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Global Financial Crisis - What caused it and how the world responded

The credit crunch

The global financial crisis (GFC) or global economic crisis is commonly believed to have begun in July 2007 with the credit crunch, when a loss of confidence by US investors in the value of sub-prime mortgages caused a liquidity crisis. This, in turn, resulted in the US Federal Bank injecting a large amount of capital into financial markets. By September 2008, the crisis had worsened as stock markets around the globe crashed and became highly volatile. Consumer confidence hit rock bottom as everyone tightened their belts in fear of what could lie ahead.

The sub-prime crisis and housing bubble The housing market in the United States suffered greatly as many home owners who had taken out sub-prime loans found they were unable to meet their mortgage repayments. As the value of homes plummeted, the borrowers found themselves with negative equity. With a large number of borrowers defaulting on loans, banks were faced with a situation where the repossessed house and land was worth less on today's market than the bank had loaned out originally. The banks had a liquidity crisis on their hands, and giving and obtaining loans became increasingly difficult as the fallout from the sub-prime lending bubble burst. This is commonly referred to as the credit crunch. Although the housing collapse in the United States is commonly referred to as the trigger for the global financial crisis, some experts who have examined the events over the past few years, and indeed even politicians in the United States, may believe that the financial system was needed better regulation to discourage unscrupulous lending.

The global financial crisis enters a new phase

The collapse of Lehman Brothers on September 14, 2008 marked the beginning of a new phase in the global financial crisis. Governments around the world struggled to rescue giant financial institutions as the fallout from the housing and stock market collapse worsened. Many financial institutions continued to face serious liquidity issues. The Australian government announced the first of it's stimulus packages aimed to jump-start the slowing economy. The U.S. government proposed a $700 billion rescue plan, which subsequently failed to pass because some members of US Congress objected to the use of such a massive amount of taxpayer money being spent to bail out Wall Street investment bankers who some people may have believed could be one of the causes of the global financial crisis. By September and October of 2008, people began investing heavily in gold, bonds and US dollar or Euro currency as it was seen as a safer alternative to the ailing housing or stock market. In January of 2009 US President Obama proposed federal spending of around $1 trillion in an attempt to improve the state of the financial crisis. The Australian government also proposed another stimulus package, pledging to give cash handouts to tax payers, and spend more money on longer-term infrastructure projects. Australia's response to the global financial crisis - the first stimulus package Australian prime minister Kevin Rudd and Treasurer Wayne Swan delivered their first budget in response to the global financial crisis, with the main objective being to fight inflation - a major problem in the local economy at the time. In October 2008 the Rudd government announced that it would guarantee bank deposits. With the economy facing a recession, an economic stimulus package worth $10.4 billion was announced. This included payments to seniors, carers and families. The payment were made in December 2008, just in time for Christmas spending, and retailers predominantly reported

strong sales. The first home buyer's grant was doubled to $14,000 for existing homes, and tripled to $21,000 for new homes. The automotive industry was also given a helping hand, as several major lenders had withdrawn from the market completely, leaving banks to fill the gaps in lending.

The crisis continues - a second stimulus package is announced A second, even larger economic stimulus package was announced by the Australian government in February 2009. $47 billion was allocated to help boost the economy:

$14.7 billion for schools $6.6 billion for 20,000 new homes $3.9 billion to insulate 2.7 million homes $890 million for road repairs and infrastructure $2.7 billion in small business tax breaks $12.7 billion for cash bonuses: $950 for every Australian taxpayer who earned less than $80,000, to be paid out in March and April 2009

Are we really immune to the worst of this crisis? Many experts had commented that the Australian economy was somewhat more insulated than other countries from the subprime issues surrounding the United States, and although Australia has not suffered as badly as some nations, the affects of the global financial crisis are very real and may yet deepen. The Australian housing market has slowed. What began as a relatively localised issue in the United States has had a massive

flow-on effect worldwide, and it is still not known how long it will take for the world economies to recover.

Financial Crisis Was Avoidable, Inquiry Finds

WASHINGTON The 2008 financial crisis was an avoidable disaster caused by widespread failures in government regulation, corporate mismanagement and heedless risk-taking by Wall Street, according to the conclusions of a federal inquiry.

The commission that investigated the crisis casts a wide net of blame, faulting two administrations, theFederal Reserve and other regulators for permitting a calamitous concoction: shoddy mortgage lending, the excessive packaging and sale of loans to investors and risky bets on securities backed by the loans. The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done, the panel wrote in the reports conclusions, which were read by The New York Times. If we accept this notion, it will happen again. While the panel, the Financial Crisis Inquiry Commission, accuses several financial institutions of greed, ineptitude or both, some of its gravest conclusions concern government failings, with embarrassing implications for both parties. But the panel was itself divided along partisan lines, which could blunt the impact of its findings. Many of the conclusions have been widely described, but the synthesis of interviews, documents and testimony, along with its government imprimatur, give the report to be released on Thursday as a 576-page book a conclusive sweep and authority. The commission held 19 days of hearings and interviews with more than 700 witnesses; it has pledged to release a trove of transcripts and other raw material online.

Of the 10 commission members, the six appointed by Democrats endorsed the final report. Three Republican members have prepared a dissent focusing on a narrower set of causes; a fourth Republican, Peter J. Wallison, has his own dissent, calling policies to promote homeownership the major culprit. The panel was hobbled repeatedly by internal divisions and staff turnover. The majority report finds fault with two Fed chairmen: Alan Greenspan, who led the central bank as the housing bubble expanded, and his successor, Ben S. Bernanke, who did not foresee the crisis but played a crucial role in the response. It criticizes Mr. Greenspan for advocating deregulation and cites a pivotal failure to stem the flow of toxic mortgages under his leadership as a prime example of negligence. It also criticizes the Bush administrations inconsistent response to the crisis allowingLehman Brothers to collapse in September 2008 after earlier bailing out another bank,Bear Stearns, with Fed help as having added to the uncertainty and panic in the financial markets. Like Mr. Bernanke, Mr. Bushs Treasury secretary, Henry M. Paulson Jr., predicted in 2007 wrongly, it turned out that the subprime collapse would be contained, the report notes. Democrats also come under fire. The decision in 2000 to shield the exotic financial instruments known as over-thecounter derivatives from regulation, made during the last year of President Bill Clintons term, is called a key turning point in the march toward the financial crisis. Timothy F. Geithner, who was president of the Federal Reserve Bank of New York during the crisis and is now the Treasury secretary, was not unscathed; the report finds that the New York Fed missed signs of trouble at Citigroup and Lehman, though it did not have the main responsibility for overseeing them.

Former and current officials named in the report, as well as financial institutions, declined Tuesday to comment before the report was released. The report could reignite debate over the influence of Wall Street; it says regulators lacked the political will to scrutinize and hold accountable the institutions they were supposed to oversee. The financial industry spent $2.7 billion on lobbying from 1999 to 2008, while individuals and committees affiliated with it made more than $1 billion in campaign contributions. The report does knock down at least partly several early theories for the financial crisis. It says the low interest rates brought about by the Fed after the 2001 recession;Fannie Mae and Freddie Mac, the mortgage finance giants; and the aggressive homeownership goals set by the government as part of a philosophy of opportunity were not major culprits. On the other hand, the report is harsh on regulators. It finds that the Securities and Exchange Commission failed to require big banks to hold more capital to cushion potential losses and halt risky practices, and that the Fed neglected its mission. It says the Office of the Comptroller of the Currency, which regulates some banks, and the Office of Thrift Supervision, which oversees savings and loans, blocked states from curbing abuses because they were caught up in turf wars. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire, the report states. The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble. The reports implications may be felt more in the political realm than in public policy. The Dodd-Frank law overhauling the regulation of Wall Street, signed in July, took as its premise the same regulatory

deficiencies cited by the commission. But the report is sure to be a factor in the debate over the future of Fannie and Freddie, which have been run by the government since 2008. Though the report documents questionable practices by mortgage lenders and careless betting by banks, one striking finding is its portrayal of incompetence. It quotes Citigroup executives conceding that they paid little attention to mortgage-related risks. Executives at the American International Group were found to have been blind to its $79 billion exposure to credit-default swaps, a kind of insurance that was sold to investors seeking protection against a drop in the value of securities backed by home loans. AtMerrill Lynch, managers were surprised when seemingly secure mortgage investments suddenly suffered huge losses. By one measure, for about every $40 in assets, the nations five largest investment banks had only $1 in capital to cover losses, meaning that a 3 percent drop in asset values could have wiped out the firm. The banks hid their excessive leverage using derivatives, offbalance-sheet entities and other devices, the report found. The speculative binge was abetted by a giant shadow banking system in which the banks relied heavily on short-term debt. When the housing and mortgage markets cratered, the lack of transparency, the extraordinary debt loads, the short-term loans and the risky assets all came home to roost, the report found. What resulted was panic. We had reaped what we had sown.The report, which was heavily shaped by the commissions chairman, Phil Angelides, is dotted with literary flourishes. It calls credit-rating agencies cogs in the wheel of financial destruction. Paraphrasing Shakespeares Julius Caesar, it states, The fault lies not in the stars, but in us.Of the banks that bought, created, packaged and sold trillions of dollars in mortgage-related securities, it says: Like Icarus, they never feared flying ever closer to the sun.

Global Financial Crisis Impact: Global Economic Slowdown Impact on Stock Markets Globally World stock markets have taken a beating, leading to a loss in confidence amongst investors who are stepping back in spite of several cuts in lending rates by the banks E.g. DJIA fell below 10,000 mark (first time in four years) plunging more than 800 points in a single day in October. The fall was mirrored in stock markets, such as NASDAQ, NYSE, Nikkei 225, Londons FTSE, Germanys DAX, etc Losses to Investors Both institutional investors and individual investors have suffered huge losses both in MBS and related products, and in equities Banks alone are reported to have suffered USD 600 Bn of credit-related losses globally. According to IMF estimates, American and European banks are predicted to loose USD 10 trillion of assets Freeze in Inter Bank Credit Failure of banks fueled anxiety in international banking markets leading to a freeze in inter-bank lending Increasing Unemployment There have been job cuts in many companies across various sectors around the globe. This trend has not been limited to the financial sector alone High number of layoffs were announced in the US through September 2008: 111,000 in financial sector, 95,000 in automotive sector, 62,000 in transportation, 51,000 in retail, 28,000 in elecommunications and more in other sectors Decline in Businesses Globally There is considerable decline in business all over world marked by reduced output and consumer spending, particularly in Britain, France, Germany and Japan. The industries being impacted include automotive, airline, building materials etc. Automotive companies such as GM, Ford and Toyota reported 45%, 30% and 23% decline in sales respectively, in October 2008 Bailouts Several bailout packages have been announced by governments around the world to fight the growing financial crisis The US has announced a USD 700 Bn bailout package for its banking sector, Germany announced a bailout package of more than USD 200 Bn and Britain more than USD 500 Bn for this financial crisis (see appendix for more detail on global bailout announcements)

Global Financial Crisis Causes: US Housing Market Collapse Many experts believe that the global crisis was triggered by the US housing market collapse US Housing Market Collapse Easy access to credit: Falling interest rates and rising availability of mortgages, combined with rising housing prices encouraged consumers to buy homes Relaxed lending standards: To cater to the growing number of mortgage seekers, lenders relaxed standards and issued a large number of sub-prime loans Inadequate regulations: Regulations did not keep pace with innovations in US financial products, leading to much higher complexity, poor transparency and greater risk Complex credit derivatives: The invention and use of complex debt derivatives such as CDOs made it difficult to identify and contain the sub-prime lending problem, once default rates began to rise Market collapse: The property boom led an over-supply of housing and prices could no longer be supported. Just like the self-perpetuating behavior that led to the rise, the crash was also self-perpetuating. As prices fell, more foreclosures started taking place, increasing the supply of homes on the market. Lenders started to tighten their standards and fewer consumers could qualify for mortgages and help reduce the supply