The crisis of 2008 was the moment of truth for global economics pointing out new possibilities for developed countries to challenge their financial system. This world phenomena was one of the most discussed and controversial during the recent decade. Crisis events, which we observed in American financial system in the second quarter of 2008 affected the majority of countries all over the world and were so drastic and huge while measures of regulators stabilizing the situation so unprecedented, that it allowed to question the effectiveness and resiliency of American financial capitalistic model on global world market (Ershov, 2010). Some key elements of financial system were practically demolished, while the system itself could not function in previous frames had to be partially nationalized or taken under government control. Extreme measures offered by American government provided only temporary stabilization being not able to liquidate fundamental causes of the crisis (Dolmetsch, 2008). In the world economy, we encounter a qualitatively different geo-economic and politic situation where the older footholding financial and stability centers are being gradually substituted by new sources of global financial resources and centers of politic and economic influence. A necessity to form new economic mechanisms and “game rules” becomes now obvious while the scale of crisis 2008 was much greater than expected, demanding emergency measures not to allow the transformation of branch and country problems into heavy system default situation.
The Crisis Case of 2008
As a result of tremendous growth of derivatives, which composed the major part of investment banks’ structures, broker and dealer companies’ assets have sharply increased (Paulson, 2008). Dynamic of such a growth has long outgone the growth rates of commercial banks’ assets, creating a vast instability zone (Table 1, 2, Appendix). There are controversial views on the basic reasons underlying the crisis shock. The former US treasury Minister H. Paulson (2008) assumed that housing sector fall was the major provoking factor. While the basis of majority operations composed derivatives of mortgaging market, the prices decrease on housing sector provoked substantial liquidity reduction and generated the credibility gap leading to huge losses for investment structures and mortgaging companies (Table 3, Appendix). American stock market prior to financial crisis 2008 has long been in a high volatility zone. On summer 2008 internal share listing of American mortgaging agencies (Fannie Mae/Freddy Mac), have fallen for more than 30% (Bloomberg Financial Survey, 2007-2008). These governed supported structures owned around 5 trillion dollars of mortgaging market in the US, which amounted on average to 50% of all mortgages in the country.
Other financial magnates, e.g. Warren Buffett (2008) supposed that crisis 2008 was provoked by liquidity squeeze, which could be efficiently regulated by government seeing the US bailout “as a golden opportunity”. Government posed a question of emergency assistance to these agencies. As the falling of listings continued, the Federal Reserve System announced a range of measures claiming states’ control over the mortgaging structures (Bicksler, 2008). As a consequence the stocks of the aforementioned agencies fell more than 80%. Some investment banks, which were not able to cope with the critical market situation were purchased by other state or commercial structures (JPMorgan Chase) with the guidance of Federal Reserve (e.g. Bear Stearns); others (e.g. Lehman Brothers), the stocks of which have sharply decreased in price (50% stocks price decrease) have to announce bankruptcy (Dolmetsch, 2008). A nervous situation on the market brought to traditional manifestation of bank crisis – depositors’ queues, mass cash withdrawals (as it was in case of America mortgaging bank IndyMac), underlying the disastrous situation with liquidity. However, the vivid picture of the forthcoming crisis appeared when the largest savings-bank of the United States with massive clientele (around of 2300 bank branches) the Washington Mutual, has endured the “depositors’ raid”. For the first 10 days of the emerged crisis, clients have withdrawn from bank accounts more than 16 billion dollars, which made the bank practically bankrupt (World Bank, 2008-2010). This situation demanded an urgent involvement of Federal Government, Federal Reserve System and Federal Corporations on endowment insurance (FDIC). As a result of negotiation the biggest share of the bank’s business was acquired by JPMorgan Chase bank (World Bank, 2008-2010). Insurance sphere have also encountered the same difficulties. For instance, one of the biggest insurance companies AIG, supported by Federal Reserve loans scheme in amount of 85 billion dollars, could not stop stocks price fall, allowing listings to collapse for more than 70% during the day. Since the loans were secured on 80% by the state, AIG has practically become the Federal property after bankruptcy. Another largest American investment banks Merrill Lynch announced critical situation in September 2008, being purchased by Bank of America shortly after. The remaining top investment Banks of Morgan Stanley and Goldman Sachs were taken under Federal Reserve System regulation in the capacity of holding structures, practically losing their status of investment banks (World Bank, 2008-2010).
The government measures helped the banks to attract additional financial resources and gained access to the Federal Reserve System liquidity instruments (“discount windows”), and possibility to work with money of private individuals, who were allowed to perform deposit operations in small scales only (Feldstein, 2007). Thus, American financial system in crisis 2008 tried to reanimate the financial architecture existed prior to the Great Depression, which allowed to carry out investment and commercial banking activity within one company. That strategy however, did not exclude the possibility of new risk sources forming which also have become a burning controversial issue for market experts. Serious problems emerged on American and European interbank credit markets, when banks sharply decreased credit arrangements due to possible default risks (Financial Stability Report, 2008) (Table 4, Appendix). This process provoked situation when banks preferred cash resources in order to form a kind of durability backlog, making the shortage of liquid assets even more serious. Further, financial crisis of 2008 covered European market and its commercial structures. Financial Institutes (Fortis, Hypo Real Estate, Bradford & Bingley) of Great Britain, Benelux, Germany and others were either partially nationalized or received a scalable federal support (European Commission, 2008). In order to activate the interbank market, the European countries have invested around 1,8 trillion dollars into government support programs. Revising that process, we can see a clear strong tendency of substantial redistribution of corporate American and European structures and consequently world financial market resources. State participation in commercial operations in modern economy sharply increased on both national and cross-border level (especially on sovereign fund investments) (Addison & Mavrotas, 2008).
International Liquidity 2008: New Risks and Sources. Volume of depreciated debts of 100 largest world companies and banks approached 600 billion dollars in 2008. The amount of money raised for liquidity support can be estimated as 430 billion (thus all the difference in money raised and borrowed should be written off from banks’ balance). However, according to recent data (World Bank 2008-2010) the total amount of the written off financial means was estimated in 2,8 trillion dollars (Financial Stability Report, 2008). Crisis of 2008 has resulted in a tremendous liquidity squeeze while during the increase of financial leverage, correlation between assets and capital exceeded 7-10 times depending on the operation type and activity sphere (hedge funds and investment banks approached 20 - 30 times correlation). The ways of who to improve liquidity for banks and global corporations headquartering in the US proved to be also controversial. Obvious enough the liquidity squeeze happened with the corresponding squeeze coefficient, what only strengthened the cumulative effect of its decrease. That effect appeared to be significant for the global economy due to multiplier influence on high-powered money transforming to it the corresponding aggregate money supply (Financial Stability Report, 2008). If we speak about the investment banks, then the Federal Reserve demanded that the practice of loss records be implemented on the mark-to-market principle, which meant that it was necessary to reflect losses and corresponding assets decrease in the balance. At that the demanded sale of assets for balance correction provoked further price decrease uprising the size of losses and write offs (i.e. we speak of the effect of self-reinforcing tendency, a kind of “snowball (Table 5, Appendix). Other experts on European Commission willing to avoid such an effect made global companies undertake radical measures, e.g. sale of “banks in crisis”. The necessity of liquidity support was connected with the decision to let these banks use the refinancing measures of the Federal Reserve (“the discount window”) (Press Briefing, 2008). Commercial banks had relatively large timespan to strengthen the liquidity balance, while they provided the write offs only in case of default situations (for instance, in cases of non-repayment of commercial loans), reflecting the assets in notional value. Having in mind the situation when they had to pay their debts, they decided whether they either would diminish the capital or carry out stock issue (World Bank, 2008-2010). Another rather controversial possibility was to sale all assets while the commercial banks tried to maximally broaden the sources of raising debt capital; one of such sources was the means of sovereign wealth funds. During the crisis 2008 such sovereign funds played an ever-increasing role in the capital of the leading banks. If that tendency remains for the next decade it might provoke the geo-economic changes, forming the new corporate and economic world map stimulating the emergence of new economic power centers, increasing the role of BRIC countries (Buffet, 2008). The disputable fact about such a tendency lies in the necessity to find new investors and funding sources during the crisis moments changing the geopolitical dimension in the global economy. Majority of the leading financial companies and banks, which historically represented the most important elements of the national economic and political system may re-orient on other priorities, reflecting the position of foreign investors and stakeholders (Hostland, 2008). Moreover, we speak of investments from countries, whose approaches to broad geopolitical spectrum could substantially differentiate from the approaches of the receiving country while resources could inflow from the unknown funding sources. In that connection activities of sovereign funds often arouse questions and draw attention of the regulating agencies (Paulson, 2008). While the crisis of 2008 was drastic, experts have to pose an issue of the financial system survival attracting all the range of instruments and sources to mobilize and support the economics despite the quality decrease of the inflowing capital with regard to its geo-economic impairments. Control and consolidation of the system in the new circumstances demanded significant broadening and hardening of regulatory approaches (Paulson, 2008).
This was determined by the necessity to, first, improve the discrepancies and imbalances on the financial market; second, monitor the problems connected with the strengthening of cross-border factor (with all connected geopolitical risks); third, forming of an integrate consistent approach system in the conditions of increasing financial market segmentation and its instruments diversification. Thus in the special measures programs aimed to reform the system of financial regulation in the US, prepared by the Treasury Department, experts underlined the necessity to coordinate the activities on regulating of different financial market segments, while the current system of financial regulation included separate regulating agencies, which were responsible only for certain market segments (Paulson, 2008). According to Henry Paulson (2008), the 74th Treasury Minister of the US, The Federal Reserve have to be granted additional emergency powers to limit the influence of temporary market difficulties. Later he marked the necessity to increase capitalization of scalable financial structures.
According to International Monetary Fund (2008) despite some success in the sphere of bank recapitalization, markets remained fragile saving the danger of losses and economic growth stagnation. Following that logic, banks become reluctant loaning money. Under the conditions of current global instability, it is important to estimate the precrisis events and make certain conclusions on the variety of measures necessary to avoid default situations.
Crisis 2008: Controversies and Conclusions
Size of losses due to mortgaging crisis in the US significantly exceeded the losses of the previous crisis periods and the Great Depression. Further housing price decrease reflected poor conditions on the housing market in the US (S&P/Case Shiller demonstrated the drastic fall for the last 20 years reaching 15%). Besides, the mortgaging loans in the US and other developed countries can be characterized by significant “loan-to-value” ratio (LTV), which achieved 75-80%. Any substantial decrease of the housing price increased the default chances on corporate and consumer level and led to new write offs and shrinkage of consumer demand. As the result the appointed tendencies obviously kept instability on financial markets, saving tough conditions for new loans attraction, slowing the tempos of economic growth in the leading economies. However, regarding the problem’s scale, which was faced by the American financial system as well as measures necessary for normalization of the market, the world global community would need a substantial amount of time to cope with the negative crisis consequences. Another controversy tackles the use of derivatives, while it is quite problematic to determine their owner, estimate their real value and as a consequence, the amount of future losses.
The stock exchange could further have periods of increased volatility, what can make the regulators use prohibitive or limitating measures. Increased volatility provoked the Central banks in different countries introduce limitations on “short operations”, allowing to sale stocks, which the broker does not have at disposal but is willing to buy them on the market at the lower price in case of possible price fall. Such operations are quite important elements of speculative operations destabilizing the markets. In autumn 2008 US Securities and Exchange Commission prohibited short operations with stocks of 799 large corporations. Experts have controversial views on such prohibitive measure while they affect the companies’ current liquidity. The problem of liquidity is expected to be a long run issue for separate financial companies and the world financial system at large. Though supportive measures undertaken by regulators softened the acuteness of the situation, the scale of write offs would hardly be obvious in the nearest years. Probably, the picture of the financial catastrophe would become even more complicated. Together with the 2008 crisis inflation tendencies (primarily in the US) would become stronger while the planned measures aimed to support American economy would mean the budget deficit growth and increase of state debt (Obstfeld, 2008).
Besides, the crisis situation provoked weakening of dollar positions around the world stimulating countries (oil exporting and producing) to use home currencies in reciprocal payments. The common dollar instability potential, implemented in the mechanisms and levels of American dollar security, would only increase in conditions of financial turbulence. Problems on housing market have distributed crisis tendencies on other spheres of economic. Obviously enough house price decrease beside the problems with loans security has parallel diminished the income and wealth level of separate households. According to the Federal Reserve (2008) 20% decrease in housing prices may shrink consumer expenditures on 1,5% GDP. Thus, monetary powers of developed countries have to use new mechanisms of wide monetary base formation. Already in the first months of 2008 the Federal Reserve refused from the model providing the monetary offers with the prevailing budget element (this approach was used in the US in the last decades); however, during the 2008 crisis the new channels of financial backing has increased its significance such as refinancing, emergency loans and other sources. Controversy of such a situation was included in the fact the US Federal Reserve system had to actively use printing currency strategy, which is not secured by the gold reserve (Table 6, Appendix). In the future, during consolidation of funding sources within budgetary mechanisms including anti-crisis measures, the role of state/budgets factor in forming of wide monetary base can increase all over the world.
Countries have to use a broad spectrum of measures on stimulating the demand and providing resource inflow to priority spheres. European experts (European commission, 2008) suggested that it makes sense to consider the question concerning tax decrease as an efficient financial leverage providing not only the possibility of growth but also the increase of its quality. Others (the Federal Reserve) assumed that an integrate system policy forming and managing the monetary resources in economy should be primarily based on internal sources and mechanisms of resource creation. American Federal Reserve takes pains now to substitute external funding sources by the internal ones. There was also another viewpoint pointing out that supporting banks by refinancing policy one should undertake measures of their reorganization and enhancement while making mergers and acquisitions procedures simple and transparent (World Trade Organization, 2008). It is extremely important to provide diversification of instruments on stock exchange making it a real functioning mechanism. Crisis 2008 has become a good lesson for the global economy demanding liberalization of financial sphere, a substantial package of anti-crisis mechanisms able to neutralize external shocking events. In this decade we encounter a unique possibility to form a qualitatively different approach and mechanisms allowing to guarantee a stable development of America and other countries within the conditions of continuous global instability.
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Appendix
Table 6. The Structure of Federal Reserve Money Base Starting 1957
