Introduction
After September 15 of the year 2008, the financial crisis which originated from the United States of America spread all over the globe which economically harmed many nations, particularly, the developing and under developed countries. Because many financial and non-financial institutions having origination in United States were operating at a global level, their fall negatively affected all those countries in which their subsidiaries were running the business operations.
In view of this, the research paper is written to demonstrate for policymakers and economists about how a financial crisis in one country could spread over and affect other countries as well. This paper is also written with an intention to propose simple, but effective, preventive measures using which the next American (or United States) financial crisis could be avoided from reoccurring.
- Evaluation of the Spread of the Next Financial Crisis
Under this section, a discussion would be made as to how a financial occurring in one country could translate into economic devastation of other countries after its spread from country of origin. It has been observed that external international or global risk exposures and business operations have significant impact over financial stability of other countries. Since economies these days have become more integrated with the rise of a global financial market and global economy, problems witnessed in one country can now easily and quickly be transmitted to other economies. In addition to this, large financial institutions tend to run business operations in many countries. Therefore, the economic or financial failure of any of these multi-national institutions can negatively influence financial conditions in all those countries where these multi-national organizations have business operations .
Furthermore, it is quite notable that uncertainty inherent in the global economic and financial outlook created by existing financial turmoil has reduced risk-taking appetite of investors. International investors, now-a-days, have less preference to assume higher risk for greater returns for which they prefer to invest in high quality and less risky assets (such as government securities) instead of investing in high risk bearing assets of emerging markets.
Particularly, the lack of investor confidence has resulted in a dramatic decline in bond issuance as well as the net-private equity flows in developing markets and number of initial public offerings (IPOs). This is so because foreign investors are less willing to make investments in equities issued by publicly traded companies in those developing economies. Another reason that a financial crisis in one country could easily spread to other countries is that given a strong relationship between net private capital flows to and global growth of developing countries, the anticipated decline in global growth, mainly driven by developed economies, may result in an additional drop in net private capital flows to developing nations .
Financial and, particularly, economic globalization have made developing countries more susceptible and, thus, impedes their economic growth. Economies should protect themselves against negative economic shocks originating from global financial markets for which a serious reconsideration and analysis of the global integration pattern has become necessary. These days, financial crisis can painfully and quickly spread leading to an increase in social cost to economies which have nothing to do with such crises.
This notion reveals that the interdependence of national economies on each other has increased overtime compared to what the trend was in the past. In the same manner, as the roles of the Statesmen and businesses needs to be rebalanced at the global and national level, it is necessary that globalization must be accompanied with “global governance” if policymakers want to avoid the spread of the next financial crisis .
- Preventive Measures to Avoid the Reoccurrence of American Financial Crisis
Under this section, various simple preventive measures will be established in an attempt to avoid the next American financial crisis to stop the global economic devastation from happening again. Financial crisis, though affecting both advanced countries and emerging markets over the centuries, always has severe consequences for every economy, yet they are very challenging to predict for prevention.
Analysis of the past suggests that in order to prevent occurrence of further financial crisis, government of every country should consider economic reforms in many underlying areas which demands the development of prudent monetary and fiscal policies, better regulation of the financial sector, tackling with the problem of too-big-to-fail banks as well as development of highly-effective macro-prudential policies . Despite better supervision and new regulations, crises are very likely to happen because they reflect deeper economic problems related to the political economy, common behavior of all economic agents and income inequality. To solve such problems, major improvement in a financial crisis management is needed .
After a careful analysis of the financial crisis of 2008, one will observe that the worldwide crisis of that year reflected high leverage and excessive risk-taking on the part of financial institutions and economic agents. A basic economic assumption is that economic agents respond, preferably, to incentives. Therefore, in an attempt to reduce the probability of the next financial crisis, it is of critical importance to learn from the past mistakes and experience by tracking down the ultimate sources of all those economic incentives that forced the global economy to face the crisis when housing prices were consistently climbing without any control.
When real estate prices started to decline, borrowers who had put no money down or little sum quickly found owing more, to the banks from whom they borrowed heavily, on their houses than the financial value for which they could sell their housing property for. In other form, they owed to every lender more than what they could earn from disposal of their houses for which they borrowed significantly. In this regard, one bold preventive measure is to regulate the way banks lend out their money to control the extension of toxic and predatory loans in an economy. It is recommended that financial institutions should, relative to their assets, borrow less.
Apart from this debt raising activity by financial institutions to play and invest into risky assets at expense of capital providers, around twenty to thirty percent of the money a bank utilizes should be funded from shareholders’ equity rather than from debt. Banks must hold more capital to borrow less for which they must raise more capital. This way, banks may not be bidding onto risky assets at expense of their deposits or bank account holders. They should either issue new stock or the banks may cut the dividend payments out of earnings and reinvest profits on the balance sheet for which the asset-liability management is required to balance maturity of deposits to that of loans .
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