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Global Financial Crisis Causes and Impacts Cause and Effect Essay

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Updated: Sep 22nd, 2019


Global financial crisis is described as the extensive economic disaster that started in the United States in 2007. Starting with the collapse of the American financial system, the economic emergency rapidly spread to other countries in the world. Interrelated markets of the current global trading systems were the major cause of the rapid spread of the financial crisis.

After a number of years since the first occurrence of the crisis, it is still not possible to explain fully the impact of the global financial crisis because the economic emergency keeps on hindering and destroying global markets (Gelos, 2009, p. 15). A number of factors caused the concurrent crush of the housing system, financial markets, and the banking industry in America.

Even though the causes of the crisis are still debated, this occurrence spread out almost immediately into the international market. Usually, the United States plays an influential role in global financial industries and stock trading. This means that the crush caused a destructive impact both within America and in countries all over the world.

The extensive effects of the economic crisis began late in 2007 at the time when prices of fuel and food started increasing globally. Factors that some years before seemed minor like increases in prices of fertilizers started to destroy crop industries and the importation of food in developing economies (Gelos, 2009, p. 17).

In 2008 as the financial crisis in America intensified, financial institutions like banks strove to decrease their spending mainly in foreign investments. This deepened the worldwide emergency because many countries depended a lot on the foreign investment of the United States for the survival of their economies.

Global governance

The outstanding increase in global integration recently has largely overwhelmed the ability of global governance. The deepening of globalization has led to an increase in insufficiency of organizations and policies responsible for global governance. This was evident in the global financial crisis and its harsh effects which are still ongoing.

The speed and frequency with which economic emergencies from one nation and spread to other countries shows the significance of sufficiently strengthening financial organizations to make sure that they are able to take fast, remedial and effective measures.

Improvement in global economic governance is the main factor in renewing the prevailing dialogue in global political economy (Crotty, 2009, p. 563). Many national economic policies which are cost effective work partly because they benefit other nations but a majority of the policies are only possible if they are also adopted by other nations.

The IMF has argued that the main cause of the global financial crisis was inadequate regulation of the financial system combined with lack of market discipline. Global imbalances alone could not have led to the crisis without the capability of financial organizations to create new tools and mechanisms to take care of the demand for higher incomes by investors.

The tools eventually became more risky than excepted (Crotty, 2009, p. 564). However, many of the investors relied on the analysis on credits by various agencies thus failing to conduct prior examination of the assets despite their optimism in the increased prices. This was considered one of the major causes of the economic crisis.

The biggest role in the crisis was however, played by flawed and ineffective financial regulation which is also called the shadow banking system. The highly interconnected but loosely regulated network of hedge funds, investment banks and mortgage sector was not subjected to prudential regulation. They were not regulated because they were never seen as systematically significant like banks (Crotty, 2009, p. 565).

Their lack of regulation made it further attractive for banks to elude capital investments by making these entities take all the risk. Over time, this institution network became very large and became systematically vital. By the end of 2007, the assets of bank-like organizations in the United States that were not prudentially regulated were estimated$10 trillion, almost equal to the assets of the regulated banking system of America (Crotty, 2009, p. 566).

Financial problems that began in the United States in 2007 rapidly spilled over to other countries around the globe to cause the harshest global financial crisis and collapse from the time of the Great Depression.

The global implications of the crisis were totally unpredicted and have forced a reconsideration of global financial connections. Even though global exposure could have offered a bit of insurance by way of constructive wealth transmission for some economies at the time of the crisis, global exposure played a destructive role by enabling the crisis to rapidly spread from the American housing market to the larger American economy and then to other countries (Porter, 2011, p. 9).

These economic shortcomings may have been prevented by extensive regulation of the financial sector. Because financiers will always find a way of evading regulations proposed, global governance could have implemented its proposed regulations and action taken against market players who go against the regulations.


The world quickly moved from the global savings glut to an abrupt contraction in international liquidity. Shocks are enlarged and spread faster when leverage exists. In early 2000s, there was a considerable build up in leverage of big American commercial banks and global investment banks (Shin, 2009, p. 101).

Although commercial banks may not seem to have problems with leverage levels before the financial crisis began, when the crisis started, internationally active banks played a very crucial role in the spread of shocks globally. A channel of this connection is the way in which these banks control liquidity throughout the whole banking association.

Banks can transmit shocks globally by managing their liquidity throughout foreign linkages, dealings with international banking linkages, and through the global lending decisions. Banking crises and recessions have adverse impact on the creation of new relations however; all banks or all nations do not experience the same effects. The 2007 crisis showed this pattern and had huge negative effect on the creation of new connections in the international network of banks.

The financial crisis made banks very cautious when lending and this meant that new relationships were not made. Banks helped in the rapid spreading of the crisis through reduced lending (Shin, 2009, p. 104). This had the impact of lessening international liquidity and also with the vital role played by banks in the United States to supply dollars, reduced lending led to an international shortage of dollar liquidity. The Federal Reserve in collaboration with other central banks injected dollars to respond to the crisis.


As banks limited lending and liquidity throughout borders, at the same time investors cut their capital flows in foreign markets. During the financial crisis, changes in international liquidity, crisis occurrences, and risk had a large impact on capital flows during the crisis. These effects were very varied in all nations but with a big part of this variation described by disparities in the strength of macro-economic fundamentals, country risk, and quality of home organizations.

Fund managers and fund investors also played a role in the spreading of the crisis across countries. The volatility of mutual fund investments is motivated by fund managers and investors through which injections into each fund and changes in management in national cash and weights (Rogoff, 2008, p. 2).

Managers as well as investors react to national crises, returns and change their investments significantly in reaction to the economic occurrences like the global financial crisis. The behavior of both managers and investors is somewhat cyclical because they pull out of countries in undesirable times and increase their exposures in the countries when economic conditions improve.

This means that investors in mutual funds are a vessel through which financial crisis of 2007 spread rapidly across nations in their portfolio leading to a global financial crisis (Rogoff, 2008, p. 3).

Real linkages

These could also be the channel through which the financial crisis rapidly spread globally. For instance, majority of Asian countries were not exposed to the subprime and housing markets of the United States and therefore, such economies had weaker connections with America through investment and direct bank relationships (Fidrmuc, 2010, p. 293). These Asian economies however still suffered harsh reduction of output in 2008 and 2009.

The financial crisis had a larger undesirable effect on companies with larger sensitivity to trade and demand especially in economies that are more open to trade. Financial openness however, appeared to have made a minimal difference. This indicates that real channels of transfer through the impact of aggregate demand and trade flows played a significant role in spreading the global financial crisis.


The financial crisis may act as medium for transformation in global governance and may signify a change from the traditional economic system. The global financial crisis has helped in revealing the big gap between international economic order and structures of governance in modern times (Helleiner, 2009, p. 17).

Many emerging economies such as China have been attaining rising political and economic significance but are not equally represented in crucial institutions. Even though the reaction to the crisis has largely been on the financial system, more attention needs to be paid to monetary issues as well as the world trade.

A debate has been ongoing about whether informal institutions such as the G20 or the G8 should really play a role in transforming the authority and governance of global financial organizations. G20 may not be fully justifiable in its present embodiment to succeed in this duty; in fact by just growing present IFI and doing nothing to change them poses a risk of dependency and the maintenance of business as usual.

Global governance is very important in a situation where trade exists. The development of trade administration will have to take into consideration the present stresses placed upon it by economic growth and sustainability questions brought about by the financial crisis.

Global governance needs to reform if it aims at meeting global economic objectives and react to challenges (Helleiner, 2009, p. 16). The main role of global governance is managing the international economy by considering the views and interests of all players and not just the G7 views.

References List

Crotty, J 2009 ‘Structural causes of the global financial crisis’, Cambridge journal of economics, vol. 33 p. no. 4, pp. 563-566.

Gelos, G 2009 ‘The global crisis: explaining cross-country differences in output impact’, Social science research network, vol. 23 no. 4, pp. 15-17.

Helleiner, E 2009 ‘Regulation and fragmentation in internal financial government special forum: crisis and the future of global financial governance’, Global governance, vol. 15 no. 1, pp. 16-21.

Porter, M 2011 ‘Managing in the new global economy’, Harvard business school, vol. 2 no. 2, pp. 7 – 12.

Rogoff, K 2008 ‘Is the 2007 U.S subprime financial crisis so different’, The national bureau of economic research, vol. 2 no. 1, pp. 2-3.

Shin, H 2009 ‘Reflection of the northern rock: the bank run that heralded the global financial crisis’, Journal of economic perspectives, vol. 23 no. 1, pp. 101-104.

Fidrmuc, J (2010) ‘The impact of the global financial crisis on business cycles in Asian emerging economies’, journal of Asian economics, vol. 21 no. 3, pp. 293 – 312.

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