Introduction
For many years, financial crises have been pervasive. According to Collardi (2012), the frequency of occurrence of financial crises in the recent decades has doubled the occurrence during the Bretton Woods Period and the Gold Standard Era. Nevertheless, the occurrence of the 2007-2008 financial crisis came as a great surprise to many individuals. Initially, the crisis was seen as difficulties that were being experienced in the United States subprime mortgage market. This, however, spilled rapidly to the financial markets before spilling over to the real economy. This paper discusses the causes of the financial crisis and the measures that the government out to have done so as to avert the crisis. The theory utilized in this paper is the Porter’s Diamond Model. Furthermore, the paper will elaborate if the government to too much time to respond to the crisis and make a decision as to whether the response from the government was a little bit too late. The second part of the paper will identify a specific bank in the United States and elaborate on how the bank dealt with the financial crisis. Porter’s Diamond model theory is one of the classical theories of trade that proposes the used of comparative advantage. This theory is vital in that I will use it to prove that regarding the banking industry, there were some banks that had a comparative advantage over others. This is why the global imbalance in finances was one of the key reasons for the financial crisis.
Keynesian theory
Keynesian proposed in his theory that it would not be rational for any sane individual to invest in circumstances that are not certain. While individuals draw on the evidence and other theories to explain the past economic events, the experience that they get cannot be used to explain or be sufficient enough to offer a guide to an uncertain future. During the financial crisis, most of the main stakeholders made decisions disregarding the uncertainty in the market.
Despite it's ample and its severity effects, the 2007-2008 financial crisis is similar to most of the other crises that have occurred in the past. Most financial crises in the past are normally preceded by asset price bubbles and credit booms. According to a study conducted by Blinder and Solow (2012), the results are that on average, over a period that spreads six years, there is a real drop in prices by 35%. Over three and a half years, the equity prices fall by 55%. Unemployment rate rises by almost 7% over a period of four years while output falls by 9% over two years. When compared to the pre-crisis level, the debt of the central government rises by 86%. While many analysts imply that the major episodes that precede the financial crises are sufficiently different when compared to other times that the crises occurred, they warn that the nature of the crisis is global and that it will take or make it more problematic for countries to grow their way out.
Reasons why it occurred
Although there have been various events that occurred before the occurrence of the financial crisis, the roots of the financial crisis can be traced to the unprecedented low-interest rates that were provided by the Federal Reserve and the other various central banks. The banks offered the low-interest rates even after the collapse of the technology stock bubble. When combined, all these factors contributed immensely by helping to fuel the dramatic increase in the house prices in the United States. Several other countries also had an immense increase in housing prices such as Spain, the United Kingdom, and Ireland. However, this bubble reached its peak in 2006 in the United States, and the prices of the houses began to fall drastically. As a result, the fall in the prices of the houses in the countries affected led to the fall of the prices of the securitized subprime mortgages thereby affecting the financial markets worldwide. By August 2007, the interbank markets experienced immense pressure that lasted for more than a few days and in doing so, it forced the central bank is to inject into the massive economy liquidity. During this time, it has to be comprehended that the conditions in the collateralized markets were also altered immensely. Low-quality collateral that had been easy to borrow became difficult to borrow as haircuts were raised.
The crisis however continued and after the default of the Lehman Brothers, the dramatic collapse in the real economy made this tactic of ensuring that everyone had the correct incentives or that the subprime mortgages were to be blamed to look less plausible. After the Lehman Brothers had filed for bankruptcy, the economies of many countries in Europe and Asia were immensely affected regardless of the fact that most of their banks had very little to do with the securitization of the subprime mortgages (Nanto, 2009).
The real estate bubble
It has to be comprehended that there was a real bubble in the in the United States, and this was one of the basic cause of the financial crisis. Furthermore, there was also a bubble in other countries such as in the U.K, Spain, and Ireland. What occurred in 2007 to 2008 is that the bubble burst. The repercussions were that the bursting of the bubble resulted in huge problems especially in the securitized market and in the real economy. Since we have determined that there be a bubble, it is imperative to comprehend what caused the bubble. The key reason as to why there was a huge bubble is the policies that were adopted by the Federal Reserve in 2003. To avoid a recession after the 9/11 attacks and the tech bubble of 2000, the Federal Reserve cut the interest rate to a very low level of 1%. During this time, the housing prices were still growing strongly at the rate of 1% annually. The repercussions of making allowing a one percent rate in interest means that it gave individuals incentives to go and borrow money so as to purchase houses. This also shows that the government could have placed some strategies to ensure that any incidences of unreal upsurge in real estates could be avoided.
Global imbalance
Apart from the low-interest rates that were provided by the Federal Reserve, there was also a huge deal of global imbalance. The Asian crisis of 1997 began this problem. Some of the Asian economies that had done well over the years such as South Korea experienced difficulties. Most of the banks in South Korea had borrowed so much in foreign currency and as a result, it turned to the International Monetary Fund to see them through the crisis. The International Monetary Fund had some conditions to South Korea in that they were supposed to cut the government spending and increase the interest rates. The United States, however, did not do this. Instead, they did exactly the opposite. A large amount of debt that was as a result of the global imbalance is considered to be the second factor that led to the financial crisis.
These two factors were however not only the only causative agents of the financial crisis. The other factor was the Yen carry trade. Imperatively, individuals would go and borrow yen that had zero interest rates and invest in other countries. Although there was a problem of exchange risk, it was possible to make large amounts of money sometimes. This means that there was a large flow of funds in Japan, and this may have helped to contribute to the property bubble in other countries especially in Europe.
Government response
The first legislative function that the Congress handed President Obama in February was to enact a $787 billion fiscal stimulus bill. This bill comprised of $499 billion that was in spending and $288 billion in tax cuts. Although there was some opposition from the Republicans in that they argued that mush of the $499 billion would be used too late and would not have any immense impacts, almost three-quarters of the principal amount were used in the following 18 months. When President Obama claimed that the bill that he passed would preserve almost 3.5 million jobs, most of his oppose claimed that the figure that the president provided was too optimistic.
It also has to be understood that the Congress played a major role in bailing out the financial institutions that were failing. Congress enacted the Troubled Asset Relief Program at the end of 2008. This legislation enabled the Treasury to invest by buying the real estate investments that were considered as being unproductive or even becoming part owners of such investments by purchasing the company financial stock. The Federal Reserved played an even bigger role during this time. Using the authority that they had, the Federal Reserve was able to print more money in instances when the money was not available. The central bank, on the other hand, guaranteed the value of the shaky assets of the foundering institutions by investing heavily. The government of the United States promised that it could not play any role in managing the companies that had been bailed out. The agreement was that it was supposed to sell their ownership stakes as soon as it became practical.
For the financial institutions, many members of the Congress made a determined effort to ensure that they regulated the financial institutions more closely in 2010. In 2009, the House passed a bill that would ensure that exotic financial instruments would be under the review of the federal regulators. The other function of the bill was to establish a single agency that was supposed to protect the financial consumers and ensure that the shareholders were guaranteed a chance to vote on the packages of compensation of the corporate executives.
It has to be noted that despite the sighs of relief due to the improving economy after the end of the year 2010, the economic destruction that had been predicted had not yet run its course. This is because most of the banks that survived the crisis had been negatively impacted by the collapse of the housing market and they became less willing than they had previously been to provide loans that grease all the capitalist economies. The huge government budget deficits that had been designed to facilitate the growth of the economy threatened currency and inflation devaluations. The low-interest rates that were offered and encouraged business activity that was immediate however like all budget deficits, the ultimate end was to feed inflation.
Even though the government reacted in a manner that seemed to solve the problem of caused by the financial crisis, it believes that it was the case of a little bit too late. From the evidence that has been gathered above, there should be no qualms as to whether the government did not receive the major warning signals before the economic crisis occurred. Furthermore, there should be no dispute from the perspective that the government should have formulated policies that were supposed to minimize the damage caused or avert the crisis altogether.
There are various things that the government should have done so as to avert the financial crisis. One key strategy that the government should have done is to ensure that the outsized fiscal deficits were reduced since it was the deficits that spurred the foreign borrowing. Additionally, the outsized fiscal deficits would also have slowed down the overheated economy. In addition, the lending rates could have been raised by the Federal Reserve so as to decelerate the credit boom. It was the responsibility of the regulators to ensure that more stringent actions could have been undertaken about applying prudential principles to most of the complex financial operations that the financial institutions were taking part in. the surprise was that none of the existing government agencies that had the power to do so made any effort to ensure that these changes and regulations were done. Some people may ask why the government was reluctant to make such decisions. Maybe it was the electoral considerations that may have mattered. This is why I believe that the financial crisis of 2007-2008 could have been averted. The government came in when it was a little bit too late.
HSBC bank
There was an unparalleled level of regulatory frameworks or reforms that took place globally regarding financial institutions after the global financial crisis. The main purpose of the reforms was aimed at reducing the global markets systemic risks so that they could be safe. Furthermore, the regulations that were introduced were designed to ensure that there was an increased transparency of transactions that the financial systems were more stable and better regulated apart from making the systems safer. Additionally, the new bank structures and the new capital rules that were introduced were intended to strengthen the resilience to any occurrence of financial crises in the future. The reforms were also intended to protect the consumers. There are various steps that HSBC undertook to ensure that they mitigated themselves from future financial crises.
HSBC, Halifax, Santander & Barclays (2009)
HSBC major reforms
One of the major reforms that were undertaken by HSBC was The European Markets and Infrastructure Regulation (EMIR) in Europe. This law was enacted so as to ensure that the risks that were posed to the financial system were reduced. In this law, HSBC was required to clear all the derivatives of the trades that were considered to be a certain threshold. Additionally, HSBC had to take it upon themselves to ensure that they reported all derivatives to an agency that had been authorized.
According to Fitsell and Williams (2007), the other strategy that enabled HSBC to cope with the financial crisis is the Alternative Investment Funds Directive. Through AIFMD, HSBC was able to enter into an agreement that was standardized. HSBC main challenge during and before the financial crisis was coordination. HSBC has made lots of progress in terms of coordinating with other financial institutions. Initially, HSBC tended to favor isolationism. Through coordination with other banks, HSBC has been able to gain comparative advantage over other banks that still favor isolationism. Furthermore, the coordination with other banks has enabled HSBC to reduce the risk of duplication of services while avoiding competition for scarce resources. Additionally, with the increased coordination with other banks, especially the World Bank, a relationship builds with the World Bank that does not depict the bank as being a distant organization creating a win-win situation for both banks.
The other aspect that enabled HSBC to recover from the financial crisis is the tax transparency (Ahmed et al., 2014). When the new global standard between the regulating authorities regarding tax was agreed, HSBC was one of the first banks to comply. This legislation enabled the prevention of United States persons from using companies and other financial institutions that were situated outside the United States to avoid taxation. This had been one of the Achilles heels of HSBC in that its main headquarters were not situated in the United States and thereby the chance that some scrupulous individuals took advantage cost HSBC. In fact, HSBC was fined more than $470 million due to what was considered as tax evasion. Other banks in the industry have also taken measures to ensure that issues of tax evasion are dealt with in a professional manner.
Regarding capital and liquidity, it is evident that HSBC is committed to ensuring that they adhere to the high standards that were set so as to be in a position to ensure that they support the new regulatory landscape. The bank structure that HSBC follows is in accordance with the structural reform of the banking in the United Kingdom and the structural reform of the banking in the European Union as a whole. Therefore, moving forward, it is vital that banks increase their coordination in their everyday operational activities or modalities so that they minimize the needless duplication of services. It also has to be noted that the manner in which banks lend money should be scrutinized so that there is an increased counterchecking on the source of funding (Roberts and Kynaston, 2015).
The above figure represents HSBC’s Market Assessment done in 2010 by Keynote.
In conclusion, the financial crisis enabled the various economies in the world to comprehend the importance of banks in the case of crisis. The occurrence of the 2007-2008 financial crisis came as a great surprise to many individuals. Initially, the crisis was seen as difficulties that were being experienced in the United States subprime mortgage market. Despite it's ample and its severity effects, the 2007-2008 financial crisis is similar to most of the other crises that have occurred in the past. Most financial crises in the past are normally preceded by asset price bubbles and credit booms. While many analysts imply that the major episodes that precede the financial crises are sufficiently different when compared to other times that the crises occurred, they warn that the nature of the crisis is global and that it will take or make it more difficult for countries to grow their way out. Although there have been various events that occurred prior to the occurrence of the financial crisis, the roots of the financial crisis can be traced to the unprecedented low-interest rates that were provided by the Federal Reserve and the other various central banks. Apart from the low-interest rates that were provided by the Federal Reserve, there was also a huge deal of global imbalance. The key reason as to why there was a huge bubble is the policies that were adopted by the Federal Reserve in 2003. In order to avoid a recession after the 9/11 attacks and the tech bubble of 2000, the Federal Reserve cut the interest rate to a very low level of 1%. In order to deal with the financial crisis, the government of the United States employed a two-pronged strategy. This was done so as to be able to reverse the financial crisis by bailing out the financial institutions that were stressed (just in case they transmitted their failure to their creditors). The other reason was to pump money from the government to the economy which was done so as to ensure that the business activities were stimulated in the case that the private loans were scarce. It also has to be understood that the congress played a major role in bailing out the financial institutions that were failing. Congress enacted the Troubled Asset Relief Program at the end of 2008. This legislation enabled the Treasury to invest by buying the real estate investments that were considered as being unproductive or even becoming part owners of such investments by purchasing the financial company stock. There are various things that the government should have done so as to avert the financial crisis. One key strategy that the government should have done is to ensure that the outsized fiscal deficits were reduced since it was the deficits that spurred the foreign borrowing. Additionally, the outsized fiscal deficits would also have slowed down the overheated economy. There was an unparalleled level of regulatory frameworks or reforms that took place globally regarding financial institutions after the global financial crisis. The main purpose of the reforms was aimed at reducing the global markets systemic risks so that they could be safe. Furthermore, the regulations that were introduced were designed to ensure that there was an increased transparency of transactions that the financial systems were more stable and better regulated apart from making the systems safer.
Bibliography
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