How did the global financial crisis affect long-term finance?

in the aftermath of the Global Financial Crisis, there were heightened concerns that a reduced
availability of long-term finance and the resulting rollover risks would adversely affect the performance
of small and medium-sized firms and hamper large fixed investments. Policy makers argued that, as a
result, developing countries’ ability to sustain rates of economic growth sufficiently high to reduce
poverty and ensure shared prosperity would be diminished. Recently, as corporates of emerging
markets have benefited from favorable global liquidity conditions to issue long-term bonds, policy
discussions focused on the stability risks of high leverage that could materialize when monetary
conditions normalize.

What does the evidence on capital structures tell us? In a new paper prepared for the Global Financial
Development Report 2015/2016 on Long-Term Finance, Asli Demirguc-Kunt, Maria-Soledad Martinez-
Peria and I study how the Global Financial Crisis impacted the capital structure of firms, focusing in
particular on privately held firms and on small and medium sized enterprises (SMEs). We rely on a large
dataset of about 277,000 firms from 79 countries, covering the period 2004-2011. The data are collected
from Bureau Van Dijk in the ORBIS database.

According to theory, leverage and debt maturity are expected to decline during a crisis because firms
and providers of finance adjust to higher uncertainty, higher risks, and lower returns by stepping up risk
and term premia (in some cases, suppliers of finance simply cut access to term finance) and because
banks restore or protect their soundness partly by tightening lending standards. The resulting decline in
the use of long-term finance may not be optimal though, because reduced use of long-term finance can
result in a decline in profitable fixed investments and can lower productivity growth.

The authors find that the impact of the Global Financial Crisis on firms’ capital structures was felt in
many countries. Firm leverage and the use of long-term debt declined not only in high income countries,
where the crisis started, but also in developing countries, including in countries that did not  experience
a systemic banking crisis. These effects on leverage and debt maturity are economically significant
among privately held firms, including among SMEs, even after accounting for the standard empirical
determinants of capital structures – such as the share of fixed assets in total assets, the return on assets,
the sales turnover (e.g. the ratio of sales to total assets), and the size of the firm – and after accounting
for firm time invariant characteristics. The empirical estimates imply that, among privately held firms
that used long-term debt before the crisis, the ratio of long-term debt to total assets declined by 1.4
percentage points on average in high income countries and by 2.7 percentage points on average in
developing countries. In contrast, the evolution of leverage and of debt maturity seems to have been
more complex among publicly traded firms.

The impact of the crisis on capital structures is likely to depend on the characteristics of financial
systems and on the institutional environment. In countries with banking systems are less developed (e.g.
where monitoring costs are high), or in countries with inefficient legal systems (e.g. where bankruptcy
procedures are lengthy and costly and contracts are difficult to enforce), the deleveraging and
shortening of maturities are likely to be more severe than elsewhere because conflicts of interest
between borrowers and suppliers of finance become more important constraints to lending and
borrowing decisions. For example, lenders are likely more reluctant, in time of crisis, to extend long-
term credit in a country with inefficient bankruptcy and collateral laws because of the intensified risk of
not recouping assets in case of default. On the other hand, the presence of developed capital markets
may help mitigate the impact of a credit crunch caused by a banking crisis, especially for large and
publicly traded companies.

The evidence suggests that institutional factors and financial development indeed played an important
role in shaping the response of capital structures during and in the aftermath of the global financial
crisis, irrespective of whether the country experienced a systemic banking crisis.

When focusing on privately owned firms, the authors find that the declines in leverage, debt maturity,
and use of long-term debt were significantly larger among SMEs located in countries with less efficient
bankruptcy procedures, with less coverage, scope and accessibility of credit information sharing
mechanisms (i.e., credit registries and credit bureaus), in countries with less developed banking systems,
and in countries with more stringent restrictions on bank entry.

Assignmentpoint

Economic crisis of 2008:

The global financial crisis, brewing for a while, really started to show its effects in
the middle of 2008. Around the world stock markets have fallen, large financial
institutions have collapsed or been bought out, and governments in even the
wealthiest nations have had to come up with rescue packages to bail out their
financial systems.
On the one hand many people are concerned that those responsible for the
financial problems are the ones being bailed out, while on the other hand, a
global financial meltdown will affect the livelihoods of almost everyone in an
increasingly inter-connected world. In 2008, a global economic crisis was
suggested by several important indicators of economic downturn worldwide.
These included high oil prices, which led to both high food prices (due to a
dependence of food production on petroleum, as well as using food crop
products (ethanol, biodiesel) as an alternative to petroleum) and global inflation;
a substantial credit crisis leading to the bankruptcy of large and well established
investment banks as well as commercial banks in various nations around the
world; increased unemployment; and the possibility of a global recession.

During the last several months we have witnessed one of the most trying times
for financial markets in several decades, perhaps since the 1930’s Great
Depression. The litany of events that have led up to the present. As you all well
know, the originators of lower quality mortgages in the United States had strong
incentives to meet a constant and, indeed, increasing demand for securitized
products of some form or another. There was little incentive to originate good
loans or monitor the borrowers’ creditworthiness. Additionally, the high demand
for other types of structured credit products, such as those formed from
commercial real estate, leveraged loans, and some other types of consumer
credit, meant that these sectors also witnessed weakened credit standards. In
these categories, the after-effects are just now becoming visible.

Global trends

High commodity prices

Further information: 2000s energy crisis and 2007–2008 world food price crisis

See also: 2008 Central Asia energy crisis and 2008 Bulgarian energy crisis

Medium term crude oil prices, (not adjusted for inflation)

The decade of the 2000s saw a 2008 commodities boom, in which the prices of
primary commodities rose again after the Great Commodities Depression of
1980-2000. But in 2008, the prices of many commodities, notably oil and food,
rose so high as to cause genuine economic damage, threatening stagflation and
a reversal of globalization.

In January 2008, oil prices surpassed $100 a barrel for the first time, the first of
many price milestones to be passed in the course of the year. [2] By July the price
of oil reached as high as $147 a barrel although prices fell soon after.

The food and fuel crises were both discussed at the 34th G8 summit in July.

Sulfuric acid (an important chemical commodity used in processes such as steel
processing, copper production and bioethanol production) increased in price 6-
fold in less than 1 year whilst producers of sodium hydroxide have declared force
major due to flooding, precipitating similarly steep price increases.

In the second half of 2008, the prices of most commodities fell dramatically on
expectations of diminished demand in a world recession.

Trade

In mid-October 2008, the Baltic Dry Index, a measure of shipping volume, fell by
50% in one week, as the credit crunch made it difficult for exporters to obtain
letters of credit.
Inflation

In February 2008, Reuters reported that global inflation was at historic levels, and
that domestic inflation was at 10-20 year highs for many nations. “Excess money
supply around the globe, monetary easing by the Fed to tame financial crisis,
growth surge supported by easy monetary policy in Asia, speculation in
commodities, agricultural failure, rising cost of imports from China and rising
demand of food and commodities in the fast growing emerging markets,” have
been named as possible reasons for the inflation.

In mid-2008, IMF data indicated that inflation was highest in the oil-exporting
countries, largely due to the unsterilized growth of foreign exchange reserves,
the term “unsterilized” referring to a lack of monetary policy operations that could
offset such a foreign exchange intervention in order to maintain a country’s
monetary policy target. However, inflation was also growing in countries
classified by the IMF as “non-oil-exporting LDCs” (Least Developed Countries)
and “Developing Asia”, on account of the rise in oil and food prices.

Inflation was also increasing in the developed countries, but remained low
compared to the developing world.

Unemployment

The International Labour Organization predicted that at least 20 million jobs will
have been lost by the end of 2009 due to the crisis – mostly in “construction, real
estate, financial services, and the auto sector” – bringing world unemployment
above 200 million for the first time.

Return of volatility

For a time, major economies of the 21st century were believed to have begun a
period of decreased volatility, which was sometimes dubbed The Great
Moderation, because many economic variables appeared to have achieved
relative stability. The return of commodity, stock market, and currency value
volatility are regarded as indications that the concepts behind the Great
Moderation were misguided by false beliefs

Financial markets

January 2008 stock market volatility

January 2008 was an especially volatile month in world stock markets, with a

surge in implied volatility measurements of the US-based S&P 500 index  and a
sharp decrease in non-U.S. stock market prices on Monday, January 21, 2008
(continuing to a lesser extent in some markets on January 22). Some headline
writers and a general news columnist called January 21 “Black Monday” and
referred to a “global shares crash,” though the effects were quite different in
different markets.

American stock markets were closed on Monday, January 21 for Martin Luther
King, Jr. Day. Seemingly in response to the fall in non-U.S. markets, the U.S.
Federal Reserve announced a surprise rate cut of 0.75% on Tuesday at 8 a.m.
This rate cut is believed to have been influential in preventing large declines in
the American stock markets, with the Dow Jones Industrial Average down only
1.1% for the day, never closing that week worse than a 1.6% decrease from the
previous Friday, and indeed closed up for the week. Later it was announced that
Société Générale, one of the largest banks in Europe, accused its employee
Jérôme Kerviel of fraudulent trades costing it €4.9 billion, and causing it to sell
approximately €50 billion in European equity derivatives from January 21–23.

The effects of these events were also felt on the Shanghai Composite Index in
China which lost 5.14 percent, most of this on financial stocks such as Ping An
Insurance and China Life which lost 10 and 8.76 percent respectively. Investors
worried about the effect of a recession in the US economy would have on the
Chinese economy. Citigroup estimates due to the number of exports from China
to America a one percent drop in US economic growth would lead to a 1.3
percent drop in China’s growth rate.

Market downturn Fall 2008

Main article: Global financial crisis of 2008

As of October 2008, stocks in North America, Europe, and the Asia-Pacific region
had all fallen by about 30% since the beginning of the year. The Dow Jones
Industrial Average had fallen about 37% since January 2008.

There were several large Monday declines in stock markets world wide during
2008, including one in January, one in August, one in September, and another in
early October.

The simultaneous multiple crises affecting the US financial system in mid-

September 2008 caused large falls in markets both in the US and elsewhere.
Numerous indicators of risk and of investor fear (the TED spread, Treasury
yields, and the dollar value of gold) set records.
Russian markets, already falling due to declining oil prices and political tensions
with the West, fell over 10% in one day, leading to a suspension of trading, while
other emerging markets also exhibited losses.

On September 18, UK regulators announced a temporary ban on short-selling of

financial stocks. On September 19 the United States’ SEC followed by placing a
temporary ban of short-selling stocks of 799 specific financial institutions. In
addition, the SEC made it easier for institutions to buy back shares of their
institutions. The action is based on the view that short selling in a crisis market
undermines confidence in financial institutions and erodes their stability.

On September 22, the Australian Securities Exchange (ASX) delayed opening by

an hour [141] after a decision was made by the Australian Securities and
Investments Commission (ASIC) to ban all short selling on the ASX. This was
revised slightly a few days later.

Subprime mortgage crisis

The subprime mortgage crisis is an ongoing financial crisis triggered by a

significant decline in housing prices and related mortgage payment delinquencies
and foreclosures in the United States. This caused a ripple effect across the
financial markets and global banking systems, as investments related to housing
prices declined significantly in value, placing the health of key financial
institutions and government-sponsored enterprises at risk. Funds available for
personal and business spending (i.e., liquidity) declined as financial institutions
tightened lending practices. The crisis, which has roots in the closing years of the
20th century but has become more apparent throughout 2007 and 2008, has
passed through various stages exposing pervasive weaknesses in the global
financial system and regulatory framework.

The crisis began with the bursting of the United States housing bubble and high
default rates on “subprime” and adjustable rate mortgages (ARM), beginning in
approximately 2005–2006. Government policies and competitive pressures for
several years prior to the crisis encouraged higher risk lending practices. Further,
an increase in loan incentives such as easy initial terms and a long-term trend of
rising housing prices had encouraged borrowers to assume difficult mortgages in
the belief they would be able to quickly refinance at more favorable terms.
However, once interest rates began to rise and housing prices started to drop
moderately in 2006–2007 in many parts of the U.S., refinancing became more
difficult. Defaults and foreclosure activity increased dramatically as easy initial
terms expired, home prices failed to go up as anticipated, and ARM interest rates
reset higher. Foreclosures accelerated in the United States in late 2006 and
triggered a global financial crisis through 2007 and 2008. During 2007, nearly 1.3
million U.S. housing properties were subject to foreclosure activity, up 79% from
2006.

Financial products called mortgage-backed securities (MBS), which derive their

value from mortgage payments and housing prices, had enabled financial
institutions and investors around the world to invest in the U.S. housing market.
Major Banks and financial institutions had borrowed and invested heavily in MBS
and reported losses of approximately US$435 billion as of 17 July 2008. The
liquidity and solvency concerns regarding key financial institutions drove central
banks to take action to provide funds to banks to encourage lending to worthy
borrowers and to restore faith in the commercial paper markets, which are
integral to funding business operations. Governments also bailed out key
financial institutions, assuming significant additional financial commitments.

The risks to the broader economy created by the housing market downturn and
subsequent financial market crisis were primary factors in several decisions by
central banks around the world to cut interest rates and governments to
implement economic stimulus packages. These actions were designed to
stimulate economic growth and inspire confidence in the financial markets.
Effects on global stock markets due to the crisis have been dramatic. Between 1
January and 11 October 2008, owners of stocks in U.S. corporations had
suffered about $8 trillion in losses, as their holdings declined in value from $20
trillion to $12 trillion. Losses in other countries have averaged about 40%. Losses
in the stock markets and housing value declines place further downward
pressure on consumer spending, a key economic engine. Leaders of the larger
developed and emerging nations met in November 2008 to formulate strategies
for addressing the crisis.

Background:

Subprime lending is the practice of lending, mainly in the form of mortgages for
the purchase of residences, to borrowers who do not meet the usual criteria for
borrowing at the lowest prevailing market interest rate. These criteria pertain to
the down payment and the borrowing household’s income level, both as a
fraction of the amount borrowed, and to the borrowing household’s employment
status and credit history. If a homeowner is delinquent in making payments to the
bank (or other holder of the mortgage loan), that entity can seize the home in a
process called foreclosure.

The value of USA subprime mortgages was estimated at $1.3 trillion as of March
2007,  with over 7.5 million first-lien subprime mortgages outstanding. [In the third
quarter of 2007, subprime ARMs making up only 6.8% of USA mortgages
outstanding also accounted for 43% of the foreclosures begun during that
quarter.[By October 2007, approximately 16% of subprime adjustable rate
mortgages (ARM) were either 90-days delinquent or the lender had begun
foreclosure proceedings, roughly triple the rate of 2005. [By January 2008, the
delinquency rate had risen to 21%[ and by May 2008 it was 25%.

The value of all outstanding USA mortgages, owed by households to purchase

residences housing at most 4 families, was US$9.9 trillion as of yearend 2006,
and US$10.6 trillion as of midyear 2008. [During 2007, lenders had begun
foreclosure proceedings on nearly 1.3 million properties, a 79% increase over
2006.[As of August 2008, 9.2% of all mortgages outstanding were either
delinquent or in foreclosure.[936,439 USA residences completed foreclosure
between August 2007 and October 2008.

Understanding credit risk:

Credit risk arises because a borrower has the option of defaulting on the loan he
owes. Traditionally, lenders (who were primarily thrifts) bore the credit risk on the
mortgages they issued. Over the past 60 years, a variety of financial innovations
have gradually made it possible for lenders to sell the right to receive the
payments on the mortgages they issue, through a process called securitization.
The resulting securities are called mortgage backed securities (MBS) and
collateralized debt obligations (CDO). Most American mortgages are now held by
mortgage pools, the generic term for MBS and CDOs. Of the $10.6 trillion of USA
residential mortgages outstanding as of midyear 2008, $6.6 trillion were held by
mortgage pools and $3.4 trillion by traditional depository institutions.

This “originate to distribute” model means that investors holding MBS and CDOs
also bear several types of risks, and this has a variety of consequences. There
are four primary types of risk: credit risk on the underlying mortgages, asset price
risk, liquidity risk, and counterparty risk. When homeowners default, the
payments received by MBS and CDO investors decline and the perceived credit
risk rises. This has had a significant adverse effect on investors and the entire
mortgage industry. The effect is magnified by the high debt levels (financial
leverage) households and businesses have incurred in recent years. Finally, the
risks associated with American mortgage lending have global impacts, because a
major consequence of MBS and CDOs is a closer integration of the USA housing
and mortgage markets with global financial markets.

Investors in MBS and CDOs can insure against credit risk by buying Credit
defaults swaps (CDS). As mortgage defaults rose, the likelihood that the issuers
of CDS would have to pay their counterparties increased. This created
uncertainty across the system, as investors wondered if CDS issuers would
honor their commitments.
Causes of Financial crisis:

The reasons for this crisis are varied and complex. The crisis can be attributed to
a number of factors pervasive in both the housing and credit markets, which
developed over an extended period of time. There are many different views on
the causes, including the inability of homeowners to make their mortgage
payments, poor judgment by the borrower and/or the lender, speculation and
overbuilding during the boom period, risky mortgage products, high personal and
corporate debt levels, complex financial innovations that distributed and perhaps
concealed default risks, central bank policies, and government regulation (or
alternatively lack thereof). In its 15 November 2008 “Declaration of the Summit
on Financial Markets and the World Economy,” leaders of the Group of 20 cited
the following causes:

During a period of strong global growth, growing capital flows, and prolonged
stability earlier this decade, market participants sought higher yields without an
adequate appreciation of the risks and failed to exercise proper due diligence. At
the same time, weak underwriting standards, unsound risk management
practices, increasingly complex and opaque financial products, and consequent
excessive leverage combined to create vulnerabilities in the system. Policy-
makers, regulators and supervisors, in some advanced countries, did not
adequately appreciate and address the risks building up in financial markets,
keep pace with financial innovation, or take into account the systemic
ramifications of domestic regulatory actions.

In its 15 November 2008 “Declaration of the Summit on Financial Markets and

the World Economy,” leaders of the Group of 20 cited the following causes:

Boom and bust in the housing market

United States housing bubble and United States housing market correction

Existing homes sales, inventory, and months supply, by quarter.

Common indexes used for adjustable rate mortgages (1996–2006).

Low interest rates and large inflows of foreign funds created easy credit
conditions for many years leading up to the crisis. [Subprime lending and
borrowing was a major contributor to an increase in home ownership rates and
the demand for housing. The U.S. home ownership rate increased from 64% in
1994 (about where it was since 1980) to a peak in 2004 with an all-time high of
69.2%.
This demand helped fuel housing price increases and consumer spending.
Between 1997 and 2006, American home prices increased by 124%. For the two
decades until 2001, the national median home price went up and down, but it
remained between 2.9 and 3.1 times the median household income. By 2004,
however, the ratio of home prices to income hit 4.0, and by 2006 the ratio was
4.6.[Some homeowners used the increased property value experienced in the
housing bubble to refinance their homes with lower interest rates and take out
second mortgages against the added value to use the funds for consumer
spending. U.S. household debt as a percentage of income rose to 130% during
2007, versus 100% earlier in the decade. A culture of consumerism is a factor “in
an economy based on immediate gratification”. Americans spent $800 billion per
year more than they earned. Household debt grew from $680 billion in 1974 to
$14 trillion in 2008, with the total doubling since 2001. During 2008, the average
U.S. household owned 13 credit cards, and 40 percent of them carried a balance,
up from 6 percent in 1970.

Overbuilding during the boom period eventually led to a surplus inventory of

homes, causing home prices to decline, beginning in the summer of 2006. Easy
credit, combined with the assumption that housing prices would continue to
appreciate, had encouraged many subprime borrowers to obtain adjustable-rate
mortgages they could not afford after the initial incentive period. Once housing
prices started depreciating moderately in many parts of the U.S., refinancing
became more difficult. Some homeowners were unable to re-finance and began
to default on loans as their loans reset to higher interest rates and payment
amounts.

An estimated 8.8 million homeowners — nearly 10.8% of total homeowners —

had zero or negative equity as of March 2008, meaning their homes are worth
less than their mortgage. This provided an incentive to “walk away” from the
home, despite the credit rating impact. In the U.S., home mortgages are non-
recourse loans, meaning the creditor cannot seize other property or income to
cover a default. The U.S. is virtually unique in such arrangements. By November
2008, 12 million homeowners had negative equity. As more homeowners stop
paying their mortgages, foreclosures and the supply of homes increase. This
places downward pressure on housing prices, which places more homeowners
upside down, continuing the cycle. The declining mortgage payments also
reduce the value of mortgage-backed securities, eating away at the financial
health of banks. This vicious cycle is at the heart of the crisis.

Increasing foreclosure rates increased the supply of housing inventory available.

Sales volume (units) of new homes dropped by 26.4% in 2007 versus the prior
year. By January 2008, the inventory of unsold new homes stood at 9.8 months
based on December 2007 sales volume, the highest level since 1981. Further, a
record of nearly four million unsold existing homes were for sale, [ including nearly
2.9 million that were vacant.

This excess supply of home inventory placed significant downward pressure on

prices. As prices declined, more homeowners were at risk of default and
foreclosure. According to the S&P/Case-Shiller price index, by November 2007,
average U.S. housing prices had fallen approximately 8% from their Q2 2006
peak and by May 2008 they had fallen 18.4%. The price decline in December
2007 versus the year-ago period was 10.4% and for May 2008 it was
15.8%.Housing prices are expected to continue declining until this inventory of
surplus homes (excess supply) is reduced to more typical levels.

Speculation

Speculation in real estate was a contributing factor. During 2006, 22% of homes
purchased (1.65 million units) were for investment purposes, with an additional
14% (1.07 million units) purchased as vacation homes. During 2005, these
figures were 28% and 12%, respectively. In other words, nearly 40% of home
purchases (record levels) were not primary residences. NAR’s chief economist at
the time, David Lereah, stated that the fall in investment buying was expected in
2006. “Speculators left the market in 2006, which caused investment sales to fall
much faster than the primary market.”

While homes had not traditionally been treated as investments like stocks, this
behavior changed during the housing boom. For example, one company
estimated that as many as 85% of condominium properties purchased in Miami
were for investment purposes. Media widely reported the behavior of purchasing
condominiums prior to completion, then “flipping” (selling) them for a profit
without ever living in the home. Some mortgage companies identified risks
inherent in this activity as early as 2005, after identifying investors assuming
highly leveraged positions in multiple properties.

Keynesian economist Hyman Minsky described three types of speculative

borrowing that can contribute to the accumulation of debt that eventually leads to
a collapse of asset values: the “hedge borrower” who borrows with the intent of
making debt payments from cash flows from other investments; the “speculative
borrower” who borrows based on the belief that they can service interest on the
loan but who must continually roll over the principal into new investments; and
the “Ponzi borrower” (named for Charles Ponzi), who relies on the appreciation of
the value of their assets (e.g. real estate) to refinance or pay-off their debt but
cannot repay the original loan.
The role of speculative borrowing has been cited as a contributing factor to the
subprime mortgage crisis.

High-risk mortgage loans and lending practices:

A variety of factors have caused lenders to offer an increasing array of higher-

risk loans to higher-risk borrowers, including illegal immigrants. The share of
subprime mortgages to total originations was 5% ($35 billion) in 1994, 9% in
1996, 13% ($160 billion) in 1999, and 20% ($600 billion) in 2006.A study by the
Federal Reserve indicated that the average difference in mortgage interest rates
between subprime and prime mortgages (the “subprime markup” or “risk
premium”) declined from 2.8 percentage points (280 basis points) in 2001, to 1.3
percentage points in 2007. In other words, the risk premium required by lenders
to offer a subprime loan declined. This occurred even though subprime borrower
credit ratings and loan characteristics declined overall during the 2001–2006
period, which should have had the opposite effect. The combination is common
to classic boom and bust credit cycles.

In addition to considering higher-risk borrowers, lenders have offered

increasingly high-risk loan options and incentives. These high risk loans included
the “No Income, No Job and no Assets” loans, sometimes referred to as Ninja
loans. In 2005 the median down payment for first-time home buyers was 2%,
with 43% of those buyers making no down payment whatsoever.

Another example is the interest-only adjustable-rate mortgage (ARM), which

allows the homeowner to pay just the interest (not principal) during an initial
period. Still another is a “payment option” loan, in which the homeowner can pay
a variable amount, but any interest not paid is added to the principal. Further, an
estimated one-third of ARM originated between 2004 and 2006 had “teaser”
rates below 4%, which then increased significantly after some initial period, as
much as doubling the monthly payment.

Mortgage underwriting practices have also been criticized, including automated

loan approvals that critics argued were not subjected to appropriate review and
documentation. In 2007, 40% of all subprime loans were generated by
automated underwriting. The chairman of the Mortgage Bankers Association
claimed mortgage brokers profited from a home loan boom but did not do enough
to examine whether borrowers could repay. Mortgage fraud has also increased.

Securitization practices

Borrowing under a securitization structure.

Securitization is structured finance process in which assets, receivables or
financial instruments are acquired, pooled together as collateral for the third party
investments (Investment banks). There are many parties involved. Due to the
securitization, investor appetite for mortgage-backed securities (MBS), and the
tendency of rating agencies to assign investment-grade ratings to MBS, loans
with a high risk of default could be originated, packaged and the risk readily
transferred to others. Asset securitization began with the structured financing of
mortgage pools in the 1970s. In 1995 the Community Reinvestment Act (CRA)
was revised to allow for the securitization of CRA loans into the secondary
market for mortgages.

The traditional mortgage model involved a bank originating a loan to the

borrower/homeowner and retaining credit (default) risk. With the advent of
securitization, the traditional model has given way to the “originate to distribute”
model, in which the credit risk is transferred (distributed) to investors through
MBS. The securitized share of subprime mortgages (i.e., those passed to third-
party investors via MBS) increased from 54% in 2001, to 75% in 2006.
Securitization accelerated in the mid-1990s. The total amount of mortgage-
backed securities issued almost tripled between 1996 and 2007, to $7.3 trillion.
The debt associated with the origination of such securities was sometimes
placed by major banks into off-balance sheet entities called structured
investment vehicles or special purpose entities. Moving the debt “off the books”
enabled large financial institutions to circumvent capital reserve requirements,
thereby assuming additional risk and increasing profits during the boom period.
Such off-balance sheet financing is sometimes referred to as the shadow
banking system and is thinly regulated. Alan stated that the securitization of
home loans for people with poor credit — not the loans themselves — were to
blame for the current global credit crisis.

However, instead of distributing mortgage-backed securities to investors, many

financial institutions retained significant amounts. The credit risk remained
concentrated within the banks instead of fully distributed to investors outside the
banking sector. Some argue this was not a flaw in the securitization concept
itself, but in its implementation.

Some believe that mortgage standards became lax because of a moral hazard,
where each link in the mortgage chain collected profits while believing it was
passing on risk.Under the CRA guidelines, a bank gets credit originating loans or
buying on a whole loan basis, but not holding the loans. So, this gave the banks
the incentive to originate loans and securitize them, passing the risk on others.
Since the banks no longer carried the loan risk, they had every incentive to lower
their underwriting standards to increase loan volume. The mortgage
securitization freed up cash for banks and thrifts, this allowed them to make even
more loans. In 1997, Bear Sterns bundled the first CRA loans into MBS.

Inaccurate credit ratings

Credit rating agencies and the subprime crisis

MBS credit rating downgrades, by quarter.

Credit rating agencies are now under scrutiny for giving investment-grade ratings
to securitization transactions (CDOs and MBSs) based on subprime mortgage
loans. Higher ratings were believed justified by various credit enhancements
including over-collateralization (pledging collateral in excess of debt issued),
credit default insurance, and equity investors willing to bear the first losses.
However, there are also indications that some involved in rating subprime-related
securities knew at the time that the rating process was faulty. Internal rating
agency emails from before the time the credit markets deteriorated, released
publicly by U.S. congressional investigators, suggest that some rating agency
employees suspected at the time that lax standards for rating structured credit
products would produce widespread negative results. For example, one 2006
email between colleagues at Standard & Poor’s states “Rating agencies continue
to create and [sic] even bigger monster—the CDO market. Let’s hope we are all
wealthy and retired by the time this house of cards falters.”

High ratings encouraged the flow of investor funds into these securities, helping
finance the housing boom. The reliance on ratings by these agencies and the
intertwined nature of how ratings justified investment led many investors to treat
securitized products — some based on subprime mortgages — as equivalent to
higher quality securities and furthered by SEC removal of regulatory barriers and
reduced disclosure requirements in the wake of the scandal. Critics claim that
conflicts of interest were involved, as rating agencies are paid by the firms that
organize and sell the debt to investors, such as investment banks. On 11 June
2008 the U.S. Securities and Exchange Commission proposed far-reaching rules
designed to address perceived conflicts of interest between rating agencies and
issuers of structured securities.

Rating agencies lowered the credit ratings on $1.9 trillion in mortgage backed
securities from Q3 2007 to Q2 2008. This places additional pressure on financial
institutions to lower the value of their MBS. In turn, this may require these
institutions to acquire additional capital, to maintain capital ratios. If this involves
the sale of new shares of stock, the value of existing shares is reduced. In other
words, ratings downgrades pressured MBS and stock prices lower.
Government policies
Government policies and the subprime mortgage crisis

Both government action and inaction have contributed to the crisis. Several
critics have commented that the current regulatory framework is outdated.
President George W. Bush stated in September 2008: “Once this crisis is
resolved, there will be time to update our financial regulatory structures. Our 21st
century global economy remains regulated largely by outdated 20th century laws.
“The Securities and Exchange Commission (SEC) has conceded that self-
regulation of investment banks contributed to the crisis. Increasing home
ownership was a goal of both Clinton and Bush administrations. [80][81][82] There is
evidence that the government influenced participants in the mortgage industry,
including Fannie Mae and Freddie Mac (the GSE), to lower lending standards. [83]
[84][85]
 The U.S. Department of Housing and Urban Development’s mortgage
policies fueled the trend towards issuing risky loans.

In 1995, the GSE began receiving government incentive payments for

purchasing mortgage backed securities which included loans to low income
borrowers. This resulted in the agencies purchasing subprime securities.
Subprime mortgage loan originations surged by 25% per year between 1994 and
2003, resulting in a nearly ten-fold increase in the volume of these loans in just
nine years. These securities were very attractive to Wall Street, and while Fannie
and Freddie targeted the lowest-risk loans, they still fueled the subprime market
as a result. In 1996 the Housing and Urban Development (HUD) agency directed
the GSE to provide at least 42% of their mortgage financing to borrowers with
income below the median in their area. This target was increased to 50% in 2000
and 52% in 2005. By 2008, the GSE owned or guaranteed nearly $5 trillion in
mortgages and mortgage-backed securities, close to half the outstanding
balance of U.S. mortgages. The GSE were highly leveraged, having borrowed
large sums to purchase mortgages. When concerns arose regarding the ability of
the GSE to make good on their guarantee obligations in September 2008, the
U.S. government was forced to place the companies into a conservatorship,
effectively nationalizing them at the taxpayer’s expense.

Liberal economist Robert Kuttner has criticized the repeal of the Glass-Steagall
Act by the Gramm-Leach-Bliley Act of 1999 as possibly contributing to the
subprime meltdown, although other economists disagree. A taxpayer-funded
government bailout related to mortgages during the savings and loan crisis may
have created a moral hazard and acted as encouragement to lenders to make
similar higher risk loans.
Additionally, there is debate among economists regarding the effect of the
Community Reinvestment Act, with detractors claiming it encourages lending to
uncreditworthy consumers and defenders claiming a thirty year history of lending
without increased risk. Detractors also claim that amendments to the CRA in the
mid-1990s, raised the amount of home loans to otherwise unqualified low-income
borrowers and also allowed for the first time the securitization of CRA-regulated
loans containing subprime mortgages.

Policies of central banks

Central banks are primarily concerned with managing monetary policy; they are
less concerned with avoiding asset bubbles, such as the housing bubble and dot-
com bubble. Central banks have generally chosen to react after such bubbles
burst to minimize collateral impact on the economy, rather than trying to avoid
the bubble itself. This is because identifying an asset bubble and determining the
proper monetary policy to properly deflate it are a matter of debate among
economists.

Federal Reserve actions raised concerns among some market observers that it
could create a moral hazard. Some industry officials said that Federal Reserve
Bank of New York involvement in the rescue of Long-Term Capital Management
in 1998 would encourage large financial institutions to assume more risk, in the
belief that the Federal Reserve would intervene on their behalf.

A contributing factor to the rise in home prices was the lowering of interest rates
earlier in the decade by the Federal Reserve, to diminish the blow of the collapse
of the dot-com bubble and combat the risk of deflation. From 2000 to 2003, the
Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%. The
central bank believed that interest rates could be lowered safely primarily
because the rate of inflation was low and disregarded other important factors.
The Federal Reserve’s inflation figures, however, were flawed. Richard W.
Fisher, President and CEO of the Federal Reserve Bank of Dallas, stated that
the Federal Reserve’s interest rate policy during this time period was misguided
by this erroneously low inflation data, thus contributing to the housing bubble.

Financial institution debt levels and incentives

Leverage Ratios of Investment Banks Increased Significantly 2003–2007

Many financial institutions borrowed enormous sums of money during 2004–2007

and made investments in mortgage-backed securities (MBS), essentially betting
on the continued appreciation of home values and sustained mortgage
payments. Borrowing at a lower interest rate to invest at a higher interest rate is
using financial leverage. This is analogous to an individual taking out a second
mortgage on their home to invest in the stock market. This strategy magnified
profits during the housing boom period, but drove large losses after the bust.
Financial institutions and individual investors holding MBS also suffered
significant losses as a result of widespread and increasing mortgage payment
defaults or MBS devaluation beginning in 2007 onward.

A SEC regulatory ruling in 2004 greatly contributed to US investment banks’

ability to take on additional debt, which was then used to purchase MBS. The top
five US investment banks each significantly increased their financial leverage
during the 2004–2007 time period (see diagram), which increased their
vulnerability to the MBS losses. These five institutions reported over $4.1 trillion
in debt for fiscal year 2007, a figure roughly 30% the size of the U.S. economy.
Three of the five either went bankrupt (Lehman Brothers) or were sold at fire-sale
prices to other banks (Bear Stearns and Merrill Lynch) during September 2008,
creating instability in the global financial system. The remaining two converted to
commercial bank models, subjecting themselves to much tighter regulation.

In 2006, Wall Street executives took home bonuses totaling $23.9 billion,
according to the New York State Comptroller’s Office. “Wall Street traders were
thinking of the bonus at the end of the year, not the long-term health of their firm.
The whole system—from mortgage brokers to Wall Street risk managers—
seemed tilted toward taking short-term risks while ignoring long-term obligations.
The most damning evidence is that most of the people at the top of the banks
didn’t really understand how those [investments] worked.”

Credit default swaps

Credit defaults swaps (CDS) are insurance contracts, typically used to protect
bondholders or MBS investors from the risk of default. As the financial health of
banks and other institutions deteriorated due to losses related to mortgages, the
likelihood that those providing the insurance would have to pay their
counterparties increased. This created uncertainty across the system, as
investors wondered which companies would be forced to pay to cover defaults.

CDS may be used to insure a particular financial exposure or may be used

speculatively. Trading of CDS increased 100-fold from 1998 to 2008, with debt
covered by CDS contracts ranging from U.S. $33 to $47 trillion as of November
2008 CDS are lightly regulated. During 2008, there was no central clearinghouse
to honor CDS in the event a key player in the industry was unable to perform its
obligations. Required corporate disclosure of CDS-related obligations has been
criticized as inadequate. Insurance companies such as AIG, MBIA, and Ambac
faced ratings downgrades due to their potential exposure due to widespread debt
defaults. These institutions were forced to obtain additional funds (capital) to
offset this exposure. In the case of AIG, its nearly $440 billion of CDS linked to
MBS resulted in a U.S. government bailout.

In theory, because credit default swaps are two-party contracts, there is no net
loss of wealth. For every company that takes a loss, there will be a
corresponding gain elsewhere. The question is which companies will be on the
hook to make payments and take losses, and will they have the funds to cover
such losses. When investment bank Lehman Brothers went bankrupt in
September 2008, it created a great deal of uncertainty regarding which financial
institutions would be required to pay off CDS contracts on its $600 billion in
outstanding debts. Significant losses at investment bank Merrill Lynch were also
attributed in part to CDS and especially the drop in value of its unhedged
mortgage portfolio in the form of Collateralized Debt Obligations after American
International Group ceased offering CDS on Merril’s CDOs. Trading partner’s
loss of confidence in Merril Lynch’s solvency and ability to refinance short-term
debt ultimately led to its sale to Bank of America.

Impact of Financial crisis:

 Financial crisis of 2007–2008 and Global financial crisis of 2008

Financial sector downturn

 List of writedowns due to subprime crisis

FDIC Graph – U.S. Bank & Thrift Profitability by Quarter

Financial institutions from around the world have recognized subprime-related

losses and write-downs exceeding U.S. $501 billion as of August 2008. Profits at
the 8,533 U.S. banks insured by the FDIC declined from $35.2 billion to $646
million (89%) during the fourth quarter of 2007 versus the prior year, due to
soaring loan defaults and provisions for loan losses. It was the worst bank and
thrift quarterly performance since 1990. For all of 2007, these banks earned
approximately $100 billion, down 31% from a record profit of $145 billion in 2006.
Profits declined from $35.6 billion to $19.3 billion during the first quarter of 2008
versus the prior year, a decline of 46%.

The financial sector began to feel the consequences of this crisis in February
2007 with the $10.5 billion writedown of HSBC, which was the first major CDO or
MBO related loss to be reported. During 2007, at least 100 mortgage companies
either shut down, suspended operations or were sold. Top management has not
escaped unscathed, as the CEOs of Merrill Lynch and Citigroup were forced to
resign within a week of each other. [124] various institutions followed up with
merger deals.

Market weaknesses, 2007

On July 19, 2007, the Dow Jones Industrial Average hit a record high, closing
above 14,000 for the first time.

On August 15, 2007, the Dow dropped below 13,000 and the S&P 500 crossed
into negative territory for that year. Similar drops occurred in virtually every
market in the world, with Brazil and Korea being hard-hit. Through 2008, large
daily drops became common, with, for example, the KOSPI dropping about 7% in
one day,[127][dead link] although 2007’s largest daily drop by the S&P 500 in the U.S.
was in February, a result of the subprime crisis.

Mortgage lenders and home builders[130][131][dead link] fared terribly, but losses cut
across sectors, with some of the worst-hit industries, such as metals & mining
companies, having only the vaguest connection with lending or mortgages.

Stock indices worldwide trended downward for several months since the first
panic in July–August 2007.

Market downturns and impacts, 2008

The TED spread – an indicator of credit risk – increased dramatically during

September 2008.

The crisis caused panic in financial markets and encouraged investors to take
their money out of risky mortgage bonds and shaky equities and put it into
commodities as “stores of value”. Financial speculation in commodity futures
following the collapse of the financial derivatives markets has contributed to the
world food price crisis and oil price increases due to a “commodities super-cycle.”
Financial speculators seeking quick returns have removed trillions of dollars from
equities and mortgage bonds, some of which has been invested into food and
raw materials.

Beginning in mid-2008, all three major stock indices in the United States (the
Dow Jones Industrial Average, NASDAQ, and the S&P 500) entered a bear
market. On 15 September 2008, a slew of financial concerns caused the indices
to drop by their sharpest amounts since the 2001 terrorist attacks. That day, the
most noteworthy trigger was the declared bankruptcy of investment bank
Lehman Brothers. Additionally, Merrill Lynch was joined with Bank of America in
a forced merger worth $50 billion. Finally, concerns over insurer American
International Group’s ability to stay capitalized caused that stock to drop over
60% that day. Poor economic data on manufacturing contributed to the day’s
panic, but were eclipsed by the severe developments of the financial crisis. All of
these events culminated into a stock selloff that was experienced worldwide.
Overall, the Dow Jones Industrial plunged 504 points (4.4%) while the S&P 500
fell 59 points (4.7%). Asian and European markets rendered similarly sharp
drops.

The much anticipated passage of the $700 billion bailout plan was struck down
by the House of Representatives in a 228–205 vote on September 29. In the
context of recent history, the result was catastrophic for stocks. The Dow Jones
Industrial Average suffered a severe 777 point loss (7.0%), its worst point loss on
record up to that date. The NASDAQ tumbled 9.1% and the S&P 500 fell 8.8%,
both of which the worst losses were those indices experienced since the 1987
stock market crash.

Despite congressional passage of historic bailout legislation, which was signed

by President Bush on Saturday, Oct. 4, Dow Jones Index tumbled further when
markets resumed trading on Oct. 6. The Dow fell below 10,000 points for the first
time in almost four years, losing 800 points before recovering to settle at -369.88
for the day.Stocks also continued to tumble to record lows ending one of the
worst weeks in the Stock Market since September 11, 2001.”

It is also estimated that even with the passing of the so-called bailout package;
many banks within the United States will tumble and therefore cease operating. It
is estimated that over 100 banks in the United States will close their doors
because of the financial crisis. This will have a severe impact on the economy
and consumers. It is expected that it will take years for the United States to
recover from the crisis.

Indirect economic effects

Indirect economic effects of the subprime mortgage crisis

The subprime crisis had a series of other economic effects. Housing price
declines left consumers with less wealth, which placed downward pressure on
consumption. Certain minority groups received a higher proportion of subprime
loans and experienced a disproportional level of foreclosures. Home related
crimes including arson increased. Job losses in the financial sector were
significant, with over 65,400 jobs lost in the United States as of September 2008.

Many renters became innocent victims, often evicted from their homes without
notice due to foreclosure of their landlord’s property. In October 2008, Tom Dart,
the elected Sheriff of Cook County, Illinois, criticized mortgage companies for
their actions, and announced that he was suspending all foreclosure evictions.

The sudden lack of credit also caused a slump in car sales. Ford sales in
October 2008 were down 33.8% from a year ago, General Motors sales were
down 15.6%, and Toyota sales had declined 32.3%. One in five car dealerships
are expected to close in fall of 2008.

Financial Crisis – Likely impact on Bangladesh

The stock price plunge and severe credit crunch we are watching today in global
financial markets are

byproducts of the developments in the US six years ago. In late 2001, fears of
global terror attacks after 9/11 shook an already struggling US economy, one that
was just beginning to come out of the recession induced by the bursting of the
dotcom bubble of late 1990s.

In response, during 2001, the Federal Reserve, the US central bank, began
cutting interest rates dramatically to encourage borrowing, which spurred both
consumption and investment spending. As lower interest rates worked their way
into the economy, the real estate market began to get itself into frenzy. The
number of homes sold and the prices they sold for increased dramatically,
beginning in 2002. At the time, the rate on a 30-year fixed rate mortgage was at
the lowest levels seen in nearly 40 years.

Subprime and similar mortgage originations in the US rose from less than 8
percent of all mortgages in 2003 to over 20 percent in 2006.

The crisis began with the bursting of the US housing bubble and high default
rates on subprime and adjustable rate mortgages, beginning in approximately
2005-2006. For a number of years prior to that, declining lending standards, an
increase in loan incentives such as easy initial terms, and a long-term trend of
rising housing prices had encouraged borrowers to assume difficult mortgages in
the belief they would be able to quickly refinance at more favorable terms.

However, once interest rates began to rise and housing prices started to drop in
2006-2007 in many parts of the US, refinancing became more difficult. Default
and foreclosure activity increased dramatically as easy initial terms expired,
home prices failed to go up as anticipated, and adjustable rate mortgage interest
rates reset higher. Foreclosures accelerated in the United States in late 2006 and
triggered a global financial crisis through 2007 and 2008.
Initially the companies affected were those directly involved in home construction
and mortgage lending. Financial institutions, which had engaged in the
securitization of mortgages, fell prey subsequently. The rest is history.

The crisis is still unfolding. There remains great uncertainty as to the depth and
severity of the crisis as well as its impact on the real sectors (so called main
streets) in US and Europe. This makes it difficult to assess clearly how it will
impact Bangladesh.

However, overall, there is absolutely no reason to panic. Bangladesh is relatively

insulated from the financial side, but vulnerable to potential global economic
slowdown, particularly in the US and EU. The foreign exchange reserves of
Bangladesh Bank and commercial banks have limited exposure to the securities
markets and banking system risk in the US and EU.

Foreign capital flows are largely in the form of concessional official lending. FDI
and foreign portfolio investments are small. However, Bangladesh’s economy
relies heavily on garment exports. This is where the main risk lies. Remittances
may also be vulnerable. On the positive side, import payments may be favorably
affected as a result of declining commodity prices, particularly oil and food.

The export sector is potentially the most vulnerable in Bangladesh since it

depends heavily on US and EU economies. The readymade garment (RMG)
industry accounts for over three quarters of export earnings and depends almost
entirely on US and EU markets. There is growing concern that a deep and
prolonged recession in the US and EU may reduce consumer spending
significantly across the board, thus undermining the demand for Bangladeshi
exports. BGMEA and BKMEA have indicated that growth in export orders was
slow in the first quarter of Fy08. IMF has projected that income growth in
Bangladesh’s export markets will decline from 1.5 percent in 2008 to 0.5 percent
in 2009. If this happens, consumer spending will decline.

Although demand for Bangladesh’s exports is not too sensitive to income, export
prices may decline and this could have significant effects on our export earnings
even if export volumes remain largely unaffected.

There is unlikely to be any direct immediate impact on remittances. Remittances

in Bangladesh proved to be resilient during previous financial crises in the world.
The bulk (over 60 percent) of Bangladesh’s remittances come from the Middle
East, and less than one-third come from the US, UK and Germany. Strong
remittance growth (44 percent) has continued in the first quarter of FY09.
However, if a deep and protracted recession ensues in the US and EU, then the
Middle-Eastern economies are likely to be adversely affected. Stock markets in
important Middle-Eastern economies have already started to crash. Even if the
current nearly $8 billion level of remittances is sustained, it would be challenging
to maintain its growth momentum since 2001 if the world economy remains
depressed for an extended period.

Official aid flows may take a hit. Governments in rich donor countries are doling
out massive amounts to rescue their domestic financial institutions. They may
look for savings from other sources to finance these bailouts. Foreign aid budget
is relatively easy to cut since the foreign aid recipients do not count as their
voters.

Import is probably the one channel through which Bangladesh may benefit.
Import payments in August have reportedly been US$531 million lower than
import payments in July. This decline in import payments is mainly due to the fall
in prices of petroleum products, wheat and edible oil. Record high oil prices last
year raised import payments to over US$20 billion in FY08, compared to slightly
over US$15 billion in payments in FY07. The gains on account of reduced import
payments can be sizable.

While mindful of the risks, early indications in FY09 are that the economy is on
track to achieving the 6.5 percent growth projected by the government.
Agricultural production outlook so far looks very good, export growth in July was
exceptionally strong (71 percent), and service sector growth should maintain its
recent growth trend.

Bangladesh’s remarkable resilience so far to this ongoing global financial crisis

and slowing growth in high-income countries is in large part because of the
country’s relative insulation from international capital markets and the negligible
role played by foreign portfolio investors in the country. This resilience also
derives from sound policy framework and macroeconomic fundamentals.
However, investor psychology is much less insulated than the capital market
itself, as demonstrated by the sudden increase in volatility in Dhaka and
Chittagong Stock Exchanges last Sunday (October 12).

The overall financial leverage in Bangladesh is low. Unlike the global financials,
Bangladesh’s banking system has no toxic derivative engagements. Barring a
prolonged slowdown in the world economy leading to a drastic reduction in RMG
exports, it is highly unlikely that the external shocks will increase the risk of asset
quality problems or precipitate a credit crunch in Bangladesh. This is due to
Bangladesh’s low level of external debt, robust international reserves, and limited
direct exposure to the international financial system.
Low level of global integration shields Bangladesh from the global financial
turmoil. However, Bangladesh is far from being completely insulated. Its heavy
dependence on US and EU markets for merchandize exports is a real source of
vulnerability as are remittances and foreign aid, though may be to a lesser
extent. There is therefore no alternative to stronger policy vigilance and
preparedness.

Policy makers have to make sure that markets do not panic by continuously
providing evidence on the economy’s resilience in various sectors. They must
proactively monitor the channels through which the global financial turmoil may
start creeping into the Bangladesh economy and take appropriate mitigation
measures.

Inflation has recently been the biggest macro policy challenge in Bangladesh.
With the aggravation of the financial turmoil we have seen a sharp decline in
global commodity prices. This makes the inflation battle a little easier for
Bangladeshi policymakers. But new policy dilemmas are likely to emerge if
export earnings begin to slow down and currencies of Bangladesh’s competitor
countries depreciate. This will put exchange rate policy under pressure to
maintain export competitiveness.

Market interventions aimed at depreciating the currency will dilute through

declining international commodity prices to domestic prices and, consequently,
undermine the objective of reducing inflation from its current double-digit level.

For Bangladesh a more momentous shock over the past couple of years has
been the soaring price of commodities, which some have also blamed on
financial speculation. The food-price spike in late 2007 and early 2008 caused
havoc to the lives of the poor and middle-income groups. In response, the
government extended its reach by increasing subsidies and expanding safety
nets. FY09 budget has already built-in an expansionary stance to continue
providing support to the poor so that they can afford to pay the high food prices.

If manufacturing is hit badly by recession in western economies, there will be

fresh demand for further expansion of safety nets and increase in direct and
indirect subsidies to exports. This will call for some more tough choices,
accommodate these demands through increased domestic borrowing and/or
restrain other spending if additional concessional financing cannot be mobilized
from external sources.

Crisis so severe, the world financial system is affected

Following a period of economic boom, a financial bubble-global in scope-has now
burst.
A collapse of the US sub-prime mortgage market and the reversal of the housing
boom in other industrialized economies have had a ripple effect around the
world. Furthermore, other weaknesses in the global financial system have
surfaced. Some financial products and instruments have become so complex
and twisted, that as things start to unravel, and trust in the whole system started
is failing. The extent of this problem has been so severe that some of the world’s
largest financial institutions have collapsed. Others have been bought out by their
competition at low prices and in other cases, the governments of the wealthiest
nations in the world have resorted to extensive bail-out and rescue packages for
the remaining large banks and financial institutions. The effect of this, the United
Nation’s Conference on Trade and Development says in its Trade and
Development Report 2008 is, as summarized by the Third World Network, that”
The global economy is teetering on the brink of recession. The downturn after
four years of relatively fast growth is due to a number of factors: the global fallout
from the financial crisis in the United States, the bursting of the housing bubbles
in the US and in other large economies, soaring commodity prices, increasingly
restrictive monetary policies in a number of countries, and stock market volatility.
… the fallout from the collapse of the US mortgage market and the reversal of
the housing boom in various important countries has turned out to be more
profound and persistent than expected in 2007 and beginning of 2008. As more
and more evidence is gathered and as the lag effects are showing up, we are
seeing more and more countries around the world being affected by this rather
profound and persistent negative effects from the reversal of housing booms in
various countries”.

Crisis so severe, those responsible are bailed out

Some of the bail-outs have also been accompanied with charges of hypocrisy
due to the appearance of “socializing the costs while privatizing the profits.” The
bail-outs appear to help the financial institutions that got into trouble (many of
whom pushed for the kind of lax policies that allowed this to happen in the first
place).Some governments have moved to make it harder to manipulate the
markets by shorting during the financial crisis blaming them for worsening an
already bad situation. It should be noted that during the debilitating Asian
financial crisis in the late 1990s, Asian nations affected by short-selling
complained, without success that currency speculators-operating through hedge
funds or through the currency operations of commercial banks and other financial
institutions-were attacking their currencies through short selling and in doing so,
bringing the rates of the local currencies far below their real economic levels.
However, when they complained to the Western governments and IMF, they
dismissed the claims of the Asian governments, blaming it on their own economic
mismanagement instead.
Other governments have moved to try and reassure investors and savers that
their money is safe. In a number of European countries, for example,
governments have tried to increase or fully guarantee depositors’ savings. In
other cases, banks have been nationalized (socializing profits as well as costs,
potentially.)In the meanwhile, smaller businesses and poorer people rarely have
such options for bail out and rescue when they find themselves in crisis. There
seems to be a growing resentment and little sympathy for those working in the
financial sector that appeared to have gambled with people’s money, and hence
their lives, while even getting fat bonuses and pay rises for it in the past.
Although in raw dollar terms the huge pay rises and bonuses are small compared
to the magnitude of the problem, the encouragement such practices have given
in the past, as well as the type of culture it creates is what has angered so many
people.
In the case of subprime mortgages, it is also argued that those who took on the
risky loans are to blame; they should not have borrowed so much money when
they knew they would not have the means to repay. While there is truth to this,
and our culture of expecting easy money, consuming beyond our means, etc is
something that needs urgent attention, in the case of subprime mortgages, it
seems easy to forget the predicament of people living in poverty. Financial
advisors that irresponsibly pushed these loans (with no interest or care of the
borrower in mind) were generally aggressive as they had a lot to gain from these
loans.
For people living in poverty even in wealthy countries life can be desperate and
miserable. Concerns will range from crime in the neighborhood, to good
schooling, to getting by week by week on very little, and ensuring a job lasts. The
hope of being able to escape it for a while was, in effect, exploited. When in
poverty, long term thinking is not always going to enter the realm of immediate
concern. Furthermore, it is likely that those lower down the social strata are not
going to be as financially savvy as those further up. Hence there is usually more
trust placed in a bank or financial advisor. It is often forgotten these days that
banks and financial institutions have changed in nature; there is less concern
about the people they serve, but more about how they can sell products from
which they can make profit. While to some extent risky borrowers may bear some
responsibility, overall they lost out while the lenders are being bailed out.

A crisis so severe, the rest suffer too

There is the argument that when the larger banks show signs of crisis, it is not
just the wealthy that will suffer, but potentially everyone. With an increasingly
inter-connected world, things like a credit crunch can ripple through the entire
economy.
For example, people may find their mortgages harder to pay, or remortgaging
could become expensive, for any recent homebuyers the value of their homes
are likely fall in value leaving them in negative equity, and many sectors may find
the credit crunch and higher costs of borrowing will lead to job cuts. As people
will cut back on consumption to try and weather this economic storm, yet other
businesses will struggle to survive leading to further fears of job losses.

The financial crisis and wealthy countries

Many have blamed the greed of Wall Street for causing the problem in the first
place because it is in the US that the most influential banks, institutions and
ideologues that pushed for the policies that caused the problems are found.
The crisis became so severe that after the failure and buyouts of major
institutions, the Bush Administration offered a $700 billion bailout plan for the US
financial system.
This bailout package was controversial because it was unpopular with the public,
seen as a bailout for the culprits while the ordinary person would be left to pay for
their folly. The initial rejection at the US House of Representatives, because of
this, sent shock waves around the world. It took a second attempt to pass the
plan, but with add-ons to the bill to get the additional congressmen and women to
accept the plan.
However, as former Nobel prize winner for Economics, former Chief Economist
of the World Bank and university professor at Columbia University, Joseph
Stiglitz, argued, the plan “remains a very bad bill:” I think it remains a very bad
bill. It is a disappointment, but not a surprise, that the administration came up
with a bill that is again based on trickle-down economics. You throw enough
money at Wall Street, and some of it will trickle down to the rest of the economy.
It’s like a patient suffering from giving a massive blood transfusion while there’s
internal bleeding; it doesn’t do anything about the basic source of the
hemorrhaging, the foreclosure problem. But that having been said, it is better
than doing nothing, and hopefully after the election, we can repair the very many
mistakes in it”.Writing in The Guardian, Stiglitz also added that,

“Americans have lost faith not only in the [Bush] administration, but in its
economic philosophy: a new corporate welfarism masquerading behind free-
market ideology; another version of trickle-down economics, where the hundreds
of billions to Wall Street that caused the problem were supposed to somehow
trickle down to help ordinary Americans. Trickle-down hasn’t been working well in
America over the past eight years”.

“The very assumption that the rescue plan has to help is suspect. After all, the
IMF and US treasury bail-outs for Wall Street 10 years ago in Korea, Thailand,
Indonesia, Brazil, Russia and Argentina didn’t work for those countries, although
it did enable Wall Street to get back most of its money. The taxpayers in these
other poor countries picked up the tab for the financial markets’ mistakes. This
time, it is American taxpayers who are being asked to pick up the tab. And that’s
the difference. For all the rhetoric about democracy and good governance, the
citizens in those countries didn’t really get a chance to vote on the bail-outs”.” In
environmental economics, there is a basic concept called the polluter pays
principle. It is a matter of fairness, but also of efficiency. Wall Street has polluted
our economy with toxic mortgages. It should now pay for the cleanup”.

The financial crisis and the developing world

For the developing world, the rise in food prices as well as the knock-on effects
from the financial instability and uncertainty in industrialized nations are having a
compounding effect. High fuel prices, soaring commodity prices together with
fears of global recession are worrying many developing country analysts.
Summarizing a United Nations Conference on Trade and Development report,
the Third World Network notes the impacts the crisis could have around the
world, especially on developing countries that are dependent on commodities for
import or export:” Uncertainty and instability in international financial, currency
and commodity markets, coupled with doubts about the direction of monetary
policy in some major developed countries, are contributing to a gloomy outlook
for the world economy and could present considerable risks for the developing
world, the UN Conference on Trade and Development (UNCTAD) said Thursday.
… Commodity-dependent economies are exposed to considerable external
shocks stemming from price booms and busts in international commodity
markets”.
“Market liberalization and privatization in the commodity sector have not resulted
in greater stability of international commodity prices. There is widespread
dissatisfaction with the outcomes of unregulated financial and commodity
markets, which fail to transmit reliable price signals for commodity producers. In
recent years, the global economic policy environment seems to have become
more favorable to fresh thinking about the need for multilateral actions against
the negative impacts of large commodity price fluctuations on development and
macroeconomic stability in the world economy”.

Asia and the financial crisis

Countries in Asia are increasingly worried about what is happening in the West.
A number of nations urged the US to provide meaningful assurances and bailout
packages for the US economy, as that would have a knock-on effect of
reassuring foreign investors and helping ease concerns in other parts of the
world. Many believe Asia was sufficiently de-coupled from the Western financial
systems, but this crisis has shown that this is not the case, at least not yet. Many
Asian countries have seen their stock markets suffer and currency values going
on a downward trend. As many nations in the region are seeing rapid growth and
wealth creation, there is enormous investment in Western countries, and
therefore, a lot of exposure to problems, too. In addition, there is increased
foreign investment, mostly from the West in Asia. Asian products and services
are also global, and a slowdown in wealthy countries means increased chances
of a slowdown in Asia and the risk of job losses. Asia has not had a subprime
mortgage crisis like many nations in the West, but the increasingly inter-
connected world means there are always knock-on effects.

Conclusion:

In summary, while the crisis is not over yet, we certainly hope the worst is
behind us. Corrective action is still needed and the lessons we are learning
are ongoing. That said, we have learned, in fact re-learned, that while crises
may manifest themselves in different ways, with new instruments, in new
markets, and sometimes in newly created types of institutional frameworks, one
of the items that remains the same is that “incentives” are often at the root of a
crisis. Often altering incentives is a difficult job as market participants and the
official sector have gotten comfortable in their various roles, rules, and
regulations. But it is time to re-evaluate how incentives altered the buildup to the
latest crisis and its aftermath and how they can be redirected to reinforce self-
corrective forces in financial markets rather than destructive ones. The Fund can
play a role in putting forth possible options, joining with various international
organizations and standard setters to discuss them, and acting as a focal point
for such discussions, and can help disseminate the new best practices or rule-
making throughout its membership to foster a more secure global economic and
financial environment.

The global financial crisis, brewing for a while, really started to show its effects in
the middle of 2008. Around the world stock markets have fallen, large financial
institutions have collapsed or been bought out, and governments in even the
wealthiest nations have had to come up with rescue packages to bail out their
financial systems.
On the one hand many people are concerned that those responsible for the
financial problems are the ones being bailed out, while on the other hand, a
global financial meltdown will affect the livelihoods of almost everyone in an
increasingly inter-connected world. The problem could have been avoided, if
ideologues supporting the current economics models weren’t so vocal, influential
and inconsiderate of others’ viewpoints and concerns.

Executive Summery
The financial crisis of 2007–2009 began in July 2007 [1] when a loss of confidence
by investors in the value of securitized mortgages in the United States resulted in
a liquidity crisis that prompted a substantial injection of capital into financial
markets by the United States Federal Reserve, Bank of England and the
European Central Bank.[2][3] The TED spread, an indicator of perceived credit risk
in the general economy, spiked up in July 2007, remained volatile for a year, then
spiked even higher in September 2008, [4] reaching a record 4.65% on October
10, 2008. In September 2008, the crisis deepened, as stock markets worldwide
crashed and entered a period of high volatility, and a considerable number of
banks, mortgage lenders and insurance companies failed in the following weeks.

Although America’s housing collapse is often cited as having caused the crisis,
the financial system was vulnerable because of intricate and highly-leveraged
financial contracts and operations, a U.S. monetary policy making the cost of
credit negligible therefore encouraging such high levels of leverage, and
generally a “hypertrophy of the financial sector” (financialization). 

2007-09 – The American financial crisis of 2007–2009 helped create the global
financial crisis of 2008–2009, thus creating the late 2000s recession

The crisis in real estate, banking and credit in the United States had a global
reach, affecting a wide range of financial and economic activities and institutions,
including the:

 Overall tightening of credit with financial institutions making both corporate and
consumer credit harder to get;[6]
 Financial markets (stock exchanges and derivative markets) that experienced steep
declines;
 Liquidity problems in equity funds and hedge funds;
 Devaluation of the assets underpinning insurance contracts and pension funds leading
to concerns about the ability of these instruments to meet future obligations:
 Increased public debt public finance due to the provision of public funds to the financial
services industry and other affected industries, and the
 Devaluation of some currencies (Icelandic crown, some Eastern Europe and Latin
America currencies) and increased currency volatility,

The first symptoms of what is now called the late 2000s recession ensued also in
various countries and various industries. The financial crisis, albeit not the only
cause among other economic imbalances, was a factor by making borrowing and
equity rising harder.

Historical background of the current financial crisis:

Share in GDP of US financial sector since 1860.  Short list of some major
financial crises since 20th century

 1910 – Shanghai rubber stock market crisis

 1930s – The Great Depression – the largest and most important economic depression in
the 20th century
 1973 – 1973 oil crisis – oil prices soared, causing the 1973–1974 stock market crash
 1980s – Latin American debt crisis – beginning in Mexico
 1987 – Black Monday (1987) – the largest one-day percentage decline in stock market
history
 1989-91 – United States Savings & Loan crisis
 1990s – Japanese asset price bubble collapsed
 1992-93 – Black Wednesday – speculative attacks on currencies in the European
Exchange Rate Mechanism
 1994-95 – 1994 economic crisis in Mexico – speculative attack and default on Mexican
debt
 1997-98 – 1997 Asian Financial Crisis – devaluations and banking crises across Asia

The previous major financial crisis occurred in 1928 to 1933. A financial crisis
occurs when there is a disorderly contraction in money supply and wealth in an
economy. It is also known as a credit crunch. It occurs when participants in an
economy lose confidence in having loans repaid by debtors. This causes lenders
to limit further loans as well as recall existing loans.

The financial/banking system relies on credit creation as a result of debtors

spending the money which in turn is ‘banked’ and loaned to other debtors. As a
result a relative small contraction in lending can lead to a dramatic contraction in
money supply. The Great Depression occurred after a dramatic expansion in
debt and money supply in the roaring twenties. Total US private credit market
debt as a percentage of GDP reached 250% in 1929. The next time debt
exceeded this level in the USA was in 1999 reaching a peak of 350% prior to the
bubble bursting.

A dramatic contraction then occurred between 1929 and 1933 as debt was
defaulted upon and resulted in a ‘contraction’ in money and wealth. The debt
deflation theory coined by Irving Fisher formed the basis of the regulation
subsequently introduced by Congress.

The Glass-Seagull Act was passed by Congress in order to prevent this

occurring again. It was found that financial firms encouraged debt to be invested
in the stock market which then overheated the stock market. The act was
designed to prevent this by separating the advising from the lending role of
financial institutions. Following its repeal by Congress in 1999, institutions could
advise and lend setting up a direct conflict of interest in many ‘deals’.

The framework which created the great depression from a regulatory point of
view were ‘re-created’ by the repeal of this act. Financial firms could profit in the
short term by simply setting up and lending on deals using others money.

A sequence of rapid debt expansion occurred including a dot-com bubble, which

was followed by equity and housing bubble and then a commodity bubble.
Without the debt expansion which measured $14 Trillion USD some analysts
have argued that there would have been no economic growth in the USA
between 1996 and 2006.

The Global financial crisis is the unwinding of the debt bubbles between 2007-
2009

What is financial crisis?-

Definition

A situation in which the economy of a country experiences a

sudden downturnbrought on by a financial crisis. An economy facing
an economic crisis will most likely experience a falling GDP, a drying up
of liquidity and rising/falling prices dueto inflation/deflation. An economic crisis
can take the form of a recession or a depression. Also called real economic
crisis

The term financial crisis is applied broadly to a variety of situations in which some
financial institutions or assets suddenly lose a large part of their value. In the
19th and early 20th centuries, many financial crises were associated
with banking panics, and many recessions coincided with these panics. Other
situations that are often called financial crises include stock market
crashes and the bursting of other financial bubbles, currency crises,
and sovereign defaults

Sources of financial crisis:-

Strategic complementarities in financial markets

It is often observed that successful investment requires each investor in a

financial market to guess what other investors will do. George Soros has called
this need to guess the intentions of others ‘reflexivity’. [10] Similarly, John Maynard
Keynes compared financial markets to a beauty contest game in which each
participant tries to predict which model other participants will consider most
beautiful.[11]

Furthermore, in many cases investors have incentives to coordinate their

choices. For example, someone who thinks other investors want to buy lots of
Japanese yen may expect the yen to rise in value, and therefore has an incentive
to buy yen too. Likewise, a depositor in Indy Mac Bank who expects other
depositors to withdraw their funds may expect the bank to fail, and therefore has
an incentive to withdraw too. Economists call an incentive to mimic the strategies
of others strategic complementarily.

It has been argued that if people or firms have a sufficiently strong incentive to do
the same thing they expect others to do, then self-fulfilling prophecies may
occur. For example, if investors expect the value of the yen to rise, this may
cause its value to rise; if depositors expect a bank to fail this may cause it to fail.
[14]
Therefore, financial crises are sometimes viewed as a vicious circle in which
investors shun some institution or asset because they expect others to do so.

Leverage

Leverage, which means borrowing to finance investments, is frequently cited as a

contributor to financial crises When a financial institution (or an individual) only
invests its own money, it can, in the very worst case, lose its own money. But
when it borrows in order to invest more, it can potentially earn more from its
investment, but it can also lose more than all it has. Therefore leverage magnifies
the potential returns from investment, but also creates a risk of bankruptcy. Since
bankruptcy means that a firm fails to honor all its promised payments to other
firms, it may spread financial troubles from one firm to another (see ‘Contagion’
below).

The average degree of leverage in the economy often rises prior to a financial
crisis. For example, borrowing to finance investment in the stock market (“margin
buying”) became increasingly common prior to the Wall Street Crash of 1929.

Asset-liability mismatch

Another factor believed to contribute to financial crises is asset-liability mismatch,

a situation in which the risks associated with an institution’s debts and assets are
not appropriately aligned. For example, commercial banks offer deposit accounts
which can be withdrawn at any time and they use the proceeds to make long-
term loans to businesses and homeowners. The mismatch between the banks’
short-term liabilities (its deposits) and its long-term assets (its loans) is seen as
one of the reasons bank runs occur (when depositors panic and decide to
withdraw their funds more quickly than the bank can get back the proceeds of its
loans).[14] Likewise, Bear Stearns failed in 2007-08 because it was unable to
renew the short-term debt it used to finance long-term investments in mortgage
securities.

In an international context, many emerging market governments are unable to

sell bonds denominated in their own currencies, and therefore sell bonds
denominated in US dollars instead. This generates a mismatch between the
currency denomination of their liabilities (their bonds) and their assets (their local
tax revenues), so that they run a risk of sovereign default due to fluctuations in
exchange rates.

Uncertainty and herd behavior

Many analyses of financial crises emphasize the role of investment mistakes

caused by lack of knowledge or the imperfections of human reasoning.
Behavioral finance studies errors in economic and quantitative reasoning.
Psychologist Torbjorn K A Eliazonhas also analyzed failures of economic
reasoning in his concept of ‘œcopathy  istorians, notably Charles P.
Kindleberger, have pointed out that crises often follow soon after major financial
or technical innovations that present investors with new types of financial
opportunities, which he called “displacements” of investors’ expectations.

Early examples include the South Sea Bubble and Mississippi Bubble of 1720,
which occurred when the notion of investment in shares of company stock was
itself new and unfamiliar,[20] and the Crash of 1929, which followed the
introduction of new electrical and transportation technologies. [21] More recently,
many financial crises followed changes in the investment environment brought
about by financial deregulation, and the crash of the dot com bubble in 2001
arguably began with “irrational exuberance” about Internet technology.

Unfamiliarity with recent technical and financial innovations may help explain how
investors sometimes grossly overestimate asset values. Also, if the first investors
in a new class of assets (for example, stock in “dot com” companies) profit from
rising asset values as other investors learn about the innovation (in our example,
as others learn about the potential of the Internet), then still more others may
follow their example, driving the price even higher as they rush to buy in hopes of
similar profits.

If such “herd behavior” causes prices to spiral up far above the true value of the
assets, a crash may become inevitable. If for any reason the price briefly falls, so
that investors realize that further gains are not assured, then the spiral may go
into reverse, with price decreases causing a rush of sales, reinforcing the
decrease in prices.

Regulatory failures:

Governments have attempted to eliminate or mitigate financial crises by

regulating the financial sector. One major goal of regulation is transparency:
making institutions’ financial situations publicly known by requiring regular
reporting under standardized accounting procedures. Another goal of regulation
is making sure institutions have sufficient assets to meet their contractual
obligations, through reserve requirements, capital requirements, and other limits
on leverage.

Some financial crises have been blamed on insufficient regulation, and have led
to changes in regulation in order to avoid a repeat. For example, the Managing
Director of the IMF, Dominique Strauss-Kahn, has blamed the financial crisis of
2008 on ‘regulatory failure to guard against excessive risk-taking in the financial
system, especially in the US’.[23] Likewise, the New York Times singled out the
deregulation of credit default swaps as a cause of the crisis.

However, excessive regulation has also been cited as a possible cause of

financial crises. In particular, the Basel II Accord has been criticized for requiring
banks to increase their capital when risks rise, which might cause them to
decrease lending precisely when capital is scarce, potentially aggravating a
financial crisis.

Fraud :

Fraud has played a role in the collapse of some financial institutions, when
companies have attracted depositors with misleading claims about their
investment strategies, or have embezzled the resulting income. Examples
include Charles Ponzi’s scam in early 20th century Boston, the collapse of the
MMM investment fund in Russia in 1994, the scams that led to the Albanian
Lottery Uprising of 1997, and the collapse of Madoff Investment Securities in
2008.

Many rogue traders that have caused large losses at financial institutions have
been accused of acting fraudulently in order to hide their trades. Fraud in
mortgage financing has also been cited as one possible cause of the 2008
subprime mortgage crisis; government officials stated on Sept. 23, 2008 that the
FBI was looking into possible fraud by mortgage financing companies Fannie
Mae and Freddie Mac, Lehman Brothers, and insurer American International
Group.
 Contagion

Contagion refers to the idea that financial crises may spread from one institution
to another, as when a bank run spreads from a few banks to many others, or
from one country to another, as when currency crises, sovereign defaults, or
stock market crashes spread across countries. When the failure of one particular
financial institution threatens the stability of many other institutions, this is
called systemic risk.

One widely-cited example of contagion was the spread of the Thai crisis in 1997
to other countries like South Korea. However, economists often debate whether
observing crises in many countries around the same time is truly caused by
contagion from one market to another, or whether it is instead caused by similar
underlying problems that would have affected each country individually even in
the absence of international linkages.

Cause of the financial crisis:-

In August 2002 an analyst identified a housing bubble. Dean Baker wrote that
from 1953 to 1995 house prices had simply tracked inflation, but that when house
prices from 1995 onwards were adjusted for inflation they showed a marked
increase over and above inflation-based increases. Baker drew the conclusion
that a bubble in the US housing market existed and predicted an ensuing crisis. It
later proved impossible to convince responsible parties such as the Board of
Governors of the Federal Reserve of the need for action. Baker’s argument was
confirmed with the construction of a data series from 1895 to 1995 by the
influential Yale economist Robert Shiller, which showed that real house prices
had been essentially unchanged over those 100 years.

A common claim during the first weeks of the financial crisis was that the problem
was simply caused by reckless, sub-prime lending. However, the sub-prime
mortgages were only part of a far more extensive problem affecting the entire
$20 trillion US housing market: the sub-prime sector was simply the first place
that the collapse of the bubble affecting the housing market showed up.

The ultimate point of origin of the great financial crisis of 2007-2009 can be
traced back to an extremely indebted US economy. The collapse of the real
estate market in 2006 was the close point of origin of the crisis. [12] The failure
rates of subprime mortgages were the first symptom of a credit boom tuned to
bust and of a real estate shock. But large default rates on subprime mortgages
cannot account for the severity of the crisis. Rather, low-quality mortgages acted
as an accelerant to the fire that spread through the entire financial system. The
latter had become fragile as a result of several factors that are unique to this
crisis: the transfer of assets from the balance sheets of banks to the markets, the
creation of complex and opaque assets, the failure of ratings agencies to
properly assess the risk of such assets, and the application of fair value
accounting. To these novel factors, one must add the now standard failure of
regulators and supervisors in spotting and correcting the emerging weaknesses.

For many months before September 2008, many business journals published
commentaries warning about the financial stability and risk management
practices of leading U.S. and European investment banks, insurance firms and
mortgage banks consequent to the subprime mortgage crisis.

Beginning with failures caused by misapplication of risk controls for bad debts,
collateralization of debt insurance and fraud, large financial institutions in the
United States and Europe faced a credit crisis and a slowdown in economic
activity. The crisis rapidly developed and spread into a global economic shock,
resulting in a number of European bank failures, declines in various stock
indexes, and large reductions in the market value of equities and commodities.
Moreover, the de-leveraging of financial institutions further accelerated the
liquidity crisis and caused a decrease in international trade. World political
leaders, national ministers of finance and central bank directors coordinated their
efforts to reduce fears, but the crisis continued.

At the end of October a currency crisis developed, with investors transferring vast
capital resources into stronger currencies such as the yen, the dollar and the
Swiss franc, leading many emergent economies to seek aid from the
International Monetary Fund.

Impact of various world financial crises:-

I found it encouraging that the economy is not trashed everywhere.  

If you happen to be living in Bhutan, Namibia, or Belarus, times is great!  The

wealthiest 1% of these countries are even lighting cigars with one dollar bills.  I
suspect some of these countries are benefiting from one-off events that have
helped them.  While most of Southern Africa is doing poorly, I expect Namibia is
seeing an up tick from the Brangelina baby effect.  Similarly, the favorable dollar
to corpse exchange rate is doing wonders for Democratic Republic of Congo’s
dead body based economy.  Unfortunately for the rest of the world, the old
saying is true… as goes Greenland, so goes the world.

After eight years of being pummeled with the Bush Doctrine, we’ve gotten used
to ignoring the rest of the rest of the world in favor of USA, USA, USA .  Futura at
cFAP has made a beautiful chart showing the job losses by state:
Global economic recession:-

Number of U.S. residential properties subject to foreclosure actions by quarter

(2007-2008).

Sub prime lending is the practice of lending, mainly in the form of mortgages for
the purchase of residences. These mortgages departed significantly from the
usual criteria for borrowing at the lowest prevailing market interest rate. The
departures in criteria pertained to “nontraditional”, higher-risk structure of the
loans (such as “option ARMs”), poor loan documentation, low levels of collateral,
the borrower’s credit score, credit history and other factors. When real estate
prices fall, the value of the collateral securing the mortgage drops and the risk of
loss to the lender increases significantly. If a borrower is delinquent in making
timely mortgage payments to the loan service (a bank or other financial firm), the
lender may be forced to take possession of the property, in a process called
foreclosure.

The value of USA sub prime mortgages was estimated at $1.3 trillion as of March
2007, with over 7.5 million first-lien sub prime mortgages outstanding. Between
2004-2006 the share of sub prime mortgages relative to total originations ranged
from 18%-21%, versus less than 10% in 2001-2003 and during 2007. In the third
quarter of 2007, sub prime ARMs making up only 6.8% of USA mortgages
outstanding also accounted for 43% of the foreclosures which began during that
quarter. By October 2007, approximately 16% of sub prime adjustable rate
mortgages (ARM) were either 90-days delinquent or the lender had begun
foreclosure proceedings, roughly triple the rate of 2005. By January 2008, the
delinquency rate had risen to 21%. and by May 2008 it was 25%.

The value of all outstanding residential mortgages, owed by USA households to

purchase residences housing at most four families, was US$9.9 trillion as of
year-end 2006, and US$10.6 trillion as of midyear 2008. During 2007, lenders
had begun foreclosure proceedings on nearly 1.3 million properties, a 79%
increase over 2006. This increased to 2.3 million in 2008, an 81% increase vs.
2007. As of August 2008, 9.2% of all mortgages outstanding were either
delinquent or in foreclosure. Between August 2007 and October 2008, 936,439
USA residences completed foreclosure. Foreclosures are concentrated in
particular states both in terms of the number and rate of foreclosure filings. Ten
states accounted for 74% of the foreclosure filings during 2008; the top two
(California and Florida) represented 41%. Nine states were above the national
foreclosure rate average of 1.84% of households.

Today’s world is integrated with product & market due to globalization. Very few
countries have lowered barriers to international trade in the era of globalization.
The global economic slow down has drastic consequences on developing
countries like Bangladesh. The countries that wear dependent on the USA, EU
and Japan as export markets for their products and tourism faced sever
constrainers in maintaining their growth and economic levels. This is turning
adversely affected foreign exchange earnings, employment generation, and govt.
tax revenues in developing countries.

How to fight recessions?

Most of the countries in the world use two major tools in fighting economic
reasons in their own countries i.e. one is Monetary policy and another are Fiscal
Policy. A Government can use its monetary policy, the regulation of the money
supply or interest’s rate in order to influence economic growth. The impact of the
monetary policy would reflect on the interest rate and investments. Providing
adequate liquidity to the market could be controlled through Statutory Reserve
Requirements (RSS). The Central Bank can use open market operation through
changing Discount and Rediscount rate. The other tool a Government could use
to stimulate economic growth is the Fiscal policy. Excise duty, customs duty and
corporate tax rates could be used as an incentive to industries in an economy.
Fiscal policy could lead to a decrease in income tax or an increase in spending.

 Fair trade could be an instrument to fight recession in a free market economy.

The private sectors through its firm play a key role in economic development. In
order to continue within the business, enter into expansion programmers and
invest more capital into industries, carry out research and developments and
enter into global market, firms must have at least normal profits. In order for them
to earn normal profits, the government should create an environment and no
unfair trade practices should upset the equilibrium of the firm.

Europe and the financial crisis:-

In Europe, a number of major financial institutions failed. Others needed

rescuing. n Iceland, where the economy was very dependent on the finance
sector, economic problems have hit them hard. The banking system virtually
collapsed and the government had to borrow from the IMF and other neighbors
to try and rescue the economy. In the end, public dissatisfaction at the way the
government was handling the crisis meant the Iceland government fell. A number
of European countries have attempted different measures (as they seemed to
have failed to come up with a united response).

For example, some nations have stepped in to nationalize or in some way

attempt to provide assurance for people. This may include guaranteeing 100% of
people’s savings or helping broker deals between large banks to ensure there
isn’t a failure.

The EU is also considering spending increases and tax cuts said to be worth
€200bn over two years. The plan is supposed to help restore consumer and
business confidence, shore up employment, getting the banks lending again, and
promoting green technologies.

One of the first victims was Northern Rock, a medium-sized British bank. The
highly leveraged nature of its business led the bank to request security from the
Bank of England. This in turn led to investor panic and a bank run in mid-
September 2007. Calls by Liberal Democrat Shadow Chancellor Vince Cable to
nationalize the institution were initially ignored; in February 2008, however, the
British government (having failed to find a private sector buyer) relented, and the
bank was taken into public hands. Northern Rock’s problems proved to be an
early indication of the troubles that would soon befall other banks and financial
institutions.

Initially the companies affected were those directly involved in home construction
and mortgage lending such as Northern Rock and Countrywide Financial.
Financial institutions which had engaged in the securitization of mortgages such
as Bear Stearns then fell prey.

Later on, Bear Stearns was acquired by JP Morgan Chase through deliberate
assistance from the US government. Its stock price plunged to $3 in reaction to
the buyout offer of $2 by JP Morgan Chase, well below its 52 week high of $134.
Subsequently, the acquisition price was raised to $10 by JP Morgan. On July 11,
2008, the largest mortgage lender in the US, Indy Mac Bank, collapsed, and
federal regulators seized its assets after the mortgage lender succumbed to the
pressures of tighter credit, tumbling home prices and rising foreclosures. That
day the financial markets plunged as investors tried to gauge whether the
government would attempt to save mortgage lenders Fannie Mae and Freddie
Mac, which it did by placing the two companies into federal conservatorship on
September 7, 2008 after the crisis further accelerated in late summer.

The media have repeatedly argued that the crisis then began to affect the
general availability of credit to non-housing related businesses and to larger
financial institutions not directly connected with mortgage lending. While this is
true, the reasons given in media reporting are usually inaccurate. Dean Baker
has repeatedly explained the actual, underlying problem:

“Yes, consumers and businesses can’t get credit as easily as they could a year
ago. There is a really good reason for tighter credit. Tens of millions of
homeowners who had substantial equity in their homes two years ago have little
or nothing today. Businesses are facing the worst downturn since the Great
Depression. This matters for credit decisions. A homeowner with equity in her
home is very unlikely to default on a car loan or credit card debt.

They will draw on this equity rather than lose their car and/or have a default
placed on their credit record. On the other hand, a homeowner who has no equity
is a serious default risk. In the case of businesses, their creditworthiness
depends on their future profits. Profit prospects look much worse in November
2008 than they did in November 2007 (of course, to clear-eyed analysts, they
didn’t look too good a year ago either). While many banks are obviously at the
brink, consumers and businesses would be facing a much harder time getting
credit right now even if the financial system were rock solid. The problem with the
economy is the loss of close to $6 trillion in housing wealth and an even larger
amount of stock wealth.

The New York City headquarters of Lehman Brothers.

Economists, economic policy makers and economic reporters virtually all missed
the housing bubble on the way up. If they still can’t notice its impact as the
collapse of the bubble throws into the worst recession in the post-war era, then
they are in the wrong profession.

At the heart of the portfolios of many of these institutions were investments

whose assets had been derived from bundled home mortgages. Exposure to
these mortgage-backed securities, or to the credit derivatives used to insure
them against failure, threatened an increasing number of firms such as Lehman
Brothers, AIG, Merrill Lynch, and HBOS.[43][44][44][45]

Other firms that came under pressure included Washington Mutual, the largest
savings and loan association in the United States, and the remaining large
investment firms, Morgan Stanley and Goldman Sachs.

The crisis rapidly developed and spread into a global economic shock, resulting
in a number of European bank failures, declines in various stock indexes, and
large reductions in the market value of equities [48] and commodities.[14] Moreover,
the de-leveraging of financial institutions further accelerated the liquidity crisis
and caused a decrease in international trade. World political leaders, national
ministers of finance and central bank directors coordinated their efforts to reduce
fears, but the crisis continued. At the end of October a currency crisis developed,
with investors transferring vast capital resources into stronger currencies such as
the yen, the dollar and the Swiss franc, leading many emergent economies to
seek aid from the International Monetary Fund.[22][23]
 Risks and regulations:

As financial assets became more and more complex, and harder and harder to
value, investors were reassured by the fact that both the international bond rating
agencies and bank regulators, who came to rely on them, accepted as valid
some complex mathematical models which theoretically showed the risks were
much smaller than they actually proved to be in practice [50]. George Soros
commented that “The super-boom got out of hand when the new products
became so complicated that the authorities could no longer calculate the risks
and started relying on the risk management methods of the banks themselves.
Similarly, the rating agencies relied on the information provided by the originators
of synthetic products. It was a shocking abdication of responsibility.”

 World Financial Crisis: India’s Hurting, Too:

It’s been one action-packed week in India. The Bombay Stock Exchange Index,
or Sensex, tumbled 6% to a two-year low. For the first time in five years, the
central bank cut the cash reserve ratiothe amount of funds that banks have to
keep with the Reserve Bank of India—by 50 basis points, to 8.5%, on Oct. 6. The
same evening, the Securities & Exchange Commission of India eased some
restrictions on foreign portfolio investors—such as registering in India before
buying shares and limits on offshore derivatives—it had imposed in 2007. And
finance minister Palaniappan Chidambaram made yet another television
appearance that day to say that India was safe from the global turmoil, and “the
only fear is fear itself.”

There’s no mistaking that the global financial crisis has found its way to India’s
shores at a time when the country is in no shape to weather it. The stock market
is choppy, there’s been a credit squeeze, interest rates are up, and banks
continue to rein in loans as inflation hovers at 12%.

Growth has slowed from the heady 9% of a year ago to 7.9% for the three
months ended in June, and it’s forecast to grow only at 7.5% for the fiscal year
ending next March. Meanwhile, an already weak currency ended Oct. 8 at 48
rupees to the dollar, its lowest level in 5½ years. The rupee has taken a 21% dive
since January. The central bank’s rate cut, which the bank statement calls “ad
hoc and temporary,” is likely to infuse $4 billion in domestic liquidity and shore up
the rupee by selling dollars.

As the global financial crisis began unfolding in the first nine months of 2008,
foreign institutional investors pulled out close to $10 billion from India, dragging
the capital market down with it. The liquidity crisis, coupled with the credit
squeeze and a weak currency, is already hurting various sectors. Banks have
reined in retail financing, affecting home and auto loans. Car loans account for
70% of consumer auto purchases now, down from 85% a year ago. Meanwhile,
consumers are deferring other purchases while financiers have been logging a
drop in loan disbursal rates. “We are tightening our lending norms to certain
customer segments,” says N.R. Narayanan, general manager of vehicle
financing at ICICI Bank (IBN), India’s largest private-sector bank. Industry
insiders say ICICI expects a 35% dip in disbursals this year, far underperforming
the industry average of 16%. Narayanan says it plans to increase auto loan rates
by 75 basis points to 100 basis points soon, which will further crimp sales. In
August, industry wide sales fell 5%.

 Corporate Money-Raising Efforts:

The corporate sector is struggling, too, as expansion plans and merger activity
are pushed to the back burner. With the capital markets drying up, and curbs
imposed on external commercial borrowings, corporate India has been looking at
alternate routes to raise money.

Private equity players say listed and unlisted companies are approaching them
for finance, offering 20% to 30% returns from the first year. And big Indian
conglomerates such as Tata Group and Birla Group are looking at rights issues
to raise money.

The weak rupee is of little help to exporters. Just last November, the textile and
apparel industry was reeling from an 11% appreciation of the rupee, as U.S. and
European clients were negotiating contracts and looking for cheaper alternatives
to source garments. This time, though, the rupee has depreciated 21% in the
past nine months, but the industry is still struggling. “What can we do when we
are struck by a triple whammy?” asks Rajendra Hinduja, managing director of
Bangalore-based Gokaldas Exports, India’s largest apparel exporter, which was
bought out by Blackstone (BX) in August 2008. The gains from a weak rupee are
offset by rising input costs—cotton prices have increased 30% in the past year—
the high cost of borrowing, and the financial turmoil in their main export markets,
the U.S. and Europe. Gokaldas’ clients include Nike (NKE), Reebok, Aidas
(ADSG.DE), and Tommy Hilfiger.

Bloody Monday September 15, 2008 

Bloody Monday, September 15, 2008.  The Dow Jones industrial average (DJIA)
declined by 504 points  (4.4%), its largest drop since Sept. 17, 2001, when
trading resumed after the 9/11 attacks.
The financial slide preceded unabated, leading to an 800 point decline of the
Dow Jones in less than a week. The World’s stock markets are interconnected
“around the clock” through instant computer link-up. Volatile trading on Wall
Street immediately “spills over” into the European and Asian stock markets
thereby rapidly permeating the entire financial system.

The Most Serious Financial Crisis since the 1929 Wall Street Crash

When viewed in a global context, taking into account the instability generated by
speculative trade, the implications of this crisis are far-reaching. The crisis,
however, has by no means reached its climax. It could potentially disrupt the very
foundations of the international monetary system. The repercussions on people’s
lives in America and around the world are dramatic.

The crisis is not limited to the meltdown of financial markets, the real economy at
the national and international levels, its institutions; its productive structures are
also in jeopardy. As stock values collapse, lifelong household savings are
eroded, not to mention pension funds. The financial meltdown inevitably
backlashes on consumer markets, the housing market, and more broadly on the
process of investment in the production of goods and services.

Impact of global economic crisis on Bangladesh:-

The financial crisis that started in the US in March of this year has now turned
into a full-fledged economic crisis that has pushed the European Union, Japan,
Hong Kong and others into recession there is a saying that when America
sneezes, countries around the world get flu. This has been evident from the fact
that the American financial crisis has left everyone in a state of shock.

Bangladesh is captive to what transpires in international markets and economies

of leading countries. Against the background, Bangladesh cannot be immune
from the global economic slowdown and is most likely to be adversely affected
sooner or later.
Why this crisis?

To put it simply, it has been argued the whole meltdown of the financial system
was “Made In America” for having relaxed rules of providing loans to jobless
people with no income for buying houses, called “sub-prime housing loans” or
now known as “toxic loans or assets” amounting to about $2.1 trillion dollars.
Banks and financial institutions that bought security-paper have lost money. In its
latest calculations, the IMF reckons that worldwide losses on “toxic assets”
originated in America will reach $1.4 trillion and so far $760 billion has been
written down by banks and financial institutions.
Normally the banks and financial institutions lend and borrow money and the
money market works well. During the crisis, money markets ceased to function
as investors and banks who ordinarily arrange foreign exchange swaps among
themselves for a set time period are nervous about the risk that their counter-
party will go bust because of liability of “toxic assets” while the swap is being put
into place and so have shied away from such deals.

Thus the global money market was closed and a severe credit-crunch was felt
across the world. If it were allowed to continue further it would have led to
depression.
How does it affect Bangladesh?

In the industrialized countries, it is reported that manufacturers are not making

money, the retailer is not making money and the consumer is complaining
because they are paying more. An unprecedented gloom in the confidence of
consumers is being experienced in these countries. The global slowdown in the
leading economies such as US, Europe, and Japan is likely to adversely affect
principally, in three sectors, namely exports, aid-flow and foreign direct
investment and remittance from workers.
About 75 % of the exports of garments and knitwear go to the US and Europe.

The exports of knitwear and ready made garments to the US and Europe are
likely to fall because there will be no demand in those countries as people would
keep money with themselves for meeting their basic needs during rainy days.
Everyone will be tight with spending money for non-essentials.

Bangladesh needs foreign direct investment (FDI) up to 28% per cent of GDP
(almost 415 billion) every year to reduce poverty in the country. Whatever FDI
was coming to Bangladesh was encouraging but it is likely to slow down
considerably.
Likewise the volume of foreign aid and loans to Bangladesh may also likely to be
affected from the industrialized countries. It is noted that during the financial year,
nearly 14% of its expenditure of the development budget of Bangladesh relies on
foreign aid and loans.

It is reported that remittances during the last financial year stood to almost $7
billion dollars, 25% per cent were from the industrialized countries in the West
and 75% per cent come from the Middle East. The Middle East has not been
immune from the crisis and stocks fell over in the oil-rich countries, even in
Dubai. Given the background, it is likely that remittances will be less because
there will be jobs-cut in the countries of economic slowdown.
There is one flip side of the financial crisis in that price of oil has plummeted to a
level, unimaginable this summer. At the time of writing it was less than $50
dollars, from the highest $147 dollars per barrel. That would enormously help
Bangladesh which imports oil.

Bangladesh could feel impact of world financial crisis :

Visiting vice-president of World Bank for South Asia Isabel Guerrero Sunday said
Bangladesh could feel an impact of the global economic recession and the
country needs to prepare social safety net program to face the impact.

“So far Bangladesh has not felt the impact of the financial crisis…But it is
possible in the future through Bangladesh’s manpower exports and remittances,”
she told reporters here after meeting with Bangladesh’s Foreign Minister
DipuMoni.

Isabel said Bangladesh has time to prepare social safety net program in a way
that when the crisis comes the government is ready to help those people who are
worst affected in the crisis.

Isabel who earlier met with Bangladesh’s Prime Minister Sheikh Hasina said
World Bank has a program of 3.6 million U.S. dollars for three years for
Bangladesh and that program will be available to help through the crisis if it
comes.

The World Bank official who came here Saturday on a 3-day visit said it is
important that the people get the benefit of the safety net programs. Besides, she
said there could be many improvements in development programs so that the
implementation is better.

About WB’s support for power generation, Isabel said “We get ready to support
on the power sector,” as the power generation is said to be the number one
priority of the government.

Suggested steps

Against the background, private sectors are likely to shed employees in the
country and as a result, unemployment is likely to increase in the country. The
government’s principal aim is to keep unemployment in check.
Many economists suggest that one of the ways to keep unemployment at bay is
to spend money on infrastructure with the benefit of enhancing employment and
ultimately increasing productivity. Second, purchasing power must be increased
to vulnerable groups by directly giving money or food for works so that their basic
needs are met.
Furthermore new business friendly policies may be adopted to attract foreign
investment and a cut in interest rate by Bangladesh Bank is an option to be
considered to boost investment by private sectors. Real estate developers and
garment manufacturers may be given more incentives in cutting taxes and
customs duties in importing raw materials so that engine of growth is maintained.

Bangladesh seems to be in unsheltered territory because such global economic

crisis has never occurred before. It is qualitatively different from earlier economic
break down in 1987 and in 1997 in South East Asia. Bangladesh’s economic
security is likely to be threatened. No one can be sure what lies ahead for at least
two years. It is commendable that the government has set up a task force with
local think-tanks and private sectors as to how to address slowing economic
growth in the country.
The volatile situation is both a challenge and an opportunity for Bangladesh to
show innovation and creativity to come out from the likely adverse effects of
global economic crisis.

Experts and economists called Saturday for formation of a high-powered

taskforce to assess the possible impact of the global financial meltdown on
Bangladesh and devise both short and medium-term policy measurers to protect
the domestic economy.

Speaking at a dialogue, most of the discussants while seeing no major impact of

the global crisis on Bangladesh gave their opinion in favor of setting up such a
body as precautionary steps.

Largely participated by policy makers, economists, business leaders,

representatives of foreign missions, politicians and members of the civil society,
the dialogue on “The Global Financial Crisis and What it means for Bangladesh”
was organised by the Centre for Policy Dialogue (CPD) at the city’s CIRDAP
auditorium.

Bangladesh Bank Governor SalehuddinAhmed spoke on the occasion while

Ambassador and Permanent Representative of Bangladesh to the WTO and UN
Offices in Geneva Debapriya Bhattacharya presented the keynote paper on the
dialogue with prominent economist RehmanSobhan in the chair.

“There is a need to set up a competent task force to assess the effects and
impact and design an adjustment package with both short and medium term
policy institutional measurers,” Debapriya said while presenting his keynote
paper.
It is too early to conclusively assess the impact on Bangladesh as the global
financial crisis continues to rage across the world, he said, adding, “We do not
have the real time data to assess the situation.”

Also laying emphasis on the need for macro-economic policy adjustment, he said
it can be done by reviewing the public expenditure portfolio to accelerate
implementation of infrastructure projects and strengthening credit flow. He put a
number of suggestions including taking the advantages of sobering trend in
inflation, persuasion of expansionary monetary policy and lowering of interest
rates in line with inflationary trend.

The economist-turned envoy also recommended an active management of

exchange rate, strict monitoring on the activities of credit rating agencies,
intensification of export market exploration in emerging economies and
consolidation of the country’s labor markets.

Agreeing with Dr.Debapriya about setting up of a taskforce, the BB governor,

however, called for united efforts from all the agencies concerned to help protect
the country from current global financial crisis.

“Not only the central bank, all the agencies should come forward to help the
country prevent the effects of global financial crisis,” the BB governor said.
He also said the central bank is closely monitoring the emerging situation and
has already taken some measures in this connection.

“We are in favour of injecting money into the market, but at the same time it must
be ensured that the money goes to small investors and agriculture sector instead
of big borrowers,” Dr.Salehuddin said.

He said: “We must not allow any short-term portfolio investments.”

The BB chief also suggested that there was an urgent need to be careful about
the activities of country’s securities market and insurance companies against the
backdrop of the global financial turmoil.

Giving his opinion in favour of setting up of a taskforce and adoption of

expansionary monetary policy, Former finance minister AbulMalAbdulMuhit,
however, observed that the highest priority should be given to the country’s
agriculture sector and rural development.

The president of Bangladesh Knitwear Manufacturers and Exporters Association

(BKMEA), FazlulHaq, said their exports are on a declining trend following the
global financial crisis. Considering the situation, he urged the government should
refrain from raising the prices of fuel oils and gas at this moment.
Also echoing the sentiment expressed by the BKMEA president, the former
BFCCI president Mir Nasir Hossain observed that the authorities should not go
for devaluation of the local currency right now.

BGMEA, BKMEA express frustration

Few trade bodies have expressed their frustration over the financial stimulus
package the government announced yesterday to help face the recession
challenges and demanded reconsideration of the incentives. “I can’t consider it a
complete stimulus package… it only addressed the concerns of three sectors
from the recession-hit ones,” FBCCI president AnnisulHuq told yesterday in an
instant reaction.
He said the spinning sub-sector of the textile industry has been affected badly,
but it has got no specific stimulus to face the situation.  The country’s apex trade
body leader, also a leader of the RMG industry, said the apparel sector would be
frustrated, although the sector has so far remained out of strong impact of the
recession.

He said: “The government needs to be flexible in this regard and remain alert so
it can come forward to rescue the sector from any worst situation as soon as
possible.”
AnnisulHuq, however, appreciated the positive initiative of the government for
giving some sort of economic direction before the next budget, which would have
a good reflection on the internal economy.

He said there are some good policy indications in the announcement, but they
are under consideration and some of them are budgetary measures. “Those are
not policy decisions,” he said, adding that if implemented, the policies would yield
some good results. BGMEA president AbdusSalamMurshedy termed the
package “unwanted” as it did not take steps to save the apparel sector from the
clutches of the ongoing economic meltdown.” We see the package hardly gave
any importance to the RMG sector,” he told a hurriedly called press briefing at
the BGMEA conference room, expressing his deep disappointment. Leaders of
BGMEA demanded the government of providing additional Taka 10 as exchange
rate per dollar up to 30 per cent of total RMG exports to help the industry tackle
the shock of the global recession. They said Bangladesh’s competitors India,
Pakistan, Vietnam and Cambodia have depreciated their currencies and China,
India and Pakistan have announced economic packages in order to support their
respective RMG sectors.

“The entrepreneurs of the industry are gradually loosing their competitiveness,”

he said and demanded wavering 0.25 per cent source tax, exemption of all VAT,
including utility bills, and fixing zero per cent duty on imports of capital
machinery, spare parts and accessories for RMG industry. Like the agriculture
sector, the government should also provide subsidy on diesel for running
generators in the garments industries, he said.

He also demanded lowering the bank interest rate to single digit and also provide
subsidy on bank interest rate and bringing down all bank charges at tolerable
levels.
The BGMEA president urged the government to reconsider the stimulus package
to accommodate allocations for them as a great danger is knocking at “our
doors.”
BKMEA, the knit sub-sector of the apparel industry, also expressed their
frustration over the stimulus package as they have been ignored.  Criticising the
package, BKMEA president Fazlul Haque said that he does not find any
justification for increasing the subsidy allocation for the agriculture as the sector
is not affected by the recession.
“The package utterly neglected the export sector,” he told a press briefing at the
BKMEA conference room.

Haque said Bangladesh Bank has decided to reduce the lending rate and waived
the down payment for loan re-scheduling as they realised the impact of the
recession. “I don’t understand why the government did not pay heed to the RMG
sector.”
During the last three months, he said, export growth of the knit apparel sector
was just five per cent as compared to its average growth of 20 per cent per year.
“We’ve already lost US$ 450 million in the last three months.”
The BKMEA president brought allegation of injustice by the government and
said: “We’ve a good opportunity to cash in on the aftermath of the recession, but
this (government) stimulus package has strangulated that opportunity.”
He urged the government to make readjustment to the allocations of the stimulus
package.

 Global financial crisis starts to bite Bangladeshi garment makers:-

The worst global financial crisis since the 1930s has started to bite Bangladesh’s
key garment industry as buyers are cutting prices and delaying orders meant for
spring and summer seasons, manufacturers said Monday.

Exporters said in the past week alone top buyers including Wall-mart, Tesco,
Prominent and Mercury — who bought apparel worth one billion dollars last year
have demanded up to two per cent rebates on their existing orders. Bangladesh,
which last year became the world’s second largest apparel makers, prides itself
of being the world’s cheapest clothing manufacturers.
But the dubious distinction was not enough to make the retailers happy, as the
credit crunch in its main markets, the United States and the European Union,
have suddenly changed all the equations. “Things are bad. Some of the buyers
have made us give rebates on the existing orders,” said SalimRahman,
managing director of KDS Garments, one of the largest apparel manufacturers of
the country.

“Some of them even are making us to adjust rebates on future orders. They said
they were hit hard by the global financial meltdown,” said Rahman, whose
company exported apparel worth $150 million. The Bangladesh Knitwear
Manufacturers Association (BKMEA) early this month reported a ten per cent
drop in knitted items such as T-shirts and pullovers, but some manufacturers said
things have worsened since then.

“The past week was like a massacre,” said Ziaul Islam Chowdhury, a director of
Knit Asia, adding buyers are now renegotiating prices and delaying orders citing
the ongoing financial turmoil.

“We thought the crisis would not affect us because we offer cheapest rates to the
buyers. But most manufacturers I talked to over the last few days narrated the
same gloomy scenario,” he said.

He said a number of big orders for the spring and summer seasons have also
been delayed as the retailers were not sure how the economic crisis would play
out in the near future. Top buyers like H&M told the FE last week that they would
increase sourcing from Bangladeshi manufacturers, despite a squeeze in retail
sales in most of the rich countries. But this week buyers including the country
chief of UK retail giant Tesco, however, would not comment on the issues of
rebates and delayed orders.

“Most of the top buyers are assessing the situation. We are hearing a lot of
noises of declining orders. Some are even trying to cut already offered prices,”
said Nazrul Islam Swapan, managing director of Nassa Group. Swapan’s group
is the country’s second largest apparel exporter, shipping garments worth $210
million last year. This year it wants to hit the $250 million mark. “I don’t know
what the situation will look like in the next few months. If the gloom persists, there
is no way we can cross our target,” Swapan said.

AnisurRahmanSinha, the owner of the country’s biggest garment manufacturing

group, Opex, however, sees no reason to be panicked, saying cheap prices will
help Bangladesh ride out the turmoil. “It’s true some of the top retailers are
downsizing their inventories due to the crisis. But we don’t think we have much to
worry about,” said Sinha, whose group exported over $250 million dollar in 2007.
“We have to be careful. If we can make shipment timely and keep the quality
intact, I don’t think the global financial crisis will affect us,” he said. Bangladesh
exported garments worth $10.7 billions last year — up more than 16 percent than
last year — which accounted for 76 per cent of the country’s total shipments.

Manpower export may come down to less than half this year: BAIRA;
Blame goes to global economic meltdown:-Dhaka, Feb 23, 2009 (Asia Pulse
Data Source via COMTEX) –

Bangladesh Association of International Recruiting Agency (BAIRA) Monday

apprehended that the global financial crisis may take its toll on the country’s
manpower export bringing it down to less than a half to about four lakh this year if
the crisis prolongs. Some 8, 75,055 workers were dispatched to different
recipient countries last year fetching US $ 9.02 billion.

But due to fall in oil price and economic recession in the West, workers ?
Recipient countries have either scrapped their development activities or trimmed
their development projects,? BAIRA president GolamMostafa told a press
conference at Dhaka Reporters Unity.

In addition to stoppage of issuing new visas, he said, a good number of

expatriate workers might get back home from some countries. The BAIRA
President said the remittance may not be seriously affected this year because
the workers, if they lose their jobs, will return home with money. He thinks that
remittance earning may be US $ one billion less than that of the previous year.
Mostafa suggested that instead of getting scared, activities of Bangladesh
missions in labor recipient countries need to be activated and convince the
employers that the workers should not be sent back as they would face workers
shortage as soon as the temporary phase of recession is over.

He said BAIRA members are in constant touch with employers so they do not
send back the Bangladeshi workers who also need to keep patience and should
not leave their respective workplaces. Mostafa said they are also trying to
transfer the workers from one closing down project to another that needs
workers. The BAIRA President appreciated the Foreign Minister’s meeting with
Ambassadors of the Middle Eastern countries on February 15 and her request to
recruit fresh workers from Bangladesh. He said such initiatives will bring positive
results to manpower export. Mostafa also praised the Prime Minister for her
government’s quick initiative to set up Expatriate Welfare Bank responding to a
proposal of BAIRA. The BAIRA President announced gold medal, crest and TK
40,000 one each for electronic and print media every year. Besides, BAIRA will
also reward two citizens every year for their scientific discoveries and welfare
activities.
Bailout Package May Be Worth Tk 3000 Crore

Wednesday, 15 April 2009

The prime minister will roll out a ‘combined financial package’ for recession-hit
sectors before she tours Saudi Arabia on Apr 22, the finance minister said
Wednesday while the commerce minister hinted that the bailout package could
be worth Tk 2500-3000 crore. Finance minister AMAMuhith, speaking to
reporters almost at the same time, was tight-lipped about the figure when
pressed.

Faruq Khan, the commerce minister, told reporters after a meeting with the
Ireland’s integration minister that the finance minister will speak about the
financial package for the export-focused sectors hit by the global financial
downturn. “But the package is being considered in the region of Tk 2500-3000.
On top of that, we are expecting assistance from the developed countries [for the
export sectors] since the financial meltdown stemmed from them,”

Faruq said. Muhith said after a meeting with the representatives of the
Association of Development Agencies Bangladesh (ADAB) at the Secretariat that
new legislation would also be put in place to ensure the affected sectors get the
financial support as fast as possible.

“The special package is almost at the final stages. It will be announced before
Sheikh Hasina’s Saudi tour,” he told reporters Asked what the package would be
worth, the minister said, “That cannot be disclosed now.” A range of benefits will
be included in the package for sectors being affected by the global recession, he
said. The government was extending financial assistance to several export-
oriented sectors including frozen food and textile. At present, the amount of
outstanding money is more than Tk 1000 crore. However, the finance ministry
waived Tk 243 crore in outstanding with the exporters several weeks ago.

The new law will make sure that the exporters receive the money as soon as
possible or there remains no outstanding amount, the minister added. The
poultry industry will be given special priority in 2009-10 fiscal year, he said to the
reporters after a meeting with Bangladesh Poultry Industries Association. Faruq
Khan told reporters at his ministry the Trading Corporation of Bangladesh will be
made more active to rein in the price of essentials on the eve of Ramadan.

Asked about the sudden price hike of edible oil, he said, “I believe the
businessmen would not do that. We will tell them to keep the price reasonable. If
they don’t then government will take steps because we would not let people
taken hostage by businessmen.”
About the BDR mutiny, the minister, who coordinates the investigation
committees, said, “The investigation is going on very well. We want a thorough
investigation. There is no point carrying out an investigation like the one of
‘Judge Mia’. Otherwise this type of incidents will increase.

“Questioned if it was possible to submit investigation report within the deadline,

he said, “The matter is being looked after by the home ministry. Meanwhile a
draft report has been made. New information will be added to this report.”

Businesses ask for Tk 6,000cr bailout

Monday, March 16th, 2009 The Federation of Bangladesh Chambers of

Commerce and Industry (FBCCI) yesterday sought a Tk 6,000 crore rescue
package to cope with the global financial meltdown.

“We proposed a Tk 6,000 crore bailout package to deal with the economic
recession. We have also asked the government to take initiatives to help boost
the country’s economy,” FBCCI President AnnisulHuq told reporters after a
meeting with Prime Minister Sheikh Hasina at the Prime Minister’s Office (PMO).

The premier said the government would offer “special package” to save country’s
business sectors from any possible negative impact of the current global
economic recession, reported UNB.

The leaders of the country’s apex business body mentioned 17 points at the
meeting and said the rescue fund could be raised by issuing bonds, if necessary.
The delegation led by Annisul said they were facing difficulty in paying bank loan
installments because of the financial meltdown that might cause further problems
and lead to closure of sick industries. “If necessary, the prime minister should
make overseas trips to protect the interests of expatriate Bangladeshi workers,”
they said.

Their points include maintaining good relation with neighboring countries,

announcing Sunday as weekly holiday, checking tender manipulation, making
Better Business Forum and Regulatory Reforms Commission active and
formation of a council for food security.

“We also proposed giving waiver for a year or two for the industries that fail to
repay loans as a result of economic recession,” the FBCCI president said.”
Already the ministries concerned have been directed to identify the problems that
might be created following the world economic recession. After identifying the
problems, government will chalk out plans and offer package programmer for the
business sectors,” the PM said, adds UNB. Under the package programmers, the
prime minister said, the business sectors will be given various facilities and
incentives to keep the country’s economy vibrant increasing the flow of export
and import. About the recent cancellation of Malaysian visas for Bangladeshi
workers, she said the labor and foreign ministers would go to Kuala Lumpur to
find out a solution to the problem. If necessary, Hasina said, she herself would go
to Malaysia and other countries to resolve the issues.

Assuring all of taking every possible measure in this regard, she said the
government, at the same time, is focusing on creating new labor markets in the
foreign countries.

The PM also informed the business leaders about some of her government’s
plans for the country’s development.

She said the government is planning to activate Bhola power plant and special
economic zone in the country’s comparatively “poor and neglected” districts to
expedite trade and business to create more employment opportunities. Hasina
further informed that the government has a plan to set up hydropower plants in
areas abound with rivers and haors. To popularize the solar energy system,
taxes on the solar system equipment have already been withdrawn, she added.

The prime minister suggested the industrialists to set up small power stations at
their own factories saying that it will help to reduce the scarcity of electricity in the
industries and even in the adjacent localities. To increase navigability of the
country’s waterways, rivers will be dredged gradually; she said adding that the
government will dredge the Mongla port to fully reactivate it. She also asked the
business leaders to invest in the proposed economic zones of the country.

Hasina said Bangladesh can capture huge market abroad for organic foods and
vegetables. “Try to exploit the potentials.” She thanked the businessmen for
reducing the price of edible oil and requested them, if possible, to reduce the
prices of other daily essentials as well. The government attaches equal
importance to both public and private sectors for overall development of the
country, the PM said.

Hasina also thanked the business leaders for their role in holding the December
29 polls in free and fair manner and for standing beside the government to
resolve the February 25-26 Pilkhana carnage in a peaceful manner. The FBCCI
leaders highly praised the PM’s “wise and farsighted” steps to resolve the BDR
carnage quickly and peacefully. The leaders observed that the prime minister’s
February 26 speech to the nation had played an outstanding role to disarm the
“killers” which saved lives of many army officers and their family members.
Hasina mourned the death of “well educated and talented” army officers and
civilians in the BDR carnage. The prime minister categorically said she does not
want to see any more conflicting situation, which is immensely harmful to the
country’s image as well as trade and investment.

Recognizing the achievements of armed forces and police department’s in the

UN peacekeeping missions, she said that if any more conflicting situation takes
place in the country, the fame earned by the armed forces and police will be
harmed. PM’s Secretary MollahWahiduzzaman, Press Secretary Abul Kalam
Azad and Deputy Press Secretary Mahbubul Hoque Shakil were present at the
meeting.

ADB cuts growth forecast for Bangladesh economy

March 10, 2009

The Asian Development Bank (ADB) has revised downward its growth forecast
for Bangladesh economy, ranging between 5.5 per cent and 6.0 per cent, for the
fiscal (FY) 2008-09 against the backdrop of the ongoing global financial crisis.
‘Before the onset of the global financial crisis, a 6.5 per cent growth target for
FY2009 appeared attainable. With the financial crisis in the advanced economies
unfolding and recession appearing to last longer than earlier anticipated, a
growth rate in the range of 5.5 per cent to 6.0 per cent seems more likely in
FY2009, the ADB said in its latest Bangladesh Quarterly Economic Update
(BQEU).

The global financial crisis is yet to significantly affect Bangladesh, the December
BQEU also said, adding that the pressure from the global slowdown is building
up with signs of moderation in growth. Economic performance in the July-
September of FY2009 had held up reasonably well with steady progress in
domestic economic activity and satisfactory growth in exports and remittances,
said the BQEU released Monday.

According to the Economic Update, growth in ready-made garment production,

together with improved business confidence and recovery in housing and
construction, stimulated the industrial activity. During the October-December
period, export growth decelerated affecting the export-based industrial
production, and growth in remittances also moderated, it revealed.

Highlighting the sector-wise performances, the ADB said Bangladesh’s

agriculture sector is expected to attain the target growth rate of 4.0 per cent, up
from the actual growth of 3.6 per cent in the FY2008.Production of rice and
wheat for the FY2009 is targeted at 34.3 million tonnes33.3 million tones of rice
and 1.0 million tones of wheat — 15.1 per cent rise from the actual production in
FY2008, the BQEU said. Bumper harvests of Aman rice, maize, wheat and
potato in FY2009 have already been reported, it said. A favorable outlook is
maintained also for the upcoming Boro crops because of good weather
conditions together with strong support from the government to ensure
availability of key agricultural inputs, it added.

The prospects for output in various non-crop sub-sectors of agriculture also

appear bright, it said, adding that the fishery sub-sector has performed well
because of the growing domestic demand.

The country’s industrial growth is expected to be in the range of 6.6 per cent to
7.2 per cent this fiscal compared to 6.9 per cent in FY2008 with production for
exports continuing the slowing trends that became evident in the October-
December period of FY2009, the ADB said. It also said aided by the robust
export growth of 42.4 per cent in the July-September of FY2009, the ready-made
garment production, together with improvements in business confidence and
recovery in housing and construction, stimulated the industrial activity.

However, exports declined by 1.4 per cent in October- December of FY2009

implying a slowdown in export-based industrial production, it said.

‘On the contrary, falling prices of construction materials and a rise in demand for
real estate because of the growth in bank credit and higher remittances helped
revive the construction sub-sector,’ the ADB said.

It also suggested that the prevailing shortages in power and gas supplies need to
be urgently addressed to promote the industrial sector. The lack of gas supplies
will also constrain power generation and new investment in manufacturing
activities, it said, adding that the country’s export-based industry sector is likely to
experience a slowdown in the coming months. According to the ADB, growth of
the country’s services sector will slow to the range of 5.8 per cent to 6.2 per cent,
down from 6.7 per cent in FY2008, due to lower activities in the export sector and
declines in consumption spending induced by lower income and moderation in
remittance growth.

Services, especially wholesale and retail trade and transport and

telecommunications, performed well in July-September of FY2009. The
satisfactory performance of agriculture and industry has contributed to healthy
service sector growth, it said, mentioning that in October-December, escalation in
demand for services during the parliamentary elections, contributed to boost
retail trade in both rural and urban areas.
On the other hand, profit margins of private sector banks remain quite healthy,
and are likely to have a positive impact on growth of financial services.

However, the global financial crisis will have an adverse impact on the services
sector as well, because of effects on industry, particularly related to exports, and
compression of domestic demand in general. In its Economic Update, the ADB
projected the rate of inflation at about 7.0 per cent for the year as a whole, down
from 9.9 per cent in FY2008.

Inflation moved steadily downward as the October-December of FY2009

unfolded, sliding from 10.2 per cent year-on-year in September to 6.0 per cent in
December, it said. It also identified a rapid decline in international commodity
prices and improved domestic food supplies as the main factors for pushing
inflation lower. The decline in food inflation to 6.8 per cent in December from 12.1
per cent in September was steeper than that of nonfood inflation that came down
to 4.8 per cent in December from 7.2 in September.

The cut in the locally-administered price of oil in October and December last,
after a rise in July, also helped ease price pressures, the ADB said. The likely
good domestic crop harvests, the effects of raising policy rates by the central
bank for restraining credit in October-December of FY2009, and the January
2009 reduction in the domestic fuel prices will also ease inflation, it added. On
the fiscal management, it said despite the recent rise in subsidy on fertiliser, the
government’s budget deficit is expected to be around 4.7 per cent within the
budgeted level of 4.9 per cent.

According to the ADB, the government revenues are showing signs of

deceleration, with the revenue collections falling from 20.5 per cent during July-
September of the FY2009 to 13.2 per cent during July-December period, over the
corresponding periods of FY2008. The ADB cautioned that the slower private
sector activity, as the impact of the global economic slowdown takes hold, could
further affect revenue collection. Import-based revenues will be affected by the
cuts in customs duties in the FY2009 budget and the erosion in import values
resulting from the decline in international commodity prices, it added.

It also mentioned that a major challenge to the new government would be to

raise the utilization rate of Annual Development Programmer (ADP). ‘Both
quantity and quality of ADP need to be stepped up by addressing capacity
constraints and better interagency and aid coordination, so that infrastructure
provision can support increased private investment and help address the
country’s development needs,’ it said.
About the monetary and financial sector, the multilateral donor agency said
Bangladesh Bank maintained an accommodating monetary policy stance with
little adjustment in policy rates to support high economic growth and to contain
inflation within tolerable levels. Broad money growth reached 17.9 per cent year-
on-year in December last, up from 14.7 per cent in December 2007, it said,
adding that the private sector credit grew rapidly at 21.8 per cent year-on-year in
December 2008 from 16.8 per cent in December 2007.

In mid-January last, Bangladesh Bank announced the Monetary Policy Statement

(MPS) for the January-June period of FY2009 with a commitment to continue its
support to maintain the flow of credit to raise production of goods and services,
and provide refinance against lending in employment-intensive sectors such as
agriculture and SMEs, it mentioned.

The ratio of gross non-performing loans (NPLs) to total loans of all banks
declined to 12.3 per cent at the end of September last from 14 per cent at the
end of September 2007. On the other hand, NPLs of the state-owned commercial
banks (SCBs) rose from 26.9 per cent to 29.3 per cent during the period, it said.
Weighted average lending rates continued to fall and stood at 12.4 per cent at
the end of September 2008 while the interest rate spread declined from 6.2 per
cent in September 2007 to 5.2 per cent in September 2008.

On the balance of payments, it said the preventing of a sharp decline in export

earnings in the face of the cooling global demand in the coming months will be a
major challenge for the government. During July-December of FY2009, imports
rose by 23.2 per cent over the same period of FY2008 while the total remittance
receipts during July-January of FY2009 rose by 29.4 per cent over the
corresponding period of the preceding fiscal year.

The annual growth in the number of workers leaving Bangladesh for overseas
jobs slowed in 2008 compared with a growth of 118.2 per cent in 2007. The trade
deficit edged up to $2.9 billion in the first half of FY2009, up from the $2.2 billion
deficit in the corresponding period of the previous fiscal year. Higher deficits in
trade and service payments reduced the current account surplus to $232 million
from $298 million of the same period the year before.

Because of the higher surplus in the financial and capital accounts, the overall
balance showed a higher surplus of $489 million in July-December 2008 against
a surplus of $44 million in July-December 2007. Gross foreign exchange
reserves of Bangladesh Bank were lower at $5.8 billion (equivalent to about 3.3
months of imports) at the end of December 2008, down from $6.2 billion at the
end of June 2008
Opinion about crisis on Bangladesh:

Visiting Assistant Secretary General AjayChhibber of the United Nations on

Tuesday said Bangladesh will be less affected by the global economic downturn
than other nations in the South Asian region as the country is not much
integrated with world financial system.  After a meeting with Bangladesh’s
Finance Minister AMA Muhith here on Tuesday, Chhibber told reporters that the
impact of global recession on Bangladesh’s exports and remittance have so far
been less but can deepen in future. “We hope the impact of recession will be
much less for Bangladesh,” said Chhibber, who arrived in Dhaka on Saturday for
a five-day visit.

He said the Bangladeshi government is aware of the possible impacts of global

economic downturn which already hit economies of many countries throughout
the Asia-Pacific region. “We’ll have to intensely monitor the world economic
situation. Impact on our export earning and remittance are still less but we must
remain high on alert,” said Bangladesh’s Finance Minister Muhith at the same
occasion,

The World Bank earlier said Bangladesh’s exports and remittance will be affected
due to global economic downturn which will bring down the country’s GDP
growth from 6.5 percent to 5.4 percent in current 2008-09 fiscal (July 2008-June
2009).

Economist’s report on Bangladesh economy not based on fact: BB

Sheikh Shahariar Zaman

High officials of the central bank have contradicted a report published in The
Economist’s latest issue titled ‘A battered economy takes another hit’ and said
the report is not based on fact. The report said that the global meltdown would
severely hit the country, and remittance and export earnings would fall sharply in
the coming months. “Remittance increased by 30 per cent in July-January period,
export and import increased by about 20 per cent in the first six months of the
current fiscal,” said a high official of the central bank.

The meltdown started in September last and the developed world has already felt
the bite of the crisis but Bangladesh has shown its resilience and the economy is
expected to grow at a rate of over 6.0 per cent, he said. “The Economist’s report
said the banking system in Bangladesh is among the weakest in Asia. If that is
the case, what they will say about the banking system of the US and the UK,
where the financial institutions are virtually bankrupt and begging mercy of the
governments for bailout package,” said another official of Bangladesh Bank (BB).
Bangladesh exports readymade garments for low-end markets and the demand
for them does not vary with respect to price and income, he explained.

The country has huge orders up to May and the export earnings from the sector
is not likely to face dramatic decline, he said. About the import payment, he said
petroleum and commodity prices are declining fast in the international market
and it would help the country maintain a positive balance of payment, he added.
In February, an IMF team visited the country and said Bangladesh was largely
protected from the first round of global crisis as its capital account dependence
was limited.

AnoopSingh, director of the Asia and Pacific Department of the IMF, said many
countries in Asia suffered export loss in December by as high as 40 per cent and
in this context Bangladesh performed relatively well. “The developed countries
are facing the biggest financial problems in the post-War period and Bangladesh
is facing the impact in a limited scale,” he said. The country has some advantage
like cheap labor and RMG exporters have orders up to April. There would not be
any sudden impact on the economy due to lower demand in the industrialized
countries, he added. The domestic economy has retained momentum from a
favorable agriculture performance and RMG order is holding up and remittance
flow is also increasing, Anoop said.

Conclusion

            The whole world is going through global financial crisis specially the
develop countries such as USA, EU Japan, Australia affected by financial crisis.
This crisis was started from USA, USA is the most affected country overall the
world. There are lot of financial organization was collapsed such as Lemon
brothers city bank etc. To overcome this situation US govt. & EU authority has
been taken some good steps. Such as bailout problem financial assistance .
Bangladesh also affected from this situation. So the govt. of Bangladesh should
be awarded about this. By taking effective steps by the govt. it is probable to
minimize the risk of affected

Topic :
Causes and effects of the global financial crisis of 2007-09, with special reference
to the impacts on financial markets and financial institutions.
Introduction:

Global financial crisis refers to a tough situation in which the demand for money is greater than the supply of
money resulting in shortage of cash or liquidity crisis. It is a tough situation that creates panic among the
common people who approach banks & financial institutions for withdrawing funds for the fear that such
deposits might be lost due to bank failure. The recent global recession had occurred during the period of 2007-
09 which had affected almost all the economies in the world including the developed ones. International trade
was affected as well. The most common impacts of global financial crisis include loss of employments, fall in
income level, reduction in consumption level, decrease in purchasing power of consumers, rise in inflation rate
and shortage of funds. However, the global financial crisis had specific impacts on the financial markets
including banks and financial institutions. The causes for the global recession might also be different if
perceived in context of financial markets. The latest global financial crisis had caused bank run, run for repo,
bad debts and liquidity crunch for the banks & financial institutions. However, the banks had tried to overcome
the tough situation through the use of financial instruments like repurchase agreements, deposit insurance
schemes, commercial papers and inter-bank lending. The current study is concerned with the critical evaluation
of the causes and effects of the global financial crisis in context of the UK financial markets.

Discussion:

The whole world evidenced a financial crisis during the period of 2007-09 however it has taken a long-time for
many countries to recover from the negative impacts of the financial crisis. The financial crisis was so severe
that it had affected even the developed economies like the US and the UK. Scholars, market analysts and
industry experts often compare this financial crisis with the great depression that took place in 1930s. A major
reason for conducting such comparison is to identify, understand and develop necessary measures to prevent
the occurrence of such financial crisis in the future. In this context, Bénétrix, Lane, and Shambaugh (2015)
stated that the global recession during 2007-09 had adversely affected the financial markets and financial
institutions globally. Low interest rates is often viewed as a major reason for the occurrence of the global
financial crisis. As mentioned by Bertaut et al. (2012), existence of low interest rate in the US prior to the
global recession had resulted in the bursting of housing bubbles which further led to huge bad debts incurred
by the commercial banks. Mortgage delinquencies can be considered as a key reason for such huge amount of
bad debts incurred by the banks. This can be attributed to the poor or inefficient credit checking of customers
conducted by the commercial banks in the country before extending loans. Put it differently, the commercial
banks did not properly evaluate and verify the loan repayment capacity of the borrowers. This has made the
subprime mortgage market a major trigger of the global recession. It does not seem inappropriate to hold the
banking system itself responsible for the occurrence of the financial crisis. In fact, conducting proper credit
checking along with a strict credit policy could have helped in avoiding the financial crisis. In addition to this,
the regulators were also equally responsible for the low level of interest rates that was seen in the market
before the financial crisis. The global financial crisis had badly affected a large number of commercial banks
and financial institutions. In fact, a commercial bank is a key element of the financial system in which deposit
and borrowing of funds take place. In this context, Chor and Manova (2012) observed that banks make use of
only a fraction of the total deposits for extending loans to the borrowers and the same is not possible to be sold
in the market at a high price. 

Demand Deposit is one of the key financial tools in context of the global financial crisis which is issued by
commercial banks to allow the investors or depositors to withdraw individual assets from banks at the time of
necessity. In this context, liquidity indicates the ease with which an asset is subject to conversion into liquid
cash at any specific point of time. According to Eun, Resnick and Sabherwal (2012), bank run is a major cause
that triggered the global financial crisis. Bank run refers to a situation in the financial market during which all
the depositors approach banks to withdraw individual deposits due to the fear that the banks might fail.
Mismatches in which the liabilities or deposits of a bank possess higher liquidity when compared to the assets
or loans of the banks leads to bank run. On the other hand, Fratzscher (2012) viewed that speculations about
the failure of a bank can be considered as a strong factors contributing to a bank run. However, prevalence of
other factors cannot be ignored as well. During the global recession 2007-09, Lehman Brothers, one of the
leading banks in the US had also suffered the impacts of the financial crisis which had further increased the
fear among the people about probable bank runs. However, it is important to understand that bank run was not
the key cause of financial downturn of the Lehman Brothers in the US rather the company suffered the adverse
effects of the recession because of withdrawal of high volume of repo or repurchase agreements. Thus, it was a
case of run for repo. Liquidity is often viewed as a major activity of commercial banks. In other words,
commercial banks need to consistently focus on creating and maintaining high level of liquidity because the
deposits can be withdrawn by the depositors at any point of time. Hence, possession of assets become essential
for commercial banks that can be liquidated quickly to meet the demand for withdrawal by depositors.

Bank run is still viewed as the major reason for the global financial crisis during 2007-09. Any rumor in the
market about the possible failure of a bank can motivate depositors to withdraw respective deposits from the
banks at the earliest. This panic leads to bank resulting in drastic fall of liquidity among the commercial banks
and financial institutions. Similarly, a long queue of customers for funds withdrawal in commercial banks is
yet another major factor that triggers bank run by creating panic among the other customers that the bank
might get insolvent due to such excessive pressure for funds withdrawal. Thus, the US and the UK
governments along with commercial banks & other financial institutions have started developing specific
strategies for preventing bank run. Deposit insurance scheme is one of such measures developed for this
purpose. A deposit insurance scheme developed by the government provides assurance to the depositors about
the security of their deposits and that the deposits can be withdrawn by the customers irrespective of the
liquidity pressure on the commercial banks.
Northern Rock was the first bank in the UK that suffered a bank run. The UK government had to take over the
bank to protect the existence of the Northern Rock bank and the ensure safety of the deposits of the customers.
The bank had taken an aggressive strategy for business expansion and this resulted in the shortage of liquidity
and finally a financial crisis. In the view of Haas and Lelyveld (2014), an increase in the quantum of credit in
any economy leads to a financial crunch in the economy. The subprime mortgage market of America have
influenced the prevailing banks to make use of short-term liquidity assets for meeting funding requirements
related to the long-term ones. This can be explained by the inadequate amount of deposits among the
commercial banks to provide loan to the borrowers. Assets backed securities can be considered as a result of
credit boom in the economy which is concerned with the development and functioning of shadow banking
system. Under this approach, personal funds are used to fund the off-balance sheet finance. The global
financial crisis during 2007-09 consisted of a run on repurchase agreements that are associated with shadow
banking. In fact, the increasing competition faced by the banks from the mutual funds operating in the money
market had made the traditional banking system less profitable. Here, mutual funds in the money market refer
to those financial institutions that enable investors to reduce investment related risks through proper
diversification of the risks in suitable investment avenues. A common pool of fund is created by these mutual
funds and the same is invested across a wide range of investment assets in suitable proportions. Commercial
paper is yet another major financial tools used during the financial crisis. Financial institutions and banks used
commercial papers to meet both long-term and short-term funding requirements. As mentioned by Higgins
(2013), Asset Backed Commercial Papers (ABCP) were mainly used by banks during the global recession in
the UK to raise funds for long-term requirements. Inter-banking lending is also viewed as a major tool used by
banks and financial institutions during the global recession to meet funding needs. Inter-banking lending refers
to the offering of loans by one bank to another for a short-term period at a suitable interest rate on the same.
Interbanking loan is an unsecured one and London Inter-Bank Offer Rate (LIBOR) plays a vital role in
determining interest rate on the inter-banking lending.

A repo agreement reduces the chances of bank run. In fact, a repo agreement are highly secured in nature and
thus provides assurance to the banks and financial institutions that occurrence of a bank run is unlikely. A repo
agreement is the one which enables a bank or financial institution to provide a loan amount to the borrower
that is lower than the value of the collateral security. In other words, a repo agreement refers to a legal
agreement between two parties in which one party buys a particular asset from the other at a specific price and
the asset is sold as a collateral. However, in case of repo agreements, the concerned party provides promise of
buying back the asset on a particular date at a specific price. This price comprises of the original price and an
extra amount which is also termed as haircut. Thus, haircut indicates the difference in the value of a particular
asset and the amount of deposit however the amount of deposit is generally less than the value of the
concerned asset. In this context, Melvin and Norrbin (2013) mentioned that there have been considerable
increase in haircuts during the global financial crisis of 2007-09 because of rising uncertainty over the banking
 sector and rapid changes in the subprime markets. Here, it is important to note that the increase in repo market
became highly severe which further reduced the quantum of investment in the concerned repo market. Assets
were becoming riskier than ever before in the UK financial market. Though the initiative had been benefitted
the invested but at the same time it had increased the financial cost to the borrowers. There had been
significant drop in the lending rate in the UK during the financial crisis (Yang, 2012). This can be attributed to
the considerable increase in risk level due to which the investors stayed away from making investments. The
increase was however backed by the investors in the UK because of the financial risk in connection to the
selling of collateral securities which are obtained from the repo market in an illiquid market if the borrower
becomes a defaulter.

Conclusion & Recommendations:

The global financial crisis that occurred during 2007-09 had badly impacted banks, financial institutions,
financial markets and the corporate world as well globally. Developing nations like the UK had to suffer the
adverse effects of the recession as well. The global financial crisis had major impacts on the UK economy like
rise in inflation rate, fall in wage rate, job cut, fall in income level, unemployment and liquidity crunch. There
are different causes for this financial crisis however two of the major reasons identified for the financial crisis
are prevalence of low interest rate and huge bad debts suffered by banks due to poor credit checking of the
borrowers. However, the banks had used certain tools to recover from the financial crisis like demand deposit,
commercial paper, repo agreement and inter-banking lending. Deposit insurance scheme had also played a
vital role in this regard. However, chances of such financial crisis can be eliminated through joint efforts by the
government and banks & financial institutions. Based on the current study the following recommendations
have been developed that could help in preventing such financial crisis in the future:

 Stringent credit policy: The credit policy of banks need to be made more stringent by lowering the
credit limit and raising the criteria level for loan sanctions. Criteria like minimum income level, value of
collateral security and similar others can be raised. Intervention of the government in the credit policy of
commercial banks is also highly advisable.

 Proper background verification of borrowers: Banks need to make sufficient background checking of
the borrowers prior to extending credit. All documents and records furnished by loan applicants need to be
verified through concerned authorities. This can reduce the chance for bad debts.

 Promotion of deposit insurance schemes: The government can focus on greater promotion of deposit
insurance schemes through Television, Newspapers and Social Media. The campaign needs to make
customers aware about deposit insurance schemes by explaining the benefits of the same. This initiative can
help in minimizing the chances of bank runs..
 Periodic checking of credit volume in the economy: The government and the central bank of a country
need to consistently monitor the volume of credit created by the commercial banks and take necessary
quantitative & qualitative measures to control high credit volume in the economy.

 Increasing the minimum liquidity ratio of banks: Banks are required to maintain a certain percentage
of the total deposits as statutory liquidity reserves as directed by the central bank of the country. However,
this ratio can be increased to ensure that adequate liquidity is available with the commercial banks to meet
sudden demand for withdrawal of funds by the customers.

A history of the past 40 years in financial crises

Financial crises have been an unfortunate part of the industry since its beginnings. Bankers and financiers
readily admit that in a business so large, so global and so complex, it is naive to think such events can ever
be avoided. A look at a number of financial crises over the last 30 years suggests a high degree of
commonality: excessive exuberance, poor regulatory oversight, dodgy accounting, herd mentalities and, in
many cases, a sense of infallibility.  

William Rhodes has been involved in the industry for more than 50 years and has lived through nearly every
modern-day financial crisis, many of which are detailed in his book, “Banker to the World”. As he puts it,
there is a common theme of countries and markets wanting to believe that they are different and that they
are not as connected to the rest of the world’s economy. In his view, many aspects of the Latin American
debt crisis of 1982 have been repeated a number of times and there is much from this crisis that we can
apply to what is currently happening in Europe and beyond.

LatAm sovereign debt crisis – 1982

This crisis developed when Latin American countries, which had been gorging on cheap foreign debt for
years, suddenly realised they could not repay it. The main culprits, Mexico, Brazil and Argentina, borrowed
money for development and infrastructure programmes. Their economies were booming, and banks were
happy to provide loans to the point where Latin American debt quadrupled in seven years. When the world’s
economy went into recession in the late 1970s the problem compounded itself. Interest rates on bond
payments rose while Latin American currencies plummeted. The crisis officially kicked off in August 1982
when Mexico’s finance minister Jesus Silva-Herzog said the country could not pay its bills.

It took years to sort out the crisis, with Latin American nations eventually turning to the IMF for a bailout in
exchange for pro-market reforms and austerity programmes. It also led in 1989 to the novel creation of
Brady bonds, which were designed to reduce debt in these countries by converting distressed sovereign debt
into a number of different types of bonds. Furthermore, banks could exchange claims on these debts for
tradable assets, which enabled them to get the debt off their balance sheets.

Rhodes recalls it as a tense period, but says that strong political leadership enabled them to get through the
crisis. He laments, however, that the lessons of the crisis weren’t heeded.

“Time and again, be it in the Asian crisis or the eurozone crisis, we have seen how governments have failed
to draw lessons from the Latin American crisis,” he said. “They have repeatedly taken the view that their
countries and regions are different and unique and, therefore events in other parts of the world cannot
provide any relevant lessons for them.

“And yet key developments seen in the Latin American crisis – the dangers of contagion, the need for
urgent and bold political leadership, the risks of over-leveraged banks – have been characteristics of every
sovereign debt crisis since then.”

Savings and loans crisis – 1980s

While the solution to the Latin American crisis was being put together, a domestic one was happening right
in front of the US regulators. The so-called savings and loans crisis took place throughout the 1980s and
even into the early 1990s, when more than 700 savings and loan associations in the US went bust.

These institutions were lending long term at fixed rates using short-term money. As interest rates rose, many
became insolvent. But thanks to a steady stream of deregulation under President Ronald Reagan, many
firms were able to use accounting gimmicks to make them appear solvent. In a sense, many of them
resembled Ponzi schemes.

The government responded with a set of regulations called the Financial Institutions Reform, Recovery and
Enforcement Act of 1989. While the act tightened up the rules on S&Ls, it also gave Freddie Mac and
Fannie Mae more responsibility for supporting mortgages for lower-income individuals.

Someone who remembers the savings and loan crisis all too well is William Black. During the 1980s he
served as litigation director for the Federal Home Loan Bank Board and deputy director of the Federal
Savings and Loan Insurance Corp. He was instrumental in the investigation into one of the most notorious
S&L villains, Charles Keating, who infamously sent a memo saying he wanted Black dead.

In Black’s view, the act didn’t go nearly far enough and in many ways contributed to the continuation and
expansion of predatory lending that would ultimately become a huge factor in the 2008 financial crisis.
“The credit crisis is a continuation of the savings and loan crisis,” he said. “It’s not that they did nothing
about it, it’s that they undid everything that worked. They could have thought, ‘we’ve seen this before, this
is bad, this is disastrous’ and we had regulations that worked and could have reinstalled.”

When asked why the government’s solution to the S&L crisis was to some degree to regulate the industry
even less, and why people such as Keating maintain that excessive regulation was the cause of the S&L
crisis, he says: “One is ideology. They hate government involvement of any kind. Second, imagine yourself
answering the … question of why did none of you get this right? You’re 55 years-old, are you going to say,
‘sorry, everything I’ve ever said and written and worked on is false? And everything I’ve said created a
criminogenic environment? And by the way, I have no useful skills’? Maybe one in 1,000 would say that,
but it’s not likely.”

Stock market crash – 1987

Despite the shock of the savings and loans crisis, two more crises took place before the 1989 Act. The most
memorable was the 1987 stock market crash. On what became known as Black Monday, global stock
markets crashed, including in the US, where the Dow Jones index lost 508 points or 23% of its value. The
causes are still debated. Much blame has been placed on the growth of programme trading, where computers
were executing a high number of trades in rapid fashion. Many were programmed to sell as prices dropped,
creating something of a self-inflicted crash.

Roger Ibbotson, a finance professor at Yale University and chairman of Zebra Capital, has written
extensively about the crash. He recalls teaching a class when it was happening, and every few minutes a
new student would drop in to his class saying the market had hit another low.

“The whole week was chaos,” he said. “The futures market was a mess, but you could actually make good
money if you were up for some risk. A lot of people tried to set up brokerage accounts to take advantage of
some of the valuations.”

Yet one of the oddest parts of such a significant crash, he recalls, was how little effect it seemed to have. It
was ultimately a short-lived event. The market continued to fall into November, but by December it was up
and it ended the year positively. Ibbotson says things basically just went back to normal. A few changes
were made, notably the introduction of circuit breakers that could halt trading, but apart from that, many
people just shrugged and went back to making money.

Junk bond crash – 1989

Next up was the 1989 junk bond collapse, which resulted in a significant recession in the US. There is some
disagreement as to what caused it, but most point to the collapse of the US$6.75bn buyout of UAL as the
main trigger. Others point to the Ohio Mattress fiasco, a deal that would become known as “burning bed”
and remains widely considered to be among the worst deals in modern finance. The culmination of the crash
is considered to be the collapse of Drexel Burnham Lambert, which was forced into bankruptcy in early
1990, largely due to its heavy involvement in junk bonds. At one point it had been the fifth-largest
investment bank in the US.

Ted Truman, now a senior fellow at the Peterson Institute for International Economics, was then director of
the international finance division at the Federal Reserve. He remembers the crisis as having similar
undertones to the more recent financial and sovereign debt crises, where banks were underwater and the
government had to bail out various institutions to avert further problems.

“You essentially had at the same time the last phase of the S&L crisis,” Truman said. “To some degree this
was the mop-up phase. There is a view out there that any time there is a rescue, it encourages people to take
risks. That’s the moral hazard issue. But I think that’s a little unfair because most people who get rescued
pay a high price in the process. The system is rescued not the perpetrators. Reputations are besmirched.”

Tequila crisis – 1994

In 1994 a sudden devaluation of the Mexican peso triggered what would become known as the Tequila
crisis, which would become a massive interest rate crisis and result in a bond rout. Analysts regard the crisis
as being triggered by a reversal in economic policy in Mexico, whereby the new president, Ernesto Zedillo,
removed the tight currency controls his predecessor had put in place. While the controls had established a
degree of market stability, they had also put an enormous strain on Mexico’s finances.

Prior to Zedillo, banks had been lending large amounts of money at very low rates. With a rebellion in the
poor southern state of Chiapas adding to Mexico’s risk premium, the peso’s value fell by nearly 50% in one
week.

The US government stepped in with a US$50bn bailout in the form of loan guarantees. Yields on Mexican
debt shot up to 11%, and capital markets activity ground to a halt not only in Mexico but across the entire
region, especially in Argentina – where yields went as high as 20%. It also hit markets across the developed
world.

Eventually, the Mexican peso stabilised and the country’s economy returned to growth. Three years later it
was able to repay all of its US Treasury loans.
Martin Egan, global head of primary markets and origination at BNP Paribas, as well as the firm’s UK head
of fixed income, says that of the moments of crises he has experienced, this one sticks out particularly
strongly.

“1994 is still quite vivid. Numerous rate increases including a 0.75 basis point upward movement on
November 16 as the Fed attempted to control inflationary pressures resulted in a dramatic collapse of
market activity,” Egan said.

“If you look at what happens now, sensitivity to rate changes is always around and markets like to have
visibility. Back then we knew rates needed to go up, but the speed and swiftness of the move derailed the
market for a long time and we saw a dramatic collapse in volumes, and serious strains in the financial
system.

“Confidence started to rebuild eventually, but it was brutal because it dragged the markets into an awfully
defensive mode. It was one of the most problematic years ever in fixed income. It was a reminder to all
participants that this is the real world and the real economy at stake.”

Asia crisis – 1997 to 1998

More than 15 years after the Latin American debt crisis of 1982, history would indeed repeat itself in Asia.
In July 1997 Thailand’s currency, the baht, collapsed when the government was forced into floating it on the
open market. The country owed a huge amount of debt to foreign entities that it couldn’t pay even before the
currency plummeted. Similarly to what was experienced in Latin America in the 1980s and present-day
Europe, the crisis spread across the region, with South Korea, Indonesia, Laos, Hong Kong and Malaysia
also affected. Rhodes says he spent considerable time warning Asian governments about the risks they
faced, but that his concerns were largely ignored.

“I was told by the Asians: ‘We’re different from Latin America because we have Asian values and because
we work harder and have a savings culture’,” Rhodes said. “But they were involved in the same practices of
overlending to the consumer area and in real estate. There is a similar phenomenon in all of these crises,
which is that people like to think they are different and that experiences elsewhere do not apply to them.”

The crisis certainly took many by surprise. Most Asian governments believed they had the right economic
and spending policies in place, but nonetheless the crisis necessitated a US$40bn bailout by the IMF. Only
one year later, in 1998, a nearly carbon-copy crisis happened in Russia.

Dotcom bubble – 1999 to 2000

Markets would yet again forget the lessons of the past in the dotcom bubble and subsequent crash in 2000.
As in most crises, it was preceded by a bull rush into one sector. In this case it was technology and internet-
related stocks. Individuals became millionaires overnight through companies such as eBay and Amazon.
The hysteria reached such a pitch that the inconvenient fact that few of these companies made any money
scarcely mattered. By 2000, however, the game was up. The economy had slowed and interest rate hikes
had diluted the easy money that was propping up these companies. Many dotcoms went bust and were
liquidated.

Kay Steffen, head of syndication and corporate broking at DZ Bank, was involved in bringing more than 80
of these companies to the market. He believes the dotcom crash was simply a case of a feeding frenzy that
went out of control, and was a symptom of the market’s underlying irrationality.

“Everyone knew this was something that was not sustainable, but it’s not always easy to take that view and
resist all the different groups that want in on the market,” he said. “I feel this is just the natural behaviour of
people. We see this happen every few years in various market segments. We see it happening today in some
bonds. People are looking for yield and if they see a 7% coupon they neglect what is behind it.”

Global financial crisis – 2007 to 2008

It was only a few years later that an even nastier crisis would hit the entire world’s financial markets. In
many ways it has still has not ended, with the billions in losses and slowing global economy manifesting
themselves in the current European sovereign debt crisis. It resulted in the collapse of a number of large
financial institutions and is considered by many economists to be the worst crisis since the Great
Depression. While the causes are numerous, the main trigger is considered to be the crash of the US housing
market.

Jean-Pierre Mustier was at the forefront of the crisis as the head of Societe Generale’s corporate and
investment bank, and had to manage the aftermath of rogue trader Jerome Kerviel’s €4.9bn trading losses.
In his mind, the crisis has changed banking for the better, and he is a supporter of the new regulations as
well as simpler business structures.

“To a certain extent, people became too dependent on models,” says Mustier, who is now head of CIB at
UniCredit. “Suddenly, the crisis showed that you should not rely on models only and more on common
sense. What you do has to be connected to reality. I think the combination of the Basel III approach and
leverage ratio is actually a good thing, but I also think the lesson we learned is, let’s use our common sense
and not blindly accept models.”
Lessons learnt?

Is financial history destined to repeat itself? It would appear to be something of a result of the way markets
function. A boom creates excessive interest and lofty prices. The ensuing crash results in “never-again”
style regulations, only for another crisis to pop up, sometimes as soon as the next year. Most recently, the
world has had to cope with the European sovereign debt crisis, a problem that never seems able to go away
entirely and seems to get worse with each ensuing multi-billion dollar bailout.

Rhodes argues that many of these incidents are avoidable, but in many ways what is more important is how
they are resolved. Above all, he sees strong political leadership as one of the most crucial elements, along
with a competent plan that the populace will understand as being good in the long term.

“One of the things that is clear in all of the crises is that strong leadership is crucial,” he says. “To take some
international examples, such as Brazil in 1994, South Korea in 1998 and Turkey in 2001, the heads of state
and finance ministers sold their programmes to their citizens saying that while these included tough
measures, they were well planned and would lead to growth – and they did. This kind of leadership is
missing in Europe.”