The Causes of the Global Economic-cum-Financial Crisis_International Relations_Delhi Summer School_Cearet Sood
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Name Cearet Sood
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Delhi Summer School; Essay
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The Causes of the Global Economic-cum-Financial
Deadline: 25th June, 2015
Date Submitted: 25th June, 2015
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WHAT ARE THE CAUSES FOR THE GLOBAL FINANCIAL-CUM-ECONOMIC
The world, at large, has gone through numerous economic and financial crises, it has
witnessed recessions, depressions, slowdowns, market crashes but none of their im-
pact could be even compared to that of the recent Global Financial-cum-Economic
Crises, or GFC/GEC, as it’s more popularly known as. Before understanding the
causes of this global meltdown, knowledge of what exactly is a crisis is essential.
Now, there is no set definition of a financial crisis, it can be interpreted in various
ways. It could be thought of as a rapid decline in the value of the financial assets held
by banks and individuals alike, or a situation where demand of money exceeds it’s
supply by a large amount. Crises usually have a domino effect, what affects one coun-
try or a region affects the whole world in ways more than one. They aren’t instanta-
neous, usually take years to build on and then suddenly, everything comes cascading
down. There’s almost always a trigging point. This crisis, the worst since the Great
Depression, stretched on from 2007 to 2009 The Global Crisis’ origin could be traced
to the burst of the property bubble in the United States. The US economy was doing
well, the real estate sector was in it’s prime, house prices were rising. This made US
banks overconfident, they adopted sub-prime lending, wherein they lent money to
people, whose credit wasn't good enough to even meet the normal standards. Little did
they realise the graveness of their actions. The housing market in the US suffered
greatly, as many home-owners who had taken loans defaulted, in other words, they
weren't able to pay back the mortgage on their homes. The default rates began to rise,
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this resulted in widespread panic among banks, as they faced a credit crunch, which
basically means that a liquidity crisis was going on. Liquidity measures how easily an
asset can be converted to cash. The banks didn’t have any money to lend, so they had
to reduce and/or stop lending altogether. This was followed by a bank run, wherein
most of the customers withdrew their deposits, when many banks go through runs at
the same time is banking panic. This period of activity before the actual meltdown is
the sub-prime mortgage crisis.
This sub-prime mortgage crisis had two aspects to it- Mortgage Backed Securities
(MBS) and Collateralized Debt Obligations (CDO). These instruments were used to
expand debt to such a large extent. Mortgage Backed Securities are asset backed secu-
rities that are secured by mortgages or a collection of mortgages. When you invest in
a mortgage-backed security you are lending money to a home buyer or business.
CDOs contain several assets such as mortgages, bonds and loans; they are debt oblig-
ations that serve as collateral for the CDO. CDOs caused between $400 to $600 bil-
lion of the write-down of banks,
The sub-prime mortgage crisis caused many financial institutions to fail, this failure
further led to the crash of the stock market. The Dow-Jones Industrial Average was at
it’s all time high at 14,164.43, less than about18 months later, it’s value fell to
6,594.44, which is a fall of more than 50%. This wasn't the largest drop, though. Dur-
ing the great depression, stock market crashed by approximately 90%, however the
time frame was alarming, this was done in 18 months and the Great Depression took
around three years. Due to the liquidity crisis and the collapse of Lehman Brothers,
the Dow dropped 504.48 points, all this brought a lot of disruption in the market. Ice-
landic krona was devalued and it secured an emergency loan from the IMF. Many
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countries had closed there markets temporarily because of the ‘Panic of 2008’, as
Business Week referred to it.
With the collapse of the US housing market, the banks weren't in a great position, ei-
ther because of the reasons mentioned above. As mentioned earlier, more often than
not, there’s a trigging point for crises of a huge magnitude. Perhaps, the infamous dec-
laration of bankruptcy by Lehman Brothers and it’s subsequent collapse served as a
point from where on, things only got worse. The reason for this isn’t surprising,
though it certainly came as a shock then! A firm which had faced so many challenges
and had survived significant crises like the railroad bankruptcies of the 1800s, the
Great Depression (1930s), two world wars and the Russian debt default of 1998, fell
victim to this one. During the sub-prime mortgage crisis, Lehman Brothers had ac-
quired five mortgage lenders, one of which specialised in Alt-A loans. Alt-A loans are
usually given to people, who cannot prove their income- they have a good credit
score, these loans are given without proper documentation. Clearly, this wasn't a very
intelligent move on their part. They had $639 billion in assets $619 billion in debt,
theirs is the largest bankruptcy till date.
This move of the US government prompted the governments all around the world to
rescue their own banks/financial institutions, they invested huge sums in them. As if
as this wasn't enough, the housing market was in shambles and the stock market was
on the verge of crashing. There was shortage of money everywhere, the liquidity crisis
was pushing it’s way forward throughout the globe. In an attempt to save the plunging
economy, interest rates were cut down. The newly reformed G20 met and discussed
reforms pertaining to stop the world economy from breaking down completely. At a
G20 summit in London in 2009, the world leaders promised a $5 trillion fiscal expan-
sion of resources to help organisations such as the International Monetary Fund and
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World Bank, which in turn would help the world economies to recover by providing a
boost to jobs and reforming the national/central banks. The move of lowering the in-
terest rates was quite a good one, it provided banks with incentives to lend out more,
given their investment had fallen drastically.
Raghuram Rajan, currently the governor of the RBI, India’s central bank was the chief
economic counsellor at the International Monetary Fund. Back in 2005, he predicted
the downfall, but no one really listened to him then. In the same month of the Lehman
Brothers crash, two more American banks, Washington Mutual (WaMu) and Wa-
chovia, collapsed. WaMu’s collapse wasn't much publicised, the federal regulators
seized it’s $307 billion of assets and gave them to JPMorgan Chase for $1.9 billion.
Whereas, Wachovia was acquired by Wells Fargo at that time, it was the fourth largest
bank holding company in the United States of America before that.
Ireland was the first country in Europe to slip into recession. Surprisingly enough, it’s
economic growth was quite strong before 2008, but it was badly affected by the Glob-
al crisis. The burst of a housing bubble and a banking crisis in itself, brought the fa-
mous ‘Celtic Tiger’ period to an end. Celtic Tiger refers to a period where there was
very high economic growth, with huge amounts of funding from the foreign investors.
The economy expanded at a rate of 9.4% and continued to grow at 5.9% till the crisis.
The main banks then became insolvent and weren't able to lend funds, Ireland’s
growth had also been unsustainable so as to say, it had grown too high and too fast in
the preceding years. The government’s fiscal position wasn't great, although it then,
began to implement austerity measures, it didn’t work out as it was expected it would.
Another nation that was badly affected by the crisis was Greece, which slipped into a
crisis of it’s own, the Greek Depression. The Greek economy was already fragile,
GFC served as a trigger after which it slipped into depression. Now, Greece had a
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high structural deficit, which is the size of the budget deficit which remain even when
the economy is functioning normally. This measures how good the financial manage-
ment of the government actually is. With the debt-to-GDP levels being high, Greece
was feared heading to a sovereign debt crisis.
Alan Greenspan, an economist and a disciple if Ayn Rand, retired in 2006 as the
Chairman of he Federal Reserve, could be blamed as the man behind this huge fiasco.
The housing bubble was at it’s prime in 2002-2006, however, the Fed did not do any-
thing to curb it. Greenspan failed to predict this in time, which would've saved a lot of
damage. Although, he had predicted and prevented the 1987 stock crash, he appeared
lax about this. His ‘I didn't know’ excuse was quite shocking actually, he single-hand-
edly brought the economy down to it’s knees. He didn’t realise this until the end of
2006, such careless attitude on the part of a Fed chair is appalling. His polices regard-
ing lending and maintaining low interest rates were the leading cause of the sub-prime
International trade almost came to a still stop, economies all over the world were
weakening progressively. The rate of unemployment was at an all time high, people
were looking for jobs everywhere. Analysing the impact of this devastating crisis on
the largest continent Asia, there was much less impact of it than in Europe and the
States. Among the various developed and developing countries, there was a sharp de-
cline in the amount of exports, some even falling by double digits. Taipei and China
saw the biggest falls in exports by almost 40%. Industrial production also fell by a
marginal amount. Private capital investment suffered a lot, it deteriorated swiftly, as a
result, GDP also fell abruptly in most of the countries with the exception of Vietnam,
whose GDP surprisingly showed an increase. In some countries, there was even nega-
tive growth rate.
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The Wall Street and the Financial Crisis: Anatomy of a Financial Collapse report on
the financial crisis by the United States Senate Permanent Subcommittee on Investi-
gation was prepared under senators Carl Levin and Tom Coburn. Their description of
it is as follows:
“The crisis was not a natural disaster, but the result of high risk, complex financial
products, undisclosed conflicts of interest; and the failure of regulators, the credit rat-
ing agencies, and the market itself to rein in the excesses of Wall Street.”
According to the report, there were four causes for it, namely:
• High risk lending
• Regulatory Failures
• Inflated credit ratings
• Investment bank abuses.
Under high risk lending, they found out that WaMu was lending high risk loans to in-
crease profits. However, when people began to default on their mortgages, it suffered
a bank run and a liquidity crisis, which made it collapse. Under regulatory failures,
the report examined the role of the Office of Thrift Supervision in the crisis. It said
that they had a major role in it as even though they had identified over 500 deficien-
cies in WaMu, they failed to take action, which resulted in it’s collapse.
Moody and Standard & Poor, the two important credit rating agencies were put under
the scanner. The report alleged that they were paid by the Wall Street and that they
were fraudulent as they did not roll out the correct ratings. There was a lack of regula-
tions, both of these agencies gave a rating of AAA, if anything less was given, these
agencies would be put out of business. Under investment bank abuses, the report in-
vestigated Goldman Sachs and Deutsche Bank. The report also provided various rec-
ommendations based on their findings.
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The Great Recession’s impact on the global front was devastating. It all started from
the burst of the property bubble in the United States of America and from then on,
there was a chain reaction. The sub-prime mortgage crisis, easy and risky lending,
credit crunch, low interest rates, stock market crash, devaluation of currencies, decline
in exports and Gross Domestic Product (GDP) of various countries were all conse-
quences and effects of this. Though, the damage that GFC caused can still be felt, the
economy is slowly resurrecting and is on it’s path to recovery.
1. Whelan, Karl. June 18, 2013. Ireland’s Economic Crisis The Good, the Bad and
the Ugly: 32 pages.
2. Chittum, Ryan. April 14, 2011. The Levin-Coburn Report Coverage
3. Levin ,Carl; Coburn, Tom. April 13, 2011. WALL STREET AND THE FINAN-
CIAL CRISIS: Anatomy of a Financial Collapse: 639 pages.
4. Reinhart, Carmen M. and Rogoff, Kenneth S. October 1, 2013. Is the 2007 US
Sub-Prime Financial Crisis So Different? An International Historical
Comparison.: 344 pages.
5. Wang Dan. May 12, 2014. May 12, 2014. Collateralised debt obligations and
credit default swaps.
6. Kawai, Masahiro. 7 July 2009. The Impact of the Global Financial Crisis on Asia
and Asia’s Responses: 21 pages.
7. This is money. 18 May, 2010. Structural Deficit- http://www.thisismoney.co.uk/
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