The immediate cause or trigger of the crisis was the
bursting of the United States housing bubble which peaked in approximately
2005–2006. High default rates on "subprime" and adjustable rate
mortgages (ARM), began to increase quickly thereafter. 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.
·
Easy Credit Conditions
Lower interest rates encourage borrowing. From 2000 to 2003,
the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%.
This was done to soften the effects of the collapse of the dot-com bubble and
of the September 2001 terrorist attacks, and to combat the perceived risk of
deflation. Additional downward pressure on interest rates was created by the
USA's high and rising current account (trade) deficit, which peaked along with
the housing bubble in 2006.
The Fed then raised the Fed funds rate significantly between
July 2004 and July 2006. This contributed to an increase in 1-year and 5-year
adjustable-rate mortgage (ARM) rates, making ARM interest rate resets more
expensive for homeowners. This may have also contributed to the deflating of
the housing bubble, as asset prices generally move inversely to interest rates
and it became riskier to speculate in housing. USA housing and financial assets
dramatically declined in value after the housing bubble burst.
·
Sub-prime Lending
The term subprime refers to the credit quality of particular
borrowers, who have weakened credit histories and a greater risk of loan
default than prime borrowers. The value of U.S. subprime mortgages was
estimated at $1.3 trillion as of March 2007, with over 7.5 million first-lien
subprime mortgages outstanding.
In addition to easy credit conditions, there is evidence
that both government and competitive pressures contributed to an increase in
the amount of subprime lending during the years preceding the crisis. Major
U.S. investment banks and government sponsored enterprises like Fannie Mae
played an important role in the expansion of higher-risk lending.
Subprime mortgages remained below 10% of all mortgage
originations until 2004, when they spiked to nearly 20% and remained there
through the 2005-2006 peak of the United States housing bubble.
·
Predatory Lending
Predatory lending refers to the practice of unscrupulous
lenders, to enter into "unsafe" or "unsound" secured loans
for inappropriate purposes.
There is growing evidence that such mortgage frauds may be a
cause of the crisis.
·
Deregulation
Government deregulation and failed regulation of the
commercial and investment banking industries were important contributors to the
subprime mortgage crisis. These included allowing the self-regulation of Wall
Street's investment banks and the failed regulation of Wall Street rating
agencies, which were responsible for incorrectly rating some $3.2 trillion
dollars of subprime mortgage-backed securities. Effects of the government
policies on the crisis was badly effected.
·
Over-leveraging
U.S. households and financial institutions became
increasingly indebted or overleveraged during the years preceding the crisis.
This increased their vulnerability to the collapse of the housing bubble and
worsened the ensuing economic downturn.
I. EFFECTS
OF THE GLOBAL BANKING CRISIS
·
Impacts on the USA
The 2008 financial crisis is affecting millions of Americans
and is one of the hottest topics in the Presidential campaigns. Between June
2007 and November 2008, Americans lost more than a quarter of their net worth.
By early November 2008, a broad U.S. stock index, the S&P 500, was down 45
percent from its 2007 high. Housing prices had dropped 20% from their 2006
peak, with futures markets signaling a 30-35% potential drop. Total home equity
in the United States, which was valued at $13 trillion at its peak in 2006, had
dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total
retirement assets, Americans' second-largest household asset, dropped by 22
percent, from $10.3 trillion in 2006 to $8 trillion in mid-2008. During the
same period, savings and investment assets (apart from retirement savings) lost
$1.2 trillion and pension assets lost $1.3 trillion. Taken together, these
losses total a staggering $8.3 trillion. Members of USA minority groups
received a disproportionate number of subprime mortgages, and so have
experienced a disproportionate level of the resulting foreclosures.
·
Impacts on the Developing Countries
A year on from the collapse of Lehman Brothers and talk in
developed countries has moved from recession to recovery. Recent OECD and
International Monetary Fund reports suggest that financial conditions in
developed countries have improved: there has been a boost in business
confidence, export orders are growing, the US housing market has bottomed out
and industrial production in emerging markets has begun to increase.
·
Impacts on the Poor Countries
Unemployment
Unemployment highly increased in the world and its very
important problem.
Poverty
While the repercussions of the financial crisis on poverty
in the developing world are severe and likely to worsen, the response to date
by governments and donors has been marginal.
The World Bank estimates that the crisis: financial
collapse, combined with the food and fuel price crises, increase the number of
poor by between 53 and 64 million people in 2009, based on estimates of those
on less than $2 a day and $1.25 respectively. The UK Department for
International Development, meanwhile, estimates that an additional 90 million
people will be living on less than $1.25 a day by the end of 2010.
Loss of income in a poor household is a serious shock.
Obviously, it increases poverty in that household. It also makes it more likely
that the wider community will become poor. It undermines a household’s ability
to buy basic supplies, and can lead to ways of coping that will derail family
well-being in the longer term, such as pulling children out of school or
cutting back on food. These strategies undermine the younger generation’s
chances of moving out of poverty or contributing to economic growth. It may
push vulnerable households into a vicious cycle of chronic inter-generational
poverty.
Prices
Poor people will also be affected by changes in prices as a
result of the financial crisis. Changes in both consumption and production
prices affect net consumers and net producers in different ways. In countries
that distinguish between aggregate and food-price inflation, the latter tends
to be higher. Persistently high inflation, in particular on food prices, will
challenge food security and reduce the resources poor consumers can spend on
non-food items, such as education and investment.
Private and Public Transfers
Reduced public revenue and an expanding debt are increasing
the pressure on government budgets. How governments reprioritise public
spending across regions, vulnerable groups and over time will shape the short
and long run impacts of the financial crisis on growth and poverty.
Assets and Good and Services
The provision of goods and services by governments, NGOs and
the private sector may be waning as a result of falling revenue. In Uganda, for
example, NGO revenues are reported to have fallen by over 5% in the space of a
year with the decline more pronounced since October 2008. Reductions in both
service provision and uptake are likely to deepen as the impact of the crisis
works its way through the economy.
Some countries are seeing strong economic growth transformed
into negative growth in 2009, others see significant slowdowns of 3-7
percentage points, though some have hardly been affected.
COMPARING
THE RECENT CRISIS TO THE PAST
If we compare today crisis to the Great Depression we say
there are some similarities. Both crises were caused in part by insufficient
regulation, as well as imprudent lending by inexperienced and often fraudulent
parties which were dealing with untested lending products. Both crises were
all-time lows for Wall Street and both were triggered by speculation,
unregulated financial markets, and a failure of confidence.
And these crises have some differrences. Current banking
crisis is much larger than the Great Depression in scale. More bank branches in
2008-2009 banking crisis than Great Depression.
2008-2009 banking crisis far exceeds from past crises.
Even when adjusted for inflation and population growth, the
2008-09 banking crisis far exceeds previous banking crises, including even the
Great Depression. There were 10,000 bank failures in the Great Depression, but
few of them had branches.
Today, a medium sized bank usually has hundreds of branches
and the two big failures, Washington Mutual and Wachovia Bank had more than
8,000 branches between them.
Four more banks went into Federal Deposit Insurance Corp.
receivership on Friday, bringing to 81 the total of FDIC actions in 2009.
Including FDIC bank closings in 2008, the total for the current financial
crisis is now 104. Assets of these 104 banks totaled $146.7 billion.
The S&L crisis was about five times bigger than the
banking crisis of the Great Depression. The current crisis is about 25 times
larger than the Great Depression. Both are per capita, adjusted for inflation.
The current crisis is so large because the financial sector has grown to
unprecedented economic dominance. The financial sector constituted 45% of
earnings for the S&P 500 in 2006.
If we compare the Assets/GDP ratios, we see that in the
2007-2009 crisis this ratio is much more than the other crisis. Following
tables are showing that:

SOLUTIONS
OF THE GLOBAL BANKING CRISIS

We propose three aspects of the system for dealing with
banking problems:
·
Deposit Insurance
Deposit insurance is needed because it is impossible to
avoid a commitment to protect depositors. This commitment cannot be avoided,
for both political and economic reasons. The public expects that its money will
be safe with any bank that has a banking license. Thus, in the event of a bank
failure, it is politically damaging for the government of the day to allow
small depositors to suffer losses. This is not quite inevitable; small
depositors have on occasion lost money. But it is difficult to avoid.
The deposit insurance fund must be further supported through
a guaranteed first line of credit from the central government so that it can
deal with a bank failure larger than the amount in the fund. In the event of
such a call in which the fund is forced to use this line of credit, insured
banks will then be required, after the event, to pay relatively high deposit
insurance premia, and if necessary a special levy, to restore the fund within a
reasonable time frame.
·
Bank Support
We now turn to the second element of reform: clear but
strictly limited procedures for the provision of financial support. As our
previous discussion makes clear, offering bank support is not a
lender-of-last-resort operation; it does not involve providing liquidity to the
market as a whole to prevent a run for cash. However, it is also clear that the
option of letting any bank in liquidity difficulties fail may create both
inefficiency and systemic problems.
·
Prompt Closure and Payout
Our third provision in bank crisis resolution is the need
for special procedures for intervention in a financial institution to resolve
its financial distress and make a rapid payout to depositors. At present, this
is not possible in the United Kingdom because closure follows standard U.K.
corporate insolvency law: A creditor applies to put a business into
administration, and the provider of liquidity support and the deposit insurance
fund then have no preference over other creditors.
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