Current Financial Crisis
The current financial crisis may at times be referred to as the Great recession. Economists consider the crisis to be the worst since the 1930s great depression. They also hold that the crisis was aggravated by the U.S. banking system’s shortfall in liquidity. Some of the consequences of the crisis include downfall of big financial bodies and stock market downturns globally. In majority of cases, there has been a negative impact on the housing market, which has led to several foreclosures, evictions and long-term vacancies. Additionally, the crisis led to downfall of major enterprises and decrease in the wealth of consumers approximated in terms of trillions of the United States dollars (Gross, 2009).
Several attempts of understanding the historical roots, the current meaning and the future direction pertaining to the current financial crisis depend on the Great Depression as a touchstone. While some people view the Great Depression as a mere metaphor, some view the great historical phenomenon as a channel to the future. Despite the fact that the current financial crisis is different from the Great Depression, there is a notable similarity concerning the fact that the people going through the crisis are making tremendous effort to understand the phenomenon even as it progresses, and many more will go on to learn more about it for the coming decades (Klein and Shabbir, 2006).
Several journalistic and popular books examining the crisis have appeared, and caught remarkable attention. Some sources are quite good and interesting to read. However, the extensive scope and their emphasis on personalities and drama mean that they are incapable of providing a definitive word concerning the crisis.
Every time something unusual, menacing and destructive happens, looking for the causes is almost always prolific and intense. This has been the case with the current financial crisis. There have been several culprits who have been put forward with regard to the crisis. Some of the claimed culprits include bankers and mortgage brokers whose structure of pay motivated them to take great risks and overlook ethical values. Fingers have also been pointed at conflicted rating agencies that were responsible for assigning Triple-A ratings to junks that were financially engineered. Majority of people have singled out the extremely low interest rates that the United States Federal Reserve maintained between the years 2002 and 2005. However, those who hold the belief that the Central Bank of America is the scapegoat instead refer to the savings glut of Asia which kept the rates of long-term interest low even as Fed maintained to strengthen the financial policy (Gross, 2009).
Marxism interpretation of the current financial crisis is that of the termination of capitalism financialization. This phenomenon is characterized by the increase in debt that has been gathering momentum since the 1970s in reaction to the universal scarcity of business venture opportunities. Austrian economists hold that financialization resulted to credit creation by the central banking institution owed to its attendant deficiencies. Despite the fact that all explanation lay emphasis on dominance of debt, they fail to delve into the core of the crisis. In order to examine the root of the crisis, it is necessary to be conversant with the fundamental principles of the order liberal democracy within which financial markets function (Klein, 2006).
Liberal democracy can be clearly defined as a type of social structure that initially emerged in the 17th and 18th centuries in the northern part of Europe. This is the same region and time when historians predictably date the earliest huge financial crises. Over the next centuries, the crises spread across the world such that its key representatives now include Canada, the United States, Japan, Much of Europe, Israel, New Zealand and Australia. The crisis has also penetrated into Africa, Asia and Latin America. The feature that clearly defines the regime is its neutral view point concerning the definition and role of human life. Accordingly, the role of the state in liberal democracy is confined to making sure that individuals follow their dreams in accordance to equality and freedom principles. Early philosophical supporters of liberal democracy considered the key role of government in liberal democracies to be promoting economic augmentation through establishing a market society (Klein, 2006).
One of the biggest barriers towards establishment of a market society was the ancient moral restriction against loaning of money with interest. One important lesson learnt from the current financial crisis is the great essence of credit in market societies. It is impossible for individuals to acquire cars, appliances and houses without loans. Moreover, without loans, organizations would find it extremely difficult to manage functional challenges caused by imperfect synchronization of outlays and receipts at each point in time. Firms have to waist for a significant time period prior to generating a return of their investment when the outlays happen to be for capital goods (Gross, 2009).
Though there is the option of equity finance, acquiring shares in individual future income stream would be burdensome. Despite companies issuing stock for funding their activities, the return rate that has to be given to investors has to be greater, owing to the risks incurred in being placed last in line to assert the cash flows of the firm. Majority of people who have savings available for deployment would evade such risks, while several capital projects that have lower prospective return rates, yet still higher than what it would cost for debt financing, would lack funds.
At the bottom of the global financial crisis is neither market failure nor money greed, but the altruistic view held by the two largest central banks in the world that interest rates that are near zero would substantially benefit workers and businesses struggling after the crisis. The Bank of Japan lowered its discount rate to a less than two percent rate in the year 1994. In September, 2001, it reached 0.1 and has maintained a rate of less than one percent since then (Cobham, Eitrheim and Gerlach, 2010).
A record accumulation in private debt in several advanced economies, including the U.S was experienced at few decades prior to the outbreak of the great financial crisis. The monetary industry and household debts remarkably increased between the years 2001 and 2007. The United States ha significantly reduced its massive Second World War debt by a substantive financial modification, a sudden surprise burst in inflation and restructuring the public and public debt. It is clear that a gradual form of debt restructuring undertaken by the United States helped to minimize the massive public debts in various progressed economies including the United States economy after the Second World War (Gross, 2009).
It is also evident that financial inflation in addition to financial repression played a fundamental role in debt reduction. Massive stocks of debt amassed during the Second World War in many developed countries such as the United States were greatly reduced through an extensive financial repression system that triumphed for many decades globally.
There are policy measures that have also led to a massive debt reduction. The first policy is the monetary policy, whereby the rate target of nominal federal funds has been reduced significantly within a short time period. It is however essential for liquidity tools and financial policy to be proactively used to address the crisis. Another challenges pertaining to monetary policy is that the degree of the great inflation is more intense than the expected degree. The expectations of the inflation have also risen. The policy has to not only provide sufficient insurance against expected threats but also confront the overall economy. It is uncertain whether the degree of temporary rates of real funds will align to the goals of low inflation and sustainable development (Cobham, et. al., 2010).
Through allowing institutions to make monetary transactions with the central banks, it would be difficult for them to finance with ease in the market, thus leading to reduction of their chances of taking actions like trading other properties into markets that are distressed or withdrawal of credit lines that are extended to other monetary institutions, that would have led to increased market pressures. The United States currently has in place a liquidity provision cooperative scaffold within key central banks (Kolb, 2010)..
There are several lessons that can be drawn from the current financial crisis. The first lesson is the essence of giving originators incentives for giving loans to high-quality borrowers, as well as careful overseeing of loan performance. The federal bank of the United States’ regulators currently provides a tight guidance regarding qualifications of riskier mortgage borrowers for loans. Consequently, there is no longer the provision of hybrid subprime loans that have low interest rates. Additionally, the congress is making considerations of controlling the United States mortgage brokers (Cobham, et. al., 2010).
Another lesson drawn from the crisis is the need for improving the governance risk management structure in financial institutions with incentives that show biases towards returns instead of the risks involved in the process of obtaining them. Many organizations have compensation plans that lay emphasis on returns rather than the risk involved in the process of obtaining those returns. Another lesson that can be learnt from the crisis is the essence of reexamining the incentives structures within agencies for credit rating. It is essential for credit rating agencies to handle the issue of incentives in an appropriate manner (Kolb, 2010).
Another lesson that is worth noting is that there is the need for investors to inquire about appropriate issues and perform their own due diligence concerning the degree of risk involved in securities purchased. While agencies for rating are clearly as significant and beneficial part of our monetary system, part of the equation also lies in the interpretation of the ratings by eventual users. This has also partly led to collapsing of markets for structured products (Kolb, 2010).
In conclusion, the current financial crisis is a great phenomenon that has greatly affected various sectors with the financial and housing sectors dominating the list. Provision of incentives to lending money to high-quality borrowers and the essence of reexamining incentive structures are among the key lessons drawn from the current financial crisis.
References
Cobham, D., Eitrheim, O., & Gerlach, S. (2010). Twenty Years of Inflation Targeting:
Lessons Learnt and Future Prospects. CambridgeUniversity
Gross, D. (2009). Dumb Money: How Our Greatest Financial Minds Bankrupted the
Nation. Simon and Schuster
Klein. L. R., & Shabbir, T. (2006). Recent financial crises: analysis, challenges and
implications. Edward Elgar Publishing
Kolb. R. W. (2010). Lessons from the Financial Crisis: Causes, Consequences, and Our
Economic Future. John Wiley and Sons
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