SHAH ABDUL LATIF UNIVERSITY

(GHOTKI CAMPUS)

ASSIGNMENT: FINANCIAL CRISES 2008

DEPARTMENT: BBA

DUE DATE: 20 NOV: 2019

SUBMITTED BY: ZAMEER HUSSAIN LAKHAN

SUBMITTED TO: SIR FAYAZ BHUTTO

What is a Credit Crunch?
A credit crunch refers to a decline in lending activity by financial institutions
brought on by a sudden shortage of funds, means a sudden shock of shortage of
funds. Often an extension of a recession, a credit crunch makes it nearly
impossible for companies to borrow because lenders are scared
of bankruptcies or defaults, resulting in higher rates.

Understanding a Credit Crunch:

A credit crunch is an economic condition in which investment capital is hard to
secure. Banks and other traditional financial institutions become wary of lending
funds to individuals and corporations as they are afraid that the borrowers will
default. This causes interest rates to rise as a way to compensate the lender for
taking on the additional risk.

Sometimes called a credit squeeze or credit crisis, a credit crunch tends to occur
independently of a sudden change in interest rates. Individuals and businesses
that could formerly obtain loans to finance major purchases or expand operations
suddenly find themselves unable to acquire such funds. The ensuing ripple effect
can be felt throughout the entire economy, as home-ownership rates drop and
businesses are forced to cut back due to a dearth of capital

NOW WE WILL DISCUSS FINANCIAL CRISES OF 2008 WHICH STARTED FROM

AMERICA.

The financial crisis of 2007–2008, also known as the global financial crisis and
the 2008 financial crisis, was a severe worldwide economic crisis considered by
many economists to have been the most serious financial crisis since after the
great crises of the 1930s, to which it is often compared.

It began in 2007 with a crisis in the subprime mortgage market in the United
States, and developed into a full-blown international banking crisis with the
collapse of the investment bank Lehman Brothers on September 15, 2008.
Excessive risk-taking by banks such as Lehman Brothers helped to magnify the
financial impact globally. Massive bail-outs of financial institutions and other
palliative monetary and fiscal policies were employed to prevent a possible
collapse of the world financial system. The crisis was nonetheless followed by a
global economic downturn, the Great Recession. The Asian markets (China, Hong
Kong, Japan, India, etc.) immediately impacted and volatilized after the U.S. sub-
prime crisis.

Causes of the Crisis:

The first sign that the economy was in trouble occurred in 2006 when housing
prices started to fall. At first, realtors applauded; they thought the overheated
housing market would return to a more sustainable level. They didn't realize there
were too many homeowners with questionable credit. Banks had allowed people
to take out loans for 100% or more of the value of their new homes. Many
blamed the Community Reinvestment Act, which pushed banks to make
investments in subprime areas, but that wasn't the underlying cause.

The Gramm-Rudman Act was the real villain. It allowed banks to engage in trading
profitable derivatives that they sold to investors. These mortgage-backed
securities needed home loans as collateral. The derivatives created an insatiable
demand for more and more mortgages.

Hedge funds and other financial institutions around the world owned the
mortgage-backed securities, but they were also in mutual funds, corporate assets,
and pension funds. The banks had chopped up the original mortgages and resold
them in tranches, making the derivatives impossible to price.

Stodgy pension funds bought these risky assets because they thought an
insurance product called credit default swaps protected them. A traditional
insurance company known as the American International Group (AIG) sold these
swaps, and when the derivatives lost value, AIG didn't have enough cash flow to
honor all the swaps.

The first signs of the financial crisis appeared in 2007. Banks panicked when they
realized they would have to absorb the losses, and they stopped lending to each
other. They didn't want other banks giving them worthless mortgages as
collateral. As a result, interbank borrowing costs, called Libor, rose. This mistrust
within the banking community was the primary cause of the 2008 financial crisis.
The Federal Reserve began pumping liquidity into the banking system via
the Term Auction Facility, but that wasn't enough.

Major causes of Global Financial Crisis which have been identified are increase in
asset prices, credit booms and failure of the regulatory agencies.

Asset Prices

Before the onset of Global Financial Crisis, housing prices increased drastically in
United States. Increase in housing prices was also seen in other developed
countries like UK and Ireland.

Credit Booms

Credit Booms were also the result of different crises which took place before
Economic Crisis of 2008. Longer duration and relatively large sizes of Credit
Booms result in economic crises soon. Credit Booms accompanied by increased
leverage of borrowers fuel such financial crises.

Failure of Regulatory Agencies

Crisis reveals that regulatory agencies were unable to predict financial turmoil.
Regulatory agencies showed lack of interest. Agencies responsible for oversight
underestimated the crisis.

Cost of the Crisis:

The chart below shows a breakdown of how much the 2008 financial crisis cost
The total amount of financial assets destroyed in the world (2007 to
2009) is Us 30 trillion dollar.

Many banks which are mentioned in figure suffered heavy losses.

Impact on Pakistan
Pakistan also did not escape from the financial crisis. Pakistan was suffering from
acute macro-economic imbalances before the onset of Global Financial Crisis.
Economic Crisis hit Pakistan in a variety of ways. Pakistan’s GDP growth rate came
down. Pakistan also witnessed high fiscal and current-account deficit. Inflation
which was an international problem also affected Pakistan. Pakistan’s
macroeconomic indicators showed very poor performance as GDP growth rate
declined from 6.8 % in 2007 to 4.1 % in 2008. Fiscal and Current Account Deficit
reached to the highest 7.4 % and 8.4 of GDP respectively.

Global Financial Crisis hampered Pakistan’s economic growth to a great extent.

Deteriorating foreign exchange reserves position due to Balance of Payment crisis
compelled Government of Pakistan to approach IMF for a bailout package.
Foreign Direct Investment (FDI) carries a considerable importance in economic
growth and as a result of Global Financial Crisis. FDI came down from $5410
million in 2008 to $3720 million in 2009. Global Financial Crisis has also widened
the Trade Gap in Pakistan as Trade Deficit rose to 12.8 % of GDP in 2008.
Unfortunately, Pakistan was suffering from different problems and thus
government was not in a condition to provide a bail-out package. Pakistani
government had adopted tight monetary policy to curb the rising inflation and
similarly it also went for an expansionary fiscal policy as there is no room for
counter cyclical fiscal policy.

Pakistan faces a major challenge of achieving macroeconomic stability and putting

economy back on track. Fiscal and Monetary Policy carry a relative importance
and thus there is a need to study the effectiveness of both the Fiscal and
Monetary Policy in stabilization of Global Financial Crisis.

Global Financial Crisis has brought attention towards many issues. Crisis has
revealed that there is a need for reformation. International Monetary Fund needs
reformation. Similarly, there is a lot of betterment required in financial system of
the World.

Solution of Financial Crises 2008:

Troubled Asset Relief Program:
The troubled relief program then introduced to resolve the financial crises.

The bailout package never cost taxpayers the full $700 billion. The Treasury
disbursed $439.6 billion from the Troubled Asset Relief Program (TARP)6 . By
2018, it had put $442.6 billion back into the fund, making $3 billion in profit. It did
this by buying shares of the companies it bailed out when prices were low and
wisely sold them when prices were high.

The TARP funds helped in five areas:

$245.1 billion was used to buy bank preferred stocks as a way to give those cash.

$80.7 billion bailed out auto companies.

$69.8 billion went to the $182 billion bailout of AIG.

$19.1 billion went to shore up credit markets. The banks repaid $23.6 billion,
creating a $4.5 billion profit.

The Homeowner Affordability and Stability Plan disbursed $27.9 billion to modify
mortgages.

President Barack Obama didn't use the remaining $700 billion allocated for TARP
because he didn't want to bail out any more businesses. Instead, he asked
Congress for an economic stimulus package. On February 17, 2009, he signed the
American Recovery and Reinvestment Act, which included tax cuts, stimulus
checks, and public works spending. By 2011, it put $831 billion directly into the
pockets of consumers and small businesses. That was enough to end the financial
crisis by July 2009.