Financial Risk Management: Based on the 2008 Global Financial Crisis Report (Assessment)

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Introduction

Global financial crisis is a term that has been widely applied in various circumstances where most financial assets or institutions are suddenly posed to mislay a considerable portion of their worth. In fact, in the nineteenth century and twentieth century, most global economic crises that transpired were essentially connected to the panic of various commercial organizations which corresponded to the global stagnations.

In fact, global financial crisis is not only connected to banking panics, but also situations namely sovereign defaults, currency crises, the bursting of financial bubbles and the crash of the stock markets (Peters 2010, p.20). In the event that a financial crisis occurs, paper wealth is directly lost but this does not directly cause variations in the real economy except when an economic slump follows.

The 2008 global financial crisis had both real and financial sectors roots yet this report draws on the financial root causes. The report further highlights the states revival attempts to end the crisis and the spillover effects which are still being witnessed to date. Based on the resultant effects and on account of the financial crisis, the report equally highlights the moves by various governments and institutions to moderate the reappearance of such a financial crisis.

The 2008 Global financial crisis (GFC)

The global financial crisis that took place in the financial year 2008 nearly led the world into a period of economic slump. It was considered to be amongst the utmost events that have ever happened in both economic and financial history because the world hardly experiences crises of these magnitudes. Basically, the 2008 global financial crisis was the worst the world has ever seen since the Great Depression of the 1930s.

The GFC had various causes that could be abridged under the “greediness factor”. The crisis was apparently manifested by the insolvency of different leading commercial institutions as well as the downfall of fiscal markets including the Wall Street. In the U.S., the GFC was signaled by the citizens’ loss of trust in their monetary system (Taylor 2008, p.7).

Events leading to the GFC

While it is believed that the U.S. subprime mortgage market might have prompted the occurrence of the global financial crisis, the primary cause of the crisis was founded on the flawed institutional practices and the instability of the modern financial systems (Truman 2009, p.1). Indeed, the inept practices adopted by financial institutions made various events to precede the 2008 global financial crisis. All the events that led to the emergence of the financial crisis are as discussed.

According to Soros (2008, p.38), the United States credit crisis was the first event to trigger off the global financial crisis. This crisis had evidently been imminent for the past twenty five years given that the world had instigated to use dollar as its most adorable currency reserve. In the earlier years, most countries globally had pegged their currencies on the dollar and they were using it as a medium of exchange.

This created a period of financial boom which materialized to be very fragile and likely to collapse. Since that time, a decline in dollar value implied a decline in the entire world economies, a scenario which occurred during the global financial crisis.

Global economies furthermore relied on the perception that the exchange rates would be stabilized by the financial markets and this would eventually lead to an equilibrium point (Soros 2008, p.67). However, this left both the economic and financial systems prone to the manipulation by business and financial institutions that aimed at amplifying their market gains.

On the other hand, IMF (2008) reported that the 2008 global financial crisis was set out by the financial crash in the United States Housing Sector. This sector started experiencing severe price decline as early as the fiscal 2005.

It was anticipated that the decline in price levels occurred mainly because house buyers took huge amounts of loans from the lending institutions to purchase the houses. It became obvious that traders never acquired the houses for settlement, but they bought them anticipating that they would make abnormal profits when the market prices rose (IMF, 2008).

When the U.S subprime mortgage industry projected the probable results, it started to offer loans to individuals and groups that had no cash to make down payments or those with poor credit. The balance of payment as a result experienced a crisis because the move made by the lending institutions was intended to support the plummeting currency that ensued from superfluous borrowing.

As it emerged during these periods, the efforts made the lending institutions to have deficits in their reserves because borrowers could not repay the loans due to skyrocketing inflation and this brought about the credit crunch (Krugman 2007, p.314). The United States subprime mortgagees were thereafter declared insolvent.

The bankruptcy in the major U.S. subprime institutions reverberated across the world because most financial and monetary institutions pegged their currencies on dollar. In fact, other nations’ currencies declined because inflation caused the dollar value to consequently weaken.

The U.S. government intervened by cutting down the Federal Reserve Bank (FRB) interest rates to as low as 0.25% due to the insolvency of the subprime industry. The FRB was crippled since the move depleted most of its reserves to a historical level that it was unable to back up the dollar value against the intensifying inflation (Calvo, Izquierdo & Loo-Kung 2009, p.234). Traders and lending institutions across the globe as result endeavored to sell off all their reserved dollars and this resulted into the experienced credit crisis.

Regardless of the collapse of the United States economic subprime section, the buildup to the global financial crisis emanated because of poor government intermediation in the manner in which lending institutions carried out most their businesses. Prior to the financial crisis, it was believed that regulated markets were less profitable as compared to free markets. This made the U.S. lending industry to be deregulated based on the fact that it posed minimal risks.

The notions created leeway for banks to intensively renovate and present new loaning techniques without seeking the FRB approvals. In case of insolvency, the lending institutions had bailout incentives which put the lending sector into further risks. For example, from the security tenures and bailouts that lending institutions were given, cycles of boom were eminent but traders manipulated them to get extra gains (Soros, 2008, p.76). Moreover, the booms were short-term since they were extremely volatile, leading to the global financial crisis.

The first identification of GFC, the adopted policy measure and the end of GFC

Even though the global financial crisis traces back its roots to the financial year 2005, it was first identified in July 2007 when the US financiers lost confidence in the subprime mortgages as a result of the credit crunch which caused liquidity crisis. The FRB in turn reacted by injecting more capital reserves into the commercial markets.

This made the crisis to worsen off in September 2008 when the global stock markets crashed and appeared to be very volatile. Everyone including the consumers was forced to tighten their belts as confidence hit the bottom rock in fear of what was lying ahead (Obstfeld & Rogoff 1995, p.75).

Owing to this widely felt crisis, it was the government, central banks and the IMF that were able to forecast the global financial crisis. However, to abate the situation, the central banks and governments reacted by offering various stimulus packages, institutional bailouts besides implementing a combination of strict monetary and fiscal policy measures. It is estimated that the federal government spent around $ 1 trillion in an effort to recover from the financial crisis.

Taxpayers were given cash handouts while the governments increased their financial spending on long-term projects. All in all, these were regarded as the viable policy measures that were to be adopted to help end the global financial crisis (Peters 2010, p.22). Albeit aftershocks of the GFC are still experienced, the crisis itself came to an end amid late 2008 and the middle of the fiscal 2009.

Concluding remarks

The global financial crisis which occurred in the late 2000s will ever be recognized as the worst great recession to have ever occurred since the 1930s Great Depression. It led to the fall of various financial institutions, slumps in global stock markets and the bailing out of financial institutions by state governments.

Many areas witnessed the suffering of the housing markets which resulted into prolonged unemployment, foreclosures and scores of evictions. Furthermore, the GFC brought down key businesses, significantly declined the consumers wealth as well as economic activities, thus paving way for the 2008 global financial downturn.

Having occurred within a short period of time compared to the 1930s Great Depression, the GFC showed the weaknesses of modern financial and monetary systems alongside the failure of governments and financial authorities to take decisive actions to curb the occurrence of such a crisis.

The security values that were tied to the real estate prices plummeted and damaged the global financial institutions. Banks became solvent, credit availability declined and the confidence of investors was totally damaged which considerably crushed the universal stock markets. Without the stimulus packages, stringent monetary and fiscal policies that governments adopted, the world economies could have gone into recession.

References

Calvo, G, Izquierdo, A & Loo-Kung, 2009, “Relative price volatility under sudden stops: The relevance of balance sheet effects”, Journal of International Economics, vol.9 no.1, pp.231–254.

Dayananda, D, Irons, R, Harrison, S, Herbohn, J, & Rowland, P, 2002, Capital budgeting: Financial appraisal of investment projects, Cambridge University Press, Cambridge UK.

IMF 2008, World economic outlook: World economic and financial surveys, International Monetary Fund, Washington, D.C.

Obstfeld, M & Rogoff, K 1995, “The mirage of fixed exchange rates”, Journal of economic perspectives, vol.9 no.4, pp.73-96.

Peters, M 2010, What the 2008/2009 world economic crisis means for global agricultural trade, Diane Publishing, Pennsylvania, US.

Soros, G 2008, The new paradigm for financial markets: the credit crisis of 2008 and what it means, Public Affairs, New York, NY.

Taylor, J 2008, “The financial crisis and the policy responses: an empirical analysis of what went wrong”, Journal of Economic Review, vol.89 no.1, pp.3-14.

Truman, E 2009, The global financial crisis: Lessons learned and challenges for developing countries, Peterson Institute for International Economics, Banco.

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IvyPanda. (2023) 'Financial Risk Management: Based on the 2008 Global Financial Crisis'. 8 December.

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IvyPanda. 2023. "Financial Risk Management: Based on the 2008 Global Financial Crisis." December 8, 2023. https://ivypanda.com/essays/financial-risk-management-based-on-the-2008-global-financial-crisis-assessment/.

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