The financial crisis and credit crunch (2008)

Amna Muzammil
Introduction
The financial crisis have remained part of the world financial system since centuries with
patterns. The Great Depression of 1929-1939 was also such event that destroyed almost the
whole economic and financial structure of the world also contributing to the reasons behind
the World War 2. Afterwards, the huge financial stress between 2007-2008 is known as the
Global Financial Crises is regarded as the major shock to the world since the Great Depression.
It began in 2007 with a crises in the subprime mortgage (the provision of loans to people who
may have difficulty maintaining the repayment schedule) market in the United States that led
to the international banking crises A significant feature during the period was the
securitisation of sub-primes and loans by their original lenders. During the first half of 2007,
when problems first became apparent, it was thought that the crises would remain to the
financial sector of the United States only but the perception was not true.
Later on, the impacts started to emerge in the global financial system. The major banks from
different states such as the bank of France BNP Paribas announced to suspend three of its
funds investing in the United States’ mortgage securities. The crises led to the collapse of
investment bank Lehman Brothers in September 2008 which was the first time in the crises
that losses were incurred by creditors of a major financial institution. The Lehman collapse
followed the effective nationalisation of the two federal mortgage agencies of the US that
together had more than $5 trillion in mortgages under management a week earlier. Excessive
risk-taking by banks such as Lehman Brothers helped to magnify the financial impact globally.
Massive bail-outs of financial institutions and other palliative monetary and fiscal policies
were employed to prevent a possible collapse of the world financial system. These events
quickly led to the nationalisation of the world’s largest insurance company the American
International Agency along with the string of other announcements of the failure or the near
failure of the financial system of Europe and the United States of America. Uncertainty about
the nature, scope and passage of the various proposed rescue packages through this period
added to the general turmoil. In the following months, the crises were increased as more
information about the scale of losses was revealed.
These events sparked a severe loss of confidence, not just in the financial sector, but also
across households and businesses. In the weeks that followed the Lehman Brothers’ collapse,
world equity markets experienced extreme volatility, with prices falling in net terms to
eventually reach levels around 50 per cent below their earlier peaks. It was also during this
period that governments around the world moved to guarantee deposits and in some cases
wholesale borrowing by their banks, in conjunction with a series of other measures designed
to support their financial systems. The crisis also spread quickly to other vulnerable countries;
towards the end of 2008, the International Monetary Fund (IMF) announced stabilisation
packages for Iceland, Pakistan and several Eastern European countries.
The global financial system was threatened to the total collapse, also resulted to huge bailouts
of financial institutions by their governments, caused sharp declines in stock prices that
followed smaller and expensive loans for corporate mendicants because banks had pulled
back on their long and short term credit facilities which led to decline in consumer lending
and lower investments in the real sector. Beginning from the United States the crises spread
to the whole world through exposure to the United States’ real assets, financial derivatives,
and a collapse in global trade. Many countries were significantly affected by these adverse
shocks, causing systemic banking crises in a number of countries, despite extraordinary policy
interventions. Systemic banking crises are disruptive events not only to financial systems but
to the economy as a whole. Such crises are not specific to the some specific countries – almost
no country has avoided the experience and some have had multiple banking crises. While the
banking crises of the past have differed in terms of underlying causes, triggers, and economic
impact, they share many commonalities. Banking crises are often preceded by prolonged
periods of high credit growth and are often associated with large imbalances in the balance
sheets of the private sector, such as maturity mismatches or exchange rate risk, that
ultimately translate into credit risk for the banking sector.
As the foreign banks were active participants in the US housing market during the boom,
including purchasing mortgage backed securities, US banks also had substantial operations in
other countries. These interconnections provided a channel for the problems in the US
housing market to spill over to financial systems and economies in other countries. Major
policy response was seen after the crises boomed including lowering the interest rates,
increased government spending and stronger oversight of financial institutions to stabilise
the financial system.
Quratulain Saleem
Why Did It Happened?

The 2008 crash was the greatest jolt to the global financial system in almost a century – it pushed the
world's banking system towards the edge of collapse. The financial crisis of 2007–2009 was the
culmination of a credit crunch that began in the summer of 2006 and continued into 2007. So why
did this phenomenon really happen? The world’s largest financial company called the “Lehman
brothers” filed for bankruptcy within a few weeks in the month of September 2008. It was 90 billion
wiped off the map. However this was one of the effects of the financial crisis in 2008 but not the cause
of it. The immediate trigger was a combination of speculative activity in the financial markets, focusing
particularly on property transactions especially in the USA and Western Europe and the availability of
cheap credit. There was borrowing on a huge scale to finance what appeared to be a one-way bet on
rising property prices. But the boom was ultimately unsustainable because, from around 2005, the
gap between incomes and debt began to widen. This was caused by rising energy prices on global
markets, leading to an increase in the rate of global inflation. This development squeezed borrowers,
many of whom struggled to repay mortgages. Property prices now started to fall, leading to a collapse
in the values of the assets held by many financial institutions. The banking sectors of the USA and the
UK came very close to collapse and had to be rescued by state intervention.

The first prominent signs of problems arrived in early 2007, when Freddie Mac announced that it
would no longer purchase high-risk mortgages, and New Century Financial Corporation, a leading
mortgage lender to risky borrowers, filed for bankruptcy. Another sign was that during this time the
ABX indexes—which track the prices of credit default insurance on securities backed by residential
mortgages—began to reflect higher expectations of default risk. While the initial warning signs came
earlier, most people agree that the crisis began in August 2007, with large-scale withdrawals of short-
term funds from various markets previously considered safe, as reflected in sharp increases in the
“haircuts” on repos and difficulties experienced by asset-backed commercial paper (ABCP) issuers who
had trouble rolling over their outstanding paper.

The financial crisis was also primarily caused by deregulation in the financial industry. That permitted
banks to engage in hedge fund trading with derivatives. Banks then demanded more mortgages to
support the profitable sale of these derivatives. They created interest-only loans that became
affordable to subprime borrowers. In 2004, the Federal Reserve raised the fed funds rate just as the
interest rates on these new mortgages reset. Housing prices started falling as supply outpaced
demand. That trapped homeowners who couldn't afford the payments, but couldn't sell their house.
When the values of the derivatives crumbled, banks stopped lending to each other. That created the
financial crisis that led to the Great Recession.

Where did the crisis start?

The crash first struck the banking and financial system of the United States, with spill-overs into
Europe. Here, another crisis, one of sovereign debt, arose from the flawed design of the Eurozone;
this allowed countries such as Greece to borrow on similar terms to Germany in the confidence that
the Eurozone would bail out the debtors. When the crisis hit, the European Central Bank refused to
reschedule or mutualize debt and instead offered a rescue package on the condition that the stricken
nations pursued policies of austerity.

The effects on the global economy

The global economy was effected by the financial crisis in profound and permanent ways in which it
has changed as a result of the crisis itself and the policy responses to it, and to underplay the
importance of these changes for global economic policy going forward.

Spillover Effects of the Global Financial Crisis on China’s Economy

Although China was able to maintain relatively high economic growth, the negative effects from the
global financial crisis on China were considerably stronger than is often realized. This misconception
arose largely because China continued to have one of the highest rates of economic growth across the
globe, recording 9.6% in 2008 and 9.2% in 2009. What is typically missed is that, while most countries
would be delighted to have such growth, these rates reflected a substantial drop from the 14.2%
growth in 2007. However, there was also a global financial impact that did not operate directly through
capital flows. The crisis affected the economic outlook and risk attitudes across the globe and China
was not immune. Before the crisis, extreme optimism had affected many markets across the globe
and China’s stock market was no exception. Like in many other countries, China had enjoyed a stock
market boom, increasing fivefold between 2005 and 2007. Such rapid growth makes markets highly
likely to suffer major reversals, and this is just what occurred when bad news hit. Starting in October
2007, the stock market in China crashed, wiping out more than two-thirds of its market value. A similar
story applies to the real estate market. A bubble started to grow with China’s booming economy, since
most of the people believe that investing in property, such as real estate, is safer than putting money
in the banks. The impacts of these developments on the Chinese economy were relatively small
compared with the trade channel, however.

In November 2008, China’s export growth rate fell sharply to −2.2% from 20% in October. As a whole,
China’s exports fell by about 17% in 2009 , before recovering to positive growth in 2010, as the
advanced countries began to grow again. The rebounds of economic growth in advanced countries
have been modest, and this has limited the size of the rebound in China’s exports. Although it remains
too early to say that China’s export business has leveled off, development of the domestic market will
help maintain China’s sustainable economic growth over the long term.

Effects of global financial crisis on USA

The crisis was the worst U.S. economic disaster since the Great Depression. In the United States, the
stock market plummeted, wiping out nearly $8 trillion in value between late 2007 and 2009.
Unemployment climbed, peaking at 10 percent in October 2009. Americans lost $9.8 trillion in wealth
as their home values plummeted and their retirement accounts vaporized. In all, the Great Recession
led to a loss of more than $2 trillion in global economic growth, or a drop of nearly 4 percent, between
the pre-recession peak in the second quarter of 2008 and the low hit in the first quarter of 2009.

In 2008, the government seized control of the troubled mortgage giants as the housing market
unraveled and the companies’ losses piled up. Taxpayers pumped billions into the companies, but over
the past few years Fannie Mae and Freddie Mac, which buy mortgages from lenders and then package
them into securities to sell to investors, have been spewing profits that feed into government coffers.
Fannie Mae, for example, took $119.8 billion in taxpayer bailout money but has handed over $167.3
billion to the Treasury Department. The smaller Freddie Mac took $71.6 billion in bailout money and
has turned over $112.4 billion in profits. The housing market was ground zero of the crisis. The market
crashed as homeowners with subprime and other troublesome loans defaulted at record levels. Home
prices dropped, and millions lost their homes to foreclosure.

The output of goods and services produced by labor and property located in the United States
decreased at an annual rate of approximately 6% in the fourth quarter of 2008 and first quarter of
2009, versus activity in the year-ago periods. The US unemployment rate increased to 10.1% by
October 2009, the highest rate since 1983 and roughly twice the pre-crisis rate. The average hours per
work week declined to 33, the lowest level since the government began collecting the data in 1964.
With the decline of gross domestic product came the decline in innovation. With fewer resources to
risk in creative destruction, the number of patent applications flat-lined. Compared to the previous 5
years of exponential increases in patent application, this stagnation correlates to the similar drop in
GDP during the same time period.

Effects of global financial crisis on Europe

In 2008, Europe entered a period of unprecedented financial crisis following a global economic
downturn. Several countries in the European Union faced declining gross domestic product (GDP),
increasing public debt, and rising borrowing costs, while individual households experienced financial
insecurity created by job loss, reduced salaries, and plummeting house prices. The situation worsened
by early 2010, and Greece became the first EU country to receive a bailout package jointly from the
International Monetary Fund, the EU, and the European Central Bank. Ireland, Portugal, and Cyprus
followed a few months later.

The global financial crisis has significantly affected the European Union, especially the new members
such as Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland, Slovenia, Slovakia, Romania and
Bulgaria. Reasons and circumstances of economic crisis in different countries in different periods are
different. The global crisis supports the idea that the regional economies, even European Union (EU27)
or USA, are not able to face to the new challenges.

Hafsa Iqbal
Impact of financial crisis on Pakistan’s economy:

Financial crisis is an economic situation in which the economy of a country faces some unanticipated
downturn or recession, price fluctuations, current account deficits and uncertainty on foreign sector.
After the Great Depression of 1930 an International crisis of 2008 was the most horrible and
dangerous. The consequences of this financial crisis seriously affected the world economies.
Developing countries of the world were further dragged into poverty tap and the total output of the
world declined up to extreme level. It affected the developing countries depending on the structure
of regional economies and their integration into world markets. According to World Bank analysis,
throughout the developing world, growth is forecast to slow down in 2009 , as a result of falling
exports and remittances and stock market declines. The financial crisis of 2008 has largely affected
the economy of Pakistan which was already facing great macroeconomic disparities and imbalances.
This crisis further pushed Pakistan’s economy into financial crisis. Pakistan has suffered from high
fiscal and current account deficits, rapid inflation, low reserves, a weak currency and a declining
economy that have put the country in a very difficult situation. These factors created a difficult
environment for economic growth.

Impact on External and financial developments:

The large net losses from food and oil prices led to a sharp decline in current account and fiscal
balances, allowing little scope for countercyclical policies. Pakistan’s exports hit severely due to
recession in the western world. The United States and the European Union are the major destinations
of Pakistani exports, both were badly hit by the financial crisis. Pakistan, therefore, faced the problems
in the exports sector as about 54% of the country’s exports go to US and European countries.

Approximately half of the additional goods import bill in financial year 2008 came from high fuel prices
in the International market that peaked in July 2008. This led to an increase in both inflation and
current account deficit. Oil imports increased by 43% in the year 2007-08 and reached 10.5 billion
dollars. Thus, International oil prices was one of the major cause of the worsening fiscal and trade
imbalances and Pakistan was caught in a vicious cycle of economic stagnation. Pakistan’s balance of
payment crisis came when the entire donor community including the US and Europe was beset with
its own financial crisis. Pakistan asked US, Saudi Arabia and urged China for a billion dollar financial
support, but it was of no benefit. Finally in November 2008, IMF agreed to a stand- by agreement of
7.6 billion dollars.

Pakistan’s GDP Growth rate came down, Pakistan also witnessed high fiscal and current account
deficit. GDP growth rate declined from 6.8% in 2007 to 4.1% in 2008. Fiscal and current account deficit
reached to the highest 7.4% and 8.4 of GDP

Foreign Direct Investment:

Foreign Direct investment carries a considerable importance in economic growth and as a result of
Global Financial Crisis, FDI came down from $5410 million in 2008 to $3720 million in 2009. Global
Financial Crisis has also widened the Trade Gap in Pakistan as Trade Deficit rose to 12.8 % of GDP in
2008.

Unfortunately, Pakistan was suffering from different problems and thus government was not in a
condition to provide a bail-out package. The economy of Pakistan was already suffering the
financial imbalances due to rise in oil prices and reducing foreign exchange reserves further
enlarged the trade gap, increase the budget deficit, current account deficit and high inflation
carried more financial challenges for the economy of Pakistan. The economy of Pakistan had no
potential to accept the discretionary fiscal policy because here public debt and shrinking in
taxes were already on top. The international financial crisis has revealed many ducks in the
financial system of Pakistan economy. The crisis has furnished a lesson to so called sustained
financial sector of Pakistan that it is an essential need of the time to improve the present
financial mechanism and to make the regulatory authority more consistent. The international
financial crisis badly damaged the macroeconomic stipulations of Pakistan economy. It is
recommended to enhance and refurnish the action plans to deal with such crisis by reducing
the fiscal and current account, trade deficits and to increase taxes to GDP.

Mohammad Shaharyar
United states policies towards Financial crisis of 2008: The string to
hold giant not to fall

“Financial Crisis requires Governments”

Timothy Geithner, United States Secretary of treasury (2013)

The quote from the Timothy Geithner, who was the Secretary of treasury in United States of America
explained the important presence of governmental intervention during the crisis period in
reestablishing the financial stability. Many people think that Financial system should be liberated from
the governmental regulations, and believing that competitions will be refrained under such
conditions. However, 2008 Global financial crisis raised the question that whether the government
should expand regulations to banks. Nevertheless, it is important to answer the above question.

As it is the most important objective of the regulation is to sustain the systematic stability of the
financial sector because without money a neither a state can run nor can survive in international
system. Many analyst and authors of economics believe that the ideology behind the objective is due
to the greater cost of bank failures compared to private costs. No doubt that the core activity of banks
was to act as intermediaries they were responsible for payment mechanism as well as accountable
amount of money of investors and savers. However, externalities problem aroused when the financial
system dominates economical activities, which meant that financial sector problem would cause
severe damage to economy.
Emergency Economic stabilization Act of 2008
The secretary of treasury of United States HENRY PAULSON and the President of United states of
America George Washington Bush proposed a legislation in which the government of US purchased
up to $700 billion of (troubled mortgage -related assets) with the hope of improving it and to build
confidence in the market so that financial firms could participate in it. On October 1 a revise
compromised version was approved by the senate and the Bill was passed by the House on October
3,2008 and signed into the law. So, the major firm of United States (Lehman brothers bank) at that
time applied for help.

American recovery and reinvestment Act of 2009

In 2009 the new elected president of United States Barrack Obama and his administration planned to
revive the economy to save 3.5 million jobs. The plan included 365.5 billion dollars to be spent on
major policy and reform of the health system, 275 billion (through tax rebates) to be redistributed
to households and firms, notably those investing in renewable energy.

Federal Reserve Response

On November 25, 2008 the Fed announced it would buy $800 billion of debt and mortgage backed
securities, in a fund separate from the 700-billion dollar (TARP) that was originally passed by Congress.
The fund would also be used to loan $200 billion to the holders of securities backed by various types
of consumer loans, such as credit cards and student loans, to help unfreeze the consumer debt market.
After December 24, 2008, the Federal Reserve had used its independent authority to spend $1.2
trillion on purchasing various financial assets and making emergency loans to address the financial
crisis.

REMARKS
The 2008 financial crisis once again affirms the role of government in stabilizing the financial system,
without the interference of government the economy could collapse.

Iqra abbas
Lessons learnt

The global financial crisis of 2008-09 can be greatly attributed to the policies of US. The elongated
period of loose monetary policies of US over the period 2003 -4 has an immense role in the crises.
Lowering of the interest rates during this era has resulted in the increased search for yield and a global
compression of risk premia. Also liquidity generated in the new economies by these monetary policies
has resulted in the flow of large capitals to the emerging economies. The factors became the cause of
rise in the commodity prices including oil creating a boast in the investment and consumption. These
accommodative economic policies led to the economic imbalances coinciding with the tax lending
standards, misuse of derivatives, credit rating and financial engineering leading to record breaking
inflation.
Society always have to pay in the form of recession of jobs ,property loses and long term loses of no
growth or slower growth when economic bubbles are allowed to build so the Central bank have to
pay its role to accommodate and control liquidity bubbles and asset bubbles. New businesses and
institutions should be regulated and supervised more carefully. Securitization process has pulled
regulators into false sense of relief for those who are in securitization chain but ultimately are not
holding securitized paper. A better job of evaluation should be done by regulators and financial firms
of what and how much risk the securitizing process is really passing. The regulatory authority must be
having all the essential information of any institution or business within a market place. No financial
institution should be kept immune of providing the necessary information. A clear mechanism must
be adopted to collect information.
There is no definite regulatory architecture that can be adopted with certainty. Whether the
regulatory authority should be part of Central bank or not and what key issues should be under the
control of regulator. However through history and the financial turmoil it is learnt that there should
be a universal application of similar rules. All the institutions within a market place performing
particular economic function should be regulated in a same manner neglecting the choice of charter
or the name.
Another takeaway is the importance of multilateral preparedness and action. Institutions like the IMF
have played a crucial role in responding to crises and keeping the global economy on track. The ability
to respond effectively to these challenges has required a constant process of reform that needs to
continue.
In the face of the discontent with multilateralism in some advanced economies, it is essential for the
process of IMF evolution to continue – across the range of lending, analytical and research activities –
so that we continue to meet our core mission of supporting global growth and financial stability. This
will become all the more important if national policy tools prove insufficient to meet a crisis.

Conclusions:
Economic crunch of 2008 caused the most devastating crisis since Great Depression.
There is no clear consensus on to what the cause of the crisis is and what needs to be done to prevent
another one from happening.
The crisis resulted by contribution of many factors: monetary policies, global economic developments,
misaligned incentives, fraud, growth of securitization and a fragmented regulatory structure. Global
financial crisis started with a collapse in the real estate industry that later spread the adverse economic
instability to other sectors of the economy. The financial institutions such as banks and large insurance
companies like the AIG were faced with financial troubles that threatened downfall of other large
organizations in the economy. Slow economic recovery in the United States is attributed to the
inefficient economic policies implemented to realize a boom. Investors in the American economy are
faced with diverse risks that were evidenced by the global financial crisis such as the liquidity, counter
party and systemic risks that pose threats of potential losses of investment in the financial markets.
Many reforms are needed to be made and many actions are required to be taken to prevent any
further mishap to take place again.
Learning the right lessons from the global financial crisis of 2007-09 is a challenge not only for the
leaders of the advanced economies and the larger emerging economies whose policies individually
and collectively will determine the evolution of the global economy and financial system over the next
several decades. Learning and applying the right lessons is a challenge for the leaders of smaller
emerging and developing economies that will have to live with the consequences. Their own words
should be clear, and their policies should be examples for all of us.