How can financial crisis defined - Free Essay Example

Financial crisis can be defined as a considerable decrease in economic activity extended across the economy, which lasts for a significant amount of time, visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales, we have already seen such a situation at the time of great depression earlier and now since 2007, What was different in the two crisis was the later one was the first one since globalisation, What that meant was that the crisis was no longer restricted to a particular country or region and if a giant economy is hit, the impact of that is felt throughout the world.. It was a notion that this it was the subprime mortgage crisis which caused the Global financial catastrophe; whereas in fact that was one very small part of the string which led to the meltdown of already hollow economy. The actual root cause goes way deep under. In my opinion and many who share the feeling, the real reason o f the Global financial crisis was the Global macroeconomic imbalance. Now when its clearly evident that focus of economy has shifted from Industrial, which is primarily transformation from manufacturing to post-Industrialism, which consisted of service industries and ‘off shoring in the east. The fact that over 90 percent of the people employed in USA are working in service industry and the number is ever increasing clearly signifies that. This resulted in shutting down of large manufacturing firms. As a consequence, now manufacturing corporations were no longer the â€Å"central pillars† of American social culture. The shift of economy also forced the shift in the type of employment, from a long-term in manufacturing industries to short-term in service industry and thus the need for more flexible pension system arose, which could transfer the risk from the employers to the employees. According to this scheme, the terminating employee can now decide on his own, as ho w to and where to invest the monetary value of his pension benefits, after being transferred to a succeeding pension plan also known as â€Å"portable pensions†. This signifies the companys pension scheme was now shifted from â€Å"Defined-Benefits† to â€Å"Defied-contributions†. As the mutual funds provided by the financial institutions seemed to be the most profitable investing venture, this became the first choice for every employee to sow in their hard earned money. There was a drastic increase in the mutual fund market and by the year 2001 almost 52% of the households in the US owned mutual fund stocks. The owner of these financial institutions, which were mainly investment banks, owned about 40% of the US industrial assets, which fundamentally made them key owners of commercial America. At the same time these were the same financial organizations which provided pension fund facility to a large group of corporate employers. The financial organization s were now concentrating on the ways they could increase the shareholders value as it was sought to be the most relevant measure of the corporate performance. The corporations made it pretty obvious that their main intend was only to create value for their shareholders. Evidently the corporations changed their mission statements which reflected their intentions. In the drive of increasing shareholders value another technique of diversification was brought into being. The companies started diversification in their product lines and services to the extent they could afford, which led to larger unmanaged or outsourced corporations. Consequently the ties between the worker and the employer weakened. The decision was then taken by the FED chairman, Alan Greenspan that the assets like loans on the balance sheet, patents and credit card receivables could now be turned into securities and can be traded on markets. The financial market grew widely after this. The largest banks of America bec ame the portals to the financial markets, corresponding to the corporate houses of the country. JP Morgan, Bank of America and Citigroup became so huge, that now they owned and managed a hefty share of the assets and deposits of the business. These banks then pounded over small local commercial banks as they were an easy prey for their acquisition. They acquired a large number of US commercial banks along with some major banks in major cities of the country. The federal activities inventory reform act of 1998 was planned and framed to encourage outsourcing in the various government departments. The aim was to amplify the effectiveness of the unit by the help of the private sector. The per annum spending on the contractors doubled by $200 billion during the presidency of Bush. The main job of the private sector in the federal government was to protect the diplomats in a foreign country and running the various government databases. The remaining manufacturing companies in the US were mainly military contractors, yielding 85% to 90% of their revenue from the government. The businesses of hedge funds, merchant shipping, intellectual property rights were distributed in countries like Bermuda, Cayman Islands in UK, Liberia, other territories of UK and many more. The household which were now both the issuers and investors through mutual fund market were entirely dependent on the financial markets for their growth and security, resultantly the crisis damaged in a much more worst manner than it could have done in normal circumstances. Then the 1991 crisis occurred because in the 1980s economic growth was very rapid and unsustainable therefore inflation increased to over 10%. To reduce this inflation the government increased interest which resulted in lowering of spending, this increase in the rates resulted in the increased the cost of mortgage interest payments. So many people were forced to sell and thus causing a fall in house prices and lower spending a nd there was a big fall in AD. Current crisis basically revolves around the mismanagement of the finances and had the following key points, There was a shortage of finance (following the collapse of northen rock) which uncovered a vicious circle between investment sector and the â€Å"real† economy causing a cost push inflation squeezing incomes and reducing disposable income but most important was the Collapse in confidence of finance sector causing lower confidence amongst real economy The defences that UK can apply for any upcoming recessions can be learned from previous learnings of the recessions. even though there are adverse effects of the falling of the pound sterling, it also brings many positivity along with it. The decline of the UK currency will lead to quick decline in both relative unit labour costs and relative export prices. Consequently which will lead to increase in the net trade although there is a point here, the UK exporters must not raise their pri ces to save some profit margin in this scenario. The ratio of the household debt servicing is also in favour of the UK economy. Even if the debts levels rise, the interest rates should be maintained low. It is vital to fortify the strength and flexibility of the financial system. The government should take steps to decrease the probability of individual commercial and nationalised banks facing complications and even if they do manage to get themselves into trouble there should be immediate actions taken into consideration. There should be arrangements for instant reimbursements in which the consumer market can believe and have faith. Toughen the central bank of the country i.e. Bank of England and guarantee effective and well coordinated actions by the authorities. UKs economy has the capability of handling and surviving through another recession. The financial position of the company is strong and sustained as per the past standards. There is hardly any sign of a wage and pri ce spiral forcing tighter policy. There is a huge room for rate cuts, which is caused by the continuing oil and commodity prices and the membership of the ERM ensures that there is barely any possibility for interest rate cuts final moment around. As correctly said by Stephen Roach, Morgan Stanley â€Å"The lack of monetary discipline has become a hallmark of unfettered globalization. Central banks have failed to provide a stable underpinning to world financial markets and to an increasingly asset-dependent global economy† which we have clearly seen before in 2000(equity bubble) and then in 2007(credit bubble) We can clearly infer from this that though the reforms are needed in many sectors our primary focus should be on the investment and financial sector as money is linked to everything.