A ‘financial crisis’ is a term that is commonly used in the field of economics to refer to various situations, whereby the financial assets or situations drop a significant proportion of their value (Markus, 2009). For instance, during the 19th and early 20th centuries, numerous financial crises that were being encountered were basically linked to banking panics, the situation was worsened by the recessions. In addition, a financial crisis is also closely associated with currency rises, stock market crashes along with sovereign defaults. A direct effect of the financial crisis is the loss of paper wealth (Roubini, 2010). However, this impact does not transform the real economy directly, unless this situation is followed by a depression or recession. Numerous theories have been offered with regard to the real causes of the financial crises, how they develop along with the measures that could be adopted to avert such situations. However, it is worth noting that there has been a little consensus, considering the fact that financial crises are still being witnessed by most of the global economies (Roubini, 2010). This paper will basically analyze a recent financial crisis, illustrating how the financial crisis started, and examining whether banks are part of the financial crisis or not. The paper will also discuss the role of the International Monetary Fund and the World Bank in the financial crisis and point up the stage in which the financial crisis is at present.
How the Financial Crisis Started
The financial crisis that hit most of the global economies in the late 2000s also referred to as the credit crunch, or the global financial crisis, has been declared by most researchers to be the most awful financial crisis that has been experienced so far (Dwyer and Paula, 2009). This financial crisis led to the collapse of numerous major financial institutions, downturns within the stock markets, together with the bailout of most banks by the affected national governments globally. Furthermore, the housing market in most areas was also affected, thus leading to numerous foreclosures, evictions, as well as protracted unemployment. There was also the collapse of key businesses, declined economic activity and a decline in the consumer wealth, which together resulted in a severe global economic recession that took place in 2008. This financial crisis is considered to have been caused by a complex interchange of the liquidity and valuation problems within the banking system in the United States (Coffee, 2009). The financial crisis occurred in 2008. Basically, the fall down of the housing bubble of the United States that heightened in 2007, led to a crash down of the values of the securities tied to the United States, thus damaging most of the financial institutions around the world. Matters pertaining to bank solvency, ruined investor confidence along with the declines with regard to credit availability, contained significant impacts on the stock markets globally, considering the fact that the securities suffered huge losses during the entire year of 2008 and the early 2009 (Markus, 2009). Most economists highlight that most of the global economies recorded a retarded growth during this period, while the international trade declined and the credit tightened (Dwyer and Paula, 2009). In addition, the central banks and governments responded with institutional bailouts, the expansion of the monetary policy and unprecedented fiscal stimulus. Despite the fact that various aftershocks have been reported, this financial crisis is said to have ended in a period between the late 2008 and early 2009. As depicted from the numerous studies conducted to identify the real causes of this financial crisis, each expert has come up with varying weights assigned to this global situation (Coffee, 2009). According to the United States Senate, in its Levin-Coburn Report, it is highlighted that this financial crisis did not occur as a natural disaster as other experts have highlighted, but occurred as a result of complex, high risk financial products. The failure of the agencies charged with the responsibility of credit rating, the regulators and the market and unidentified conflicts of interest. Critics highlight that the investors and the credit rating agencies failed to estimate the actual price connected to the risk contained in the financial products related to mortgage (Markus, 2009). In addition, critics highlight that the governments did not respond appropriately, considering the fact that most of them did not have regulatory practices suit to address the 21st financial markets. They ought to have adjusted their regulatory practices to enable them to deal with the needs of the financial markets in the 21st century (Dwyer and Paula, 2009). However, the immediate cause of the 2008 financial crisis is highlighted to be the bursting of the housing bubble in the United States. Increasing default rates on the adjustable rate mortgages and subprime started to increase from then on rapidly. While most banks began issuing out more loans to the would-be home owners, experts highlight that the housing prices increased. This therefore means that the banks encouraged the potential home owners to take on significantly high loans with the belief that the loans would be repaid more quickly, however, failing to notice the interest rates (Susan, 2009). The interest rates started to rise significantly, while the housing prices dropped. Refinancing became a challenge in most states, for instance, in California and as a result, the amount of foreclosed homes increased as well. The combination of money inflow and easy credit is what contributed to the housing bubble in the United States. As part of the credit and housing booms, financial agreements known as collateralized debt obligations and mortgage-backed securities that derived their value from the housing prices and the mortgage payments increased significantly. It is from this financial innovation that most investors and institutions around the world were encouraged to invest in the housing market in the United States (Susan, 2009). However, when the housing prices declined, most of the major financial institutions around the world that had heavily invested and borrowed in subprime mortgage-backed securities recorded considerable losses. The declined prices also led to homes with worth less compared to the mortgage loan, thus generating a financial incentive to allow foreclosure (Markus, 2009). Nonetheless, the continuing foreclosure pandemic that started in 2006 continued to drain more wealth from the consumers, while at the same time, eroding the financial strength of the banking intuitions within the United States. Losses together with defaults on the other types of loans also started to increase significantly, thus making the crisis expand from the housing market and enter into the other sectors of the economy (Coffee, 2009). However, according to the Financial Crisis Inquiry Commission report, the 2008 financial crisis that affected most of the global economies could easily be avoided and according to this report, the crisis was caused by extensive failures with regard to financial regulation together with the failure of the Federal Reserve to curtail the surge of toxic mortgages, the excessive borrowing by the households along with the Wall Street, thus putting the financial system at risk, the breakdowns experienced within the corporate governance sector, along with the financial institutions taking on a lot of risks and acting so recklessly, ill preparation for the crisis by the key policy makers with inadequate understanding of the financial system they had already predicted and some ethical and accountability breaches within the concerned systems. However, as analysts estimate, the total losses caused by the crisis globally can sum up to trillions of the United States dollars. Statistics highlights that the average housing prices in the United States by September 2008 had fallen down by more than 20 percent (Dwyer and Paula, 2009). However, while the prices were declining, most of the borrowers with the adjustable-rate mortgages had no capacity to refinance their loans in order to avoid the higher payments that were linked to the increasing interest rates, and thus resulted in default. The foreclosures proceedings in 2007 are estimated to be approximately 1.3 million properties and increased to 2.9 million in 2008.
Micro Credit and Off Share Banking
The micro-credit sector was as well affected by the financial crisis considering the fact that it became difficult for the banks as well as other financial institutions to provide funds to run the micro-credit sector. Indeed, as highlighted by various studies, it became difficult for some banks to continue with their operations as they became bankrupt, and thus had to close down while others had to be acquired by the government. It is further highlighted that some governments had to step in and bailout some of the affected banks in order to enable them to continue with their operations. The World Bank Group had to provide some funds to run the micro-credit sector, especially among the worst hit economies, as well as among the poorest countries. The off-share banking sector was also affected adversely, considering the fact that the financial crisis had significant adverse effects in almost all banking sectors. However, numerous studies have indicated that the most risky and poor performing mortgages during the financial crisis time had been funded through the off-share banking system. Competition from the off-share banking pressurized the traditional institutions to reduce their own standards of underwriting, hence resulting in more risky loans.
Are Banks Parts Of The Problem For Financial Crisis?
Banking institutions indeed are considered to play a significant role when it comes to the financial crisis problem. Economists highlight that when a bank goes through an abrupt rush of withdrawals by its depositors, such a condition is considered as a bank run. However, considering the fact that most banks lease a significant proportion of the money they obtain from the deposits, it becomes challenging for them to reimburse all the deposits quickly whenever these are unexpectedly demanded. Therefore, a run may lead to bankruptcy, a situation that may cause most of the depositors to lose whatever they have been saving with the banks, unless such risks are covered by the deposit insurance. There is also a condition whereby the banks become reluctant in lending out their funds on the basis that they might become bankrupts, or rather they have a worry that they possess insufficient funds available to allow them to lend out, thus resulting in a condition that is known as a credit crunch. In the light of such situations, the banks are considered to be the accelerators of the financial crisis. With regard to the financial crisis that hit most of the global economies in 2008, the banking sector played a significant role in causing this situation as well as accelerating it (Dwyer and Paula, 2009). These are the banks which encouraged the homeowners to borrow loans having the belief that the loans would be repaid quickly. However, one major mistake these institutions made, according to most economic experts, was to ignore the interest rates. When the interest rates began to drop steadily, the housing prices also dropped at a greater margin. It, thus, became difficult to refinance these loans, a situation that led to the increased of foreclosed homes. The banks assumed considerable debt burdens as they were providing the loans to the homeowners and were left with an insufficient financial cushion that would enable them to absorb the huge loan defaults. Furthermore, the losses that were incurred affected the financial institutions’ ability to lend money to interested investors, thus slowing down the overall economic activity. In essence, the financial crisis that was experienced in 2008 is considered to have been triggered by the interplay of the liquidity and the valuation of the banking system in the United States. Most of the banks encouraged the borrowing of loans as a way of financing the housing sector, a situation that had significant impacts on the overall economy, considering the fact that these institutions did not take a careful consideration of the interest rates, which increased significantly leading to numerous foreclosures. It can, thus, be concluded that banks form an integral part when it comes to the problem of financial crisis.
What Has The Role Of IMF And The World Bank Been In Financial Crisis?
As the financial experts highlight, the recovery process from a financial crisis is considered as a fragile one, as careful consideration has to be taken into consideration in order to avoid getting back to the situation. In addition, there are various risks that are associated with this process, for instance, high unemployment rates, low growth and debt among the developed countries, along with the volatile food prices. The World Bank Group, together with the International Monetary Fund have played significant roles when it comes to addressing the problems caused by the financial crisis. Their specific roles, especially with regard to the financial crisis that was experienced in 2008 are examined below.
The Role of the World Bank
The World Bank provides funds to assist the global economies during such crisis times. From the onset of the 2008 financial crisis, the World Bank is reported to have provided to the developing nations about $196.3 billion, together with some support for the nutrition, health, education, and the infrastructure for the crisis-hit economies. All through the crisis time, the World Bank Group assisted in keeping the children in schools, providing microfinance loans to the women groups and funding the health clinics in the affected economies. Analysts postulate that the World Bank Group’s support for social protection, especially for the most vulnerable and poorest economies, along with the cash transfer and the school feeding programs, for instance, the Oportunidades in Mexico is estimated to have accumulated to about $9 billion spread across the 72 nations during the financial years 2009-2011 (Dwyer and Paula, 2009). Furthermore, the World Bank increased its annual financing to the agricultural projects to $6-8 billion to boost up food security, up from $ 4.1 that was provided in 2008. Food security program, the Global Food Crisis Response Program, was also established as a response to the 2008 food crisis, and about $2 billion was allocated to this program. The program is said to be supporting well over 40 million people globally. The World Bank has also increased its support to the drought stricken areas and about $ 1.88 billion has been allocated towards this project. Besides, the Bank is also committed in fighting disease and malnutrition, especially within the refugee camps, through a Crisis Response Window that was created to provide a quick response to the up-and-coming crisis within the undeveloped states. Approximately $30 million has been granted to help to attain this goal. However, despite the fact that there is a significant growth reported in various developing countries, financial experts highlight that the demand for assistance from the World Bank Group is still high. For instance, the bank provided about $57 billion for the financial year 2011 together with $26.7 to support the poorest nations, which is considered to be a higher amount compared to $14.5 billion that was provided in the 2010 financial year (Paul, 2008). It can, thus, be concluded that the World Bank Group plays a major role during the financial crisis, considering the fact that it provides aids to the worst hit countries along with the poorest countries. This role is well evident from the 2008 financial crisis that hit most of the global economies, while the World Bank stepped in to assist most of the affected nations through food programs along with other programs that are meant to assist the affected nations.
The Role of the International Monetary Fund
The International Monetary Fund also plays a significant role in financial crisis times. With regard to the recent financial crisis, a study that was conducted highlighted that the financial crisis depicted that most of the national policies, particularly financial supervision and regulation, contain significant impacts on the global stability basically through the capital flows. This report further highlighted that the limitations within the supervision and the regulation policies among the source countries, gave banks as well as other financial institutions the power to take on extreme cross-border risks that in turn led to the transmission of economic and financial risks across borders, hence affecting most global economies. As the International Monetary Fund’s report illustrates, there was excessive capital flowing from one country to the other during the boom years, a condition that was suddenly upturned during the crisis period. The International Monetary Fund has in turn implemented international and national supervisory and regulatory reforms to help to manage capital flows of the recipient countries as well as the entire global systems in order to prevent the reoccurrence of such situations. In addition, these reforms are aimed at fostering better risk management practices. According to the International Monetary Fund report, sound prudential measures applied within the source countries, together with the regulations that govern more financial institutions and activities, as well as complete data monitoring, would facilitate the mitigation of most risks that are associated with the global capital flows and liquidity creation. It is, thus, apparent that the International Monetary Fund has established various elements to assist the policymakers in understanding the risks that can be transmitted across borders, just like the financial crisis, along with promoting policy coordination with the aim of stabilizing the global financial system (Read, 2009). Furthermore, the International Monetary Fund has funded various projects, especially among the poorest economies to help to combat the consequences of the global financial crisis. However, it is apparent that the major role the International Monetary Fund has with regard to the financial crisis, is its ongoing work on capital flows.
From this analysis, it can thus be concluded that both the World Bank and the International Monetary Fund have significant roles to play in times of the financial crisis. This is basically with regard to the provision of funds to help the worst hit as well as the poorest economies to recover from the impacts caused by such dramatic situations. In addition, these global monetary institutions have created various policies that could be implemented by states to avoid the reoccurrence of such situations. Various regulatory, as well as market-based solutions were created and have already been implemented, while others are still under consideration to help the global economies.
At What Stage Is The Financial Crisis Is Right Now?
The 2008 financial crisis that hit most of the global economies is reported to have come to an end between the late 2008 and early 2009. This is probably due to the fact that various governments had to step in and bail out their financial institutions. However, as experts report, various countries are still undergoing through the recovery process, considering the fact that some aftershocks are still being experienced. According to the National Bureau of Economic Research, the financial crisis is reported to have begun in December 2007 and was concluded in June 2009 (Paul, 2008). However, the aftermaths of this global crisis were still being experienced by some economies. The President of the United States however announced on January 27, 2010 that the impacts of the financial crisis had ceased and that markets were now stabilized. In addition, it was highlighted that the most of the funds that had been spent on the banks as well as other financial institutions had been recovered. According to the Financial Times, March 2009 is indeed considered to be the lowest point of the crisis, and most stock markets globally are presently reporting more than 75 percent compared to this time (Dwyer and Paula, 2009). In addition, the financial stocks that were adversely affected, considering the fact that they lowered the markets, have also risen. It is, thus, apparent that the 2008 financial crisis ended and thus can be considered to be beyond the recovery stage, considering the fact that most economies have already recovered from the impacts of this financial crisis. Moreover, most of the worst hit countries, for instance, the United States have reported that they have already stabilized.
It is apparent that those financial crises are hard economic times, as the affected nations stand to experience adverse effects. From the analysis of the 2008 financial crisis, some of the consequences of this situation include the collapse of the many banks and financial institutions, prolonged unemployment, downturns within the stock markets along with the collapse of key businesses. However, various experts have suggested some of the causes of this situation, with each assigning varying weights to the real causes of the situation. Furthermore, some of the market participants such as the International Monetary Fund and the World Bank have as well provided their own views with regard to the 2008 financial crisis, each with some of the corrective measures to be implemented to avert the re-emergence of such a situation. However, the lack of implementation of the necessary changes within the financial and banking markets is a worry to many experts, as well as to the market participants, together with the International Monetary Fund. This is based on the fact that the financial and banking market is considered to have played a significant role in causing this situation and it is, thus, feared that the same mistake could be made and, hence, result in another financial crisis (Read, 2009). It is therefore my suggestion that necessary corrective measures are developed and implemented by the financial and banking market in order to prevent the reoccurrence of such a situation. Team of experts could be appointed to come up with the necessary measures to be adopted to avert such situations. In addition, it is my suggestion that more regulatory measures should be adopted within the financial and banking sectors, as they control a significant proportion of the country’s economy. The power of the banks should be controlled so that their ability to indulge in an activity is regulated. From the above scenario, it is well evident that the banks assumed extreme power to issue loans to the homeowners, disregarding the rising interest rates. If such power had been controlled, then this crisis would have as well been avoided. It is therefore necessary that some necessary amendments are done on the banking policies, especially with regard to their power. Furthermore, some key players within the monetary sector such as the International Monetary Fund have established measures to be implemented to avoid financial crisis. It is my suggestion that such measures are applied by the nations for the benefit of their economies, as well as for the benefit of the entire global economy.
Financial crisis refers to a situation in which the financial institutions lose a significant proportion of their value. This is often caused be various factors such as the stock market crashes, currency rises, sovereign defaults, among many other factors. This paper has analyzed a recent financial crisis, the 2008 financial crisis that hit most of the major global economies. The financial crisis is considered to have been caused by the interplay of various complex factors as highlighted by various experts. However, what has been commonly identified as the main cause was the housing bubble, a situation whereby banks and other financial situation offered loans to the homeowners with the expectation that they would be repaid within a short period, however disregarding the interest rates. The increases in the interest rates in turn resulted in numerous foreclosures and most of the banks suffered. It is thus apparent that banks played a significant role in this financial crisis. Nonetheless, the World Bank Group and the International Monetary Fund have provided aids in terms of funds and policies that have helped most of the most affected economies recover. It is my suggestion therefore that the corrective measures are identified and implemented to avert the reoccurrence of such a situation.