it came to matters of the economy of the market (Baker, 1998).

In terms of the Gross Domestic Product (GDP), Russias economic decline was much worse. The financial crisis led to rates of increased economic imbalances as well as poverty among its population. Surveys conducted reveal that in the year 1993, the percentage of Russias population living in sheer poverty was between 39% and 50% (Gaïdar, 2003). By the year 1998, per capita earnings of the Russian economy declined by a further 15% (Ibid 2003). Russias financial crisis not only led to poverty and economic imbalances but also to a rapid decline in public health.

In 1990, the life expectancy of Russias population was 64 years for men and 74 years for women (Greenbaum & Anjan 1995). But by the year 1994, those figures sharply declined to become 57 years for men and 71 years for women (Aslund 1995). Cases of unnatural deaths amongst majority of young people have also been responsible for the decline in public health as well as mortality rate of the population. Due to poverty caused by the financial crisis, deaths as a result of parasitic diseases and infections rose up to 100% while deaths caused by alcoholism rose by about 60% (Gaïdar, 2003). This is because people could no longer afford proper medical care, medicines and/or afford to go for counselling due to their state of poverty.

In addition, even though Yeltsin era stores were fully stocked, those Russians who were on fixed incomes, that is, the work force, did not have the purchasing power and could therefore only afford to buy something little, if any (Carr, 1966).

In the 1990s structural reforms not only formed political oppositions but also lowered the living standards of most individuals of Russias population (Neave, 1998). With the ability to vote for parties of the opposition, Russian voters instead rejected economic reforms quite often and desired for personal security as well as stability which was present in the Soviet era. The theme most constant concerning the history of Russia in the 1990s is that of the conflict between individuals viewed as hostile towards new free enterprise and the economic reformers (Smith & Ingo 1997). Those individuals who were literate and possessed a level of education, occupying jobs which had potential in growth and lived comfortable lives having steady incomes were greatly affected by the financial crisis in Russian economy (Twigg & Schecter, 2003).

Due to increased financial debts by the country, lack of savings as well as credit was a resulting factor. Most citizens of Russia lost the trust they had on the countrys banking system hence less investments were made (Steve & Lars, 1993). The middle-class Russian population was the one adversely affected by the 1990s financial crisis in that there were enormous layoffs as well as unemployment, collapse of banks due to debts incurred, lack of compensation from fund-raising schemes which were government-sponsored and shortages in food and supply (Ibid, 1993). Russia failed to pay up its debts, devaluing the ruble (Russian currency) and as a result causing the collapse of banks while in the process wiping out private citizens savings (Geisst, 1995). White-collar employees thus lost their pensions, jobs as well as their hard-earned savings.

On the other hand, Russias government hiked the tariffs charged on automobile imports so as to try curbing with and preventing layoffs of the auto-industry employees (Greenbaum & Anjan, 1995). Declining oil prices greatly affected the ruble which was once considered a currency resistant to financial chaos.

In a span of 500 years, Russia has been seen to fall apart into pieces and surveys show that about 39% of Russians claim not to be satisfied with the government (Gaïdar 2003). In addition, when the value was lost on the Russian stock market, Russian authorities showed little or no concern whatsoever on the issue. They were soon to realise that they had made a wrong assumption that would cost the Russian economy (Steve & Lars, 1993). In 2008, the Russian ruble had devalued to a staggering 15% as related to the U.S. dollar (Ibid, 1993). Citizens of Russia thus began to withdraw their savings from the private banks and deposited them in state banks which were considered more reliable (Aslund 2003). But still some of these resources have since been converted into cash and are being put aside.

Russias financial crisis was revealed to be one of the main reasons as to why the date of the speech to be made by recently elected Russian President, Mr. Dimitri Medvedev, was moved before both parliament houses (Neave, 1998). It was to take place on November 5^th, 2008 but instead was given on October 23^rd, 2008 (Ibid, 1998).

In the 1990s, the International Monetary Fund (IMF) came to Russias rescue by giving advice on how to pursue a strict financial polity as well as fight inflation. But the Russian government were not so keen or as consistent in carrying out the advice (Smith & Ingo, 1997). Former president, Mr. Vladimir Putin, even tried to convince individuals to accept the drastic measures meant for inflation moderation but Russian consumer prices refused to heed to his advice. Thus in 2007, the rates of inflation further accelerated as compared to those of the previous years (Aslund, 1995). Milk, grain crops and food prices also shot up as a result.

Many countries started paying more attention to their economies as a result of Russias financial crisis. Despite it being too early to draw numerous lessons for today from the financial crisis, solutions can be found so as to prevent similar circumstances both at home and globally from occurring in future (Gaïdar, 2003).

Inventors ought to be encouraged so as to lend high-quality borrowers loans and in the process carefully monitor loan performance (Smith & Ingo, 1997). The regulators of the federal bank of the United States have given out more strict guidelines as to how mortgage borrowers who are willing to take higher risks ought to be considered for loans. Since risk managers do not deal with the sale of products, are not profit centers as well as concerned with writing trading tickets, they tend to be in most cases ignored when profits shoot up (Baker, 1998). Therefore, top management should be made to listen to them and choose the risk-return mergence which represents the risk appetite well (Neave, 1998).

Another lesson that ought to be learnt from the financial crisis of Russia is that investors need to be alert and careful as well as ask the appropriate questions concerning the risks involved due to purchase of securities (Greenbaum & Anjan, 1995). In the public sector, there is need to improve the regulatory structure so as to avoid distortion of incentives. Companies should be provided with resources as well as incentives to investigate deeper any possible errors in the risk management systems of the financial institutions they run (Neave, 1998).

In addition, the decisions made by the banks as well as deposit-insurance structures ought to be made stronger so as to cope with issues which arise from financial crisis. Tools which are outdated have with time been replaced with those whose aim is to fix the low volumes within bank markets and give them a boost (Steve & Lars, 1993).

The success gained after the financial crisis will in the end be determined by how the crisis is handled when it happens. Those market governments that are currently emerging have made the decision to become more engaged in the global economy as well as global capital markets, which in turn places much responsibility on the international organizations to ensure improvement of the system (Smith & Ingo, 1997). This will prevent unavoidable financial crises occurring in the future and having a bad impact as the one which occurred in Russia in the 1900s.

Governments should pay more attention to structural reforms. In Russia, during the financial crisis, economic imbalances showed insufficient reform as well as industrial restructuring hence the inability on the side of the government (Aslund, 1995). Therefore, to avoid such situations, a country needs to move quickly and try attempting structural transformations. This will ensure the economy of a country becoming a process of growth that is sustainable (Ibid, 1995).

Additionally, another lesson learnt from the financial crisis of Russia during the 1990s and is applied today is that countries are considering the adoption of flexible systems of exchange rates to enable them handle financial pressures caused by crises that arise (Twigg & Schecter, 2003). Another important factor that is being considered is that of ownership in the terminology of international financial organizations. A country possessing ownership of its economic program has higher chances of successful reforms (Geisst, 1995). International agencies as well as governments should do all they can via financial support and designing programs to make good policies stronger.

Governments need to form stronger institutions capable of lasting for a long time as well as be able to discharge of purposes as to why they were created in the first place (Neave, 1998). There is also need to form a global structure which includes both financial and economic relations and does not only cater to the needs of a number of large economies but cater to all economies as a whole.

Todays global financial crisis provides individuals with a renewed chance to act for long-term benefits rather than act selectively for a short time (Gaïdar, 2003). Countries ought to consider working with global financial institutions such as the IMF and the G-20 so as to try and formulate action plans which ought to be urgently and comprehensively implemented (Smith & Ingo 1997). Governance frameworks that are global should also be considered to meet the needs of all stakeholders.

Special attention should be paid to Russias financial crisis as to its causes, priority measures to be implemented inorder to avoid financial and economic collapse, the method of interaction between Russias financial and economic aspects as well as long-term end results of a withdrawal from the financial crisis (Greenbaum & Anjan, 1995). From 1991 to 1994, Russias Gross Domestic Product had fallen by about 40% and its inflation reached a shocking 1500% in 1992 (Geisst, 1995). This prompted its government to try finding ways of overcoming inflation as well as regaining financial stability.

Those countries which possess upcoming markets need special attention also since they face totally different problems from those of developed economies.

On observing Russia plunge into financial crisis, countries took up various measures to avoid suffering the same fate. These measures included buying out of a number of banks by the state, provision of liquidity as well as insistent lowering of discount rates (Gaïdar, 2003). In addition, governments of countries worldwide agreed to cut down the rates of exchange of their respective national currencies against the U.S. dollar (Ibid, 2003). The measure was taken so as to provide an additional factor for the stimulation of domestic production as well as for the preservation of international reserves.

After Russias 1998 financial crisis, banks were given extensive financial resources meant to overcome the liquidity crisis. This would ensure the banking systems stability which was responsible for the maintenance of political as well as social stability in Russia (Geisst, 1995). Banks worldwide need to be taught on risk management in case of financial crisis and the financial sector should reconsider its motivational framework. There is also need for credit rating systems which its users can once again have great confidence in (Baker, 1998).

Conclusion

The financial crisis in Russia which occurred in the 1990s was not only a blow to Russians themselves but also to other major economies. Panic was rampant leading to withdrawal of savings from many private banking institutions by the citizens of Russia.

Despite the crisis, Russia has been a lesson to other countries worldwide and has made them more cautious and alert when it comes to financial matters. Government agencies as well as international financial institutions have implemented various programs to maintain financial stability and reduce rates of inflation in economies. Russia, together with other countries are currently better equipped and well informed to face, handle as well as overcome future financial crisis.

References

1. Aslund, Anders 1995, How Russia Became a Market Economy, Washington D.C.,: Brookings Institution, pp. 378
2. Baker, James C. 1998, International Finance: Management, Markets and Institutions, London: Prentice-Hall, pp. 233  234
3. Carr, E.H. 1966, A History of Soviet Russia: The Bolshevik Revolution, 1917  1223, London
4. Gaïdar, Yegor, ed 2003, The Economics of Transition, Cambridge, Mass.,: MIT Press, pp. 1030
5. Geisst, Charles R. 1995, Investment Banking in the Financial System, London: MacMillan
6. Greenbaum, Stuart I. and Anjan V. Thakor 1995, Contemporary Financial Intermediation, Fort Worth: The Dryden Press
7. J. L., Twigg and K. Schecter 2003, The Role of International Financial Organizations during the Transition in Russia, Social Capital and Social Cohesion in Post-Soviet Russia, M. E. Sharpe
8. Neave, Edwin H. 1998, Financial Systems: Principles and Organisation, London: Routledge
9. Smith, Roy C. and Ingo Walter 1997, Global Banking, Oxford: Oxford University Press
10. Steve, H. Hanke and Lars, Jonung 1993, Russian Currency and Finance: A Currency Board Approach to Reform, London: Routledge, pp. 222

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

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

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

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

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

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

Bibliography

1. Turner, John D. ‘Banking in Crisis: The Rise and Fall of British Banking Stability, 1800 to the Present’. 2014, Cambridge: Cambridge University Press, final chapter.
2. Barth, James R., and Clas Wihlborg. ‘Too Big to Fail and Too Big to Save: Dilemmas for Banking Reform’, National Institute Economic Review, vol. 235, no. 1, February 2016, R27-R39.
3. Bell, David N.F., and David G. Blanchflower. ‘UK Unemployment in the Great Recession’. National Institute Economic Review, No. 214, October 2010, R3-R25.
4. Crafts, Nicholas. ‘UK Economic Growth Since 2010: Is It as Bad as It Seems?’. National Institute Economic Review, No. 231, February 2015, R17-R29.
5. King, Mervyn. ‘The End of Alchemy: Money, Banking and the Future of the Global Economy’. 2016, London, Little, Brown.
6. Shin, H.S., ‘Reflections on Northern Rock: The Bank Run That Heralded the Global Financial Crisis’. Journal of Economic Perspectives, vol. 23, no. 1, 2009, pp.101-119
7. https://esrc.ukri.org/public-engagement/social-science-for-schools/resources/the-global-financial-crisis/#:~:text=This%20caused%20a%20series%20of,the%20UK%20so%20badly%20affected%3F
8. https://www.economicshelp.org/blog/334/uk-economy/uk-national-debt/
9. https://www.bis.org/bcbs/publ/d457.pdf
10. https://commonslibrary.parliament.uk/research-briefings/sn06171/
11. https://www.fca.org.uk/consumers/ring-fencing
12. https://www.bankofengland.co.uk/-/media/boe/files/speech/2017/rethinking-financial-stability.pdf
13. https://www.economicsonline.co.uk/Global_economics/Policies_for_stability_and_growth.html#:~:text=Floating%20exchange%20rates%20are%20also,an%20automatic%20increase%20in%20competitiveness
14. https://www.forbes.com/advisor/investing/fannie-mae-and-freddie-mac/
15. https://www.investopedia.com/terms/l/liquidity.asp
16. https://www.economicshelp.org/blog/4946/economics/capital-immobility/
17. https://www.bis.org/bcbs/basel3.htm
18. https://voxeu.org/article/financial-repression-then-and-now
19. https://www.imf.org/external/about/histend.htm
20. https://www.allagents.co.uk/house-prices-adjusted/
21. https://www.economicshelp.org/blog/6901/economics/the-great-moderation/

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What Triggered the Global Crisis

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

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

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

Role That Banks Played During the Crise

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

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

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

Role of the Government

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

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

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

Role of Legislation

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

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

Impact of the Global Recession in Developing Countries

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

Trade

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

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

Diamonds

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

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

Conclusion

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

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

Recommendation

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

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

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

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

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

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

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

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

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

From Privilege to Curse

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

Greece’ Economy from 1997-2010

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

Excessive Borrowing

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

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

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

Bailouts by Troika

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

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

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

Why Has Still There Been Crisis?

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

The Global Effect

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

Effects of Global Financial Crisis on Greece Economy

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

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

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

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

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

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

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

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

Analysis

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

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

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

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

Conclusion

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

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

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

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

Subprime Mortgages

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

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

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

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

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

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

Securitization

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

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

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

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

Housing Initiatives and Other Policy Factors

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

Conclusion

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

References

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