Literature Review
We tend to think of the task of managing as one defined by carefully considered, long-term thinking. If the global financial crisis taught us anything, it is that more often than not organizations operate with very short horizons, reacting to an ever-changing environment.
Introduction
Financing resolutions rank second in the hierarchy of crucial decisions that firms and their economic administrators make. Fiscal decisions are charged with investigation of the economic combination or capital organization in a company. Back then, they faced modest shortfalls since funding was easily accessible.
There are different definitions to the crisis, with some calling it global financial recession or the global economic downturn. Regardless of the name affixed, the main issue lies with the underlying impact it is having on the financial configuration in firms. Evidently, current financial resolutions have exhibited the toughest period to human economic history (Collyns & Kincaid 2003).
The Countrywide bank of America had a comparable industry model, although it had rolled out disastrous credit facilities. Supervising liquidity risks was treated as it was foreign to market policies.
Evidently, the Institute of International Finance (2007), which appeared proxy to key international financial firms, raised alarm on the importance of upgrading liquidity risk management by March 2007. This happened after having higher-ranking personnel working in these banks in 2005, prior to the financial upheaval in August 2007.
Many funding options have been exploited in the past, giving rise to the notion that most fiscal tools are harmful in nature. The impacts of such extremities further complicated the environment for financial executives in executing their financing decisions (Powers et al. 2002). As share indexes remain on a downward trend, the demands from stakeholders on fiscal managers continue to grow. This scenario makes it more complex for firms to venture into the capital market for extra funding (Englund 1999).
Conversely, the scary banking sector devastation has done away with the only option helpful to managers; credit. The proposition derived from the above illustrates that sound capital contracting has shifted from being virtually impossible to being hypothetically unattainable. The rationale behind this claim includes the lack of economical loans.
The conventional standpoint of capital organization recommends that the rise in requisite proceeds on equity by shareholders will be balanced by use of more low-priced debts. The underlying question remains with the expected progression after the disappearance of cheap loans in the face of worldwide economic slump (Zhang 1995).
The swelling bankruptcy expenses calls for prudent managerial decisions. Other than legal and managerial costs associated with insolvency, liabilities that come with incompetence portrayed by the actions of companies facing liquidation combined with disposal of assets at a throw away price brutally distress the pursuit for the accomplishment of the most favorable financing mix. This is particularly because the cost of capital and expenditure on equity will have shot up in the wake of increasing corporate bankruptcy (Jackall 1988).
In view of the above looming shortfalls, there is only one substitute for companies to use, so as to achieve considerable financial combination. This remaining option is dictated by observing sound corporate governance.
Superior corporate governance dictates the presence of an accountable and practical management supported by shrewd business ethics, as well as the existence of excellent operational capital administration and the presence of a clear reporting structure (Watson 2001).
The indirect implications from these observations show that financial managers may no longer invest resources in the quest for best possible capital structure. Financing decision in the wake of global economic recession ought to be ordinarily planned in advance if a firm is to achieve fiscal stability. Evidently, financiers and lending agents will be willing to unconditionally fund a company should it provide that it is performing above par in relation to other economic pointers.
Since the Great Depression, the economy of the whole world has undergone tremendous threats with most countries experiencing the worst crisis since 13th century. The challenges in international economic and financial cooperation were however better that time. Regardless of the deadly crisis that we have gone through, global authorities have amicably addressed these problems in unison. However, we should now learn a lesson from the crisis and maintain the cooperation, which was initiated those days.
There are no similar explanations of this crisis. Any narration gives a different cause of the crisis. We lack enough information and reasons to dismiss various explanations and agree to others that we think are true. Therefore, we are limited by lack of similar causes of the crisis. Many countries including the United States need different structures for all important financial institutions. Cooperation and mutual understanding are the two most important global issues that bring about efficient progress, regardless of differences in emphasis.
Causes of the crisis in 2007-09
The cause of the crisis fall into four broad categories and several sub-categories, the first category is the macro-economic failures which include monetary policies, fiscal policies, global imbalances and housing booms. Second are the failures in the financial sector supervision and regulatory policies and practices.
Third is the multiple misunderstood innovations in financial engineering, which include Sub-prime mortgages, Credit default swaps, new forms of securitization, and lack of responsibility in large private financial institutions which operate globally.
This time it is different
Many people conclude that the crisis was caused by poor financial engineering innovations and failures in the financial sector regulations and supervision.
Fiscal policy in the United States led to low saving rate and monetary policy, which was persistently too simple. Other countries affected by monetary policy problems were; Asia, the United Kingdom, Switzerland and some countries within the Euro area, which had issues with the real interest rates.
Many countries, like Korea, had some policies which led to large amounts of foreign exchange reserves. The policies also led to global imbalances and distortion of international adjustment process. These reserves put pressure on the macro-economic policies of many countries including the U.S. global imbalances phenomenon.
This, however, was not a major cause of the recent economic and financial crisis. The imbalances and the crisis were simultaneously as a result of faults in design and implementation of macro-economic policies in the world. This led to increase in global credit. It also led to housing booms in the U.S and other places accompanied by a rise in equity prices and other factors showing inflation.
Financial sector regulation and supervision and regulation also caused the crisis, but the errors were not necessarily committed during that period. More so, if people did not believe that a change would occur, then the crisis would have been different.
Bad conditions lead to too much lending and credit standards. Financial sector supervision could have reduced the excesses but this was not the case anywhere in the world. Innovations in financial engineering have been partly blamed, but they existed even in the past.
In most cases, the innovations were not clearly understood, thus leading to lack of noticing of the risks involved, which is important in risk management. Financial innovations did not cause the crisis, but they intensified through market dynamics and distorted financial institutions’ incentives.
As such, large private financial institutions which operated globally had an upper hand in this because they caused this crisis to a bigger extent. The failure of these institutions was not due to lack of national supervisors, but because they neglected their responsibility. The global scope of these institutions was not the cause of failure, but their large size and complexity. Cases were generally unique but the institutions were very large.
Managers of these institutions were deceived that unfavorable economic and financial crisis would persist indefinitely or until they complete their tasks. However, most of them were wrong (Guerrera & Thal-Larsen 2008).
An outstanding element in the existing confusion was as a result of liquidity risks, which culminated into the disintegration of Bear Stearns and Northern Rock7. These two have put forward explanations that the risks involved with the reduction of liquidity had previously gone unnoticed, since they had enough capital resources back then.
The global economy faced its most serious threat since the Great Depression in 2007. For many countries, the threat was larger than the one that took place eight years earlier. Fortunately, the contours of international economic and financial cooperation were better this time. Managers went through a serious crisis, but authorities around the world acted cooperatively and forcefully to address common problems.
The challenge today is to sustain that cooperation and to learn and apply the lessons of the crisis (O’Connor 1987). Many sources have attributed different factors to this crisis; however, we lack sufficient information to discriminate among the narratives and to assign weights to them.
Thus, we are hampered in our discourse by the absence of a shared diagnosis of the origins of the crisis (Eyers 2010). In the United States and other countries, a combination of approaches involving concern for the size of institutions, regulatory limitations on certain activities of financial institutions, expansion of the perimeter of supervision, and an effective resolution mechanism for all systemically important financial institutions is needed.
Regarding these global issues, cooperation and mutual understanding are essential to achieving significant progress. Even in different jurisdictions, differences of emphasis are unavoidable (Basel Committee on Banking Supervision 1998)
Poor financial management
The financial crisis experienced globally during the years 2007 to 2009 occurred largely due to lack of proper financial management and unsuccessful policies of macroeconomics. While addressing the problem of unsuccessful enactment of policies, little is yet to be done. This is not to say that the systems responsible for regulating and supervising global financial matters were flawless.
There is an urgent need to address the uncovered structural flaws, both at global and national levels. It is high time this was done to correct the mistakes that began building up many years ago. Clearly, it has taken a crisis of this scale to realize these mistakes. Going by History, the case has always been this way.
Throughout the world, the economy performed very well, just before the sudden recession experienced in the year 2007.This trend continued for a few months through the summer season. This was a clear indication of a disaster in waiting, for leaders of government and financial institutions, both locally and internationally.
Those responsible for making policies in governments or institutions of finance understood this very well, but had to continue playing their part. Hence, there was no alarm raised to ensure proper regulation of macroeconomic levels. This resulted into deterioration of the global economy.
At this point, no one could tell that negative consequences as a result of poor systems of finance, could be witnessed. Moreover, there was a need for more insightful knowledge of the macroeconomic level. This would help to improve the economy, as well as regulate the financial systems.
All nations would like to see that the structure of their macroeconomic policies and what it contains functions well. International institutions such as the Financial Stability Board and the IMF are responsible for this role, and so are the countries of the G-20 which do so, either collectively or individually.
Discussions to do with macroprudential policies have until today, omitted the mention of policies of supervision, and the way macroeconomic policies are interdependent in a two way manner.
Also, omitted is how these two affect the economy as a whole. Clearly observed is the fact that in the policies of macroprudential, there is more emphasis placed on how the prudential impacts on the macro, rather than vice Versa. This gap, ought to be closed. It forms the basic reason as to why central banks take the major responsibility in the two aspects of policies that are macroprudential (Hau, Steinbrecher & Thum 2009).
It is not news any more, to hear of the use of public resources such as money, with the intention of saving big and complex financial firms from collapsing. Acts of such nature having occurred during the financial crisis about less than two years ago have only brought out the most important facts about the issue. Too big to fail are the words that have used to describe it. This has set in an important precedent for dealing with a large number of similar cases. However, there is an acceptable desire to bring this to an end.
It is more important to consider the powerful effect felt by the big institutions being saved, or how they are being managed rather than to dwell on the cost incurred in saving them or on who bears the cost of recovery. In this whole situation, the possibility of failing is considered to be much more important than the size of the institution.
The fact that there was no moral lesson learnt in the past mistake does not mean that it will never happen in the future. Creative destruction, a process considered desirable by Schumpeter, is said to be undermined, if the governments will take on the task to saving private institutions from failing. Also, to be undermined is the discipline existing in the market space (Thompson & McHugh 2002).
Thus, competition is ruined and poor allocation of capital is evident. Management of risk is poorly executed and making of losses is tolerated, and at this point, the taxpayers get involved. Nevertheless, the losses remain intact. Governments then begin to indirectly or directly manage the institutions of finance.
As a result, too many financial institutions of high risk nature are formed, most of which are little known for any kind of assistance to the society. Such institutions are synonymous with decreased efficiency, higher costs on services rendered, or insufficient of credit facilities (Honohan 2008).
Risk Management
Regardless of the critical significance attached to Risk Management by supervising authorities and business control acts, financial anarchy has pointed out rigorous inadequacies in the performance of both in-house administration and the overall function of the executive board in the control of risk management protocols in several banking institutions.
Whereas a good number of the 11 key reservoir banks, assessed by the Senior Supervisors Group (2008) did not succeed in forecasting the consequence and scope of the latest market tensions, notably, they exhibited deviations in resultant outcomes. This fact was greatly influenced by their respective top ladder management makeup, together with the quality of their risk management policies.
Arguably, this aspect should have been noticed by the boards. Certainly, a few banks managed to spot the origins of specific threats, from their onset, in the middle of 2006 (apparently the same time when sectors within the real estate market in the US begun to rise with sub-prime non-payment).
They, therefore, established interventions to reduce risk. An outstanding element in the existing confusion was as a result of liquidity risks, which culminated into the disintegration of Bear Stearns and Northern Rock7. These two have put forward explanations that the risks involved with the reduction of liquidity had previously gone unnoticed, since they had enough capital resources back then.
Nonetheless, cautionary indicators were up and running within the first zones of 2007. The executive managers in Northern Rock accepted they had reviewed the Bank of England’s economic firmness statement together with an FSA account, which simultaneously directed clear consideration to liquidity risks.
However, there was no evidence of sufficient emergency lending facilities that were put into practice. The Countrywide bank of America had a comparable industry model, although it had rolled out disastrous credit facilities. Supervising liquidity risks was treated as it was foreign to market policies.
Evidently, the Institute of International Finance (2007), which appeared proxy to key international financial firms, raised alarm on the importance of upgrading liquidity risk management by March 2007. This happened after having higher-ranking personnel working in these banks in 2005, prior to the financial upheaval in August 2007.
Pressure assessment and associated settings scrutiny rank as a crucial instrument in risk management, which boards may employ within their strategic oversight and re-evaluation methods.
Latest data indicate a number of shortfalls in several banking firms. The Senior Supervisors Group (2008) discovered, “some firms found it challenging before the recent turmoil to persuade senior management and business line management to develop and pay sufficient attention to the results of forward-looking stress scenarios that assumed large price movements” (p. 5).
This denotes a failing inadequacy within corporate circles owing to the fact that a board is liable to assessment and guidance of corporate and risk control strategies, and for guaranteeing the presence of suitable risk control methods. In the IIF statement, it was evident that stress testing should be incorporated between the interactions of top management and the risk roles regarding the scope of stress.
Stress testing should be a major aspect in the functions of existing management protocols, if desired results are to be achieved while implementing meaningful business resolutions. It emerges that, these procedures were not observed in several financial establishments, with some believed to have employed incompatible stress testing models in their operations.
References
Basel Committee on Banking Supervision 1998, Framework for Internal Control Systems in Banking Organizations, BCBS, Basel.
Collyns, C & Kincaid, R 2003, Occasional paper no. 217: Managing financial crises: Recent experiences and lessons for Latin America, IMF, Washington, DC.
Englund, P 1999, ‘The Swedish banking crisis’, Oxford Review of Economic Policy, vol. 15 no. 3, pp.80–97.
Eyers, J 2010, KPMG may be joined to OZ action, The Australian Financial Review, Fairfax Media Publications Pty Ltd, Sydney, pp. 1-64.
Guerrera, F & Thal-Larsen, P 2008, ‘Gone by the Board: why the directors of big banks failed to spot credit risks’, Financial Times, 26 June.
Hau, H, Steinbrecher, J & Thum, M 2009, Board (in) competence and the subprime crisis. Web.
Honohan, P 2008, ‘Bank failures: the limitations of risk modelling’, Institute for International Integration Studies Discussion Paper, 263.
Institute of International Finance 2007, Interim Report of the IIF Committee on Market Best Practices, IIF, Washington, D.C.
Jackall, R 1988, Looking up and looking around: excerpt from Moral mazes: the world of corporate managers Oxford, Oxford University Press, Oxford.
Ladipo, D. et al. 2008, Board profile, structure and practice in large European banks, Nestor Advisors, London.
O’Connor, J 1987, The meaning of crisis: A theoretical introduction, Basil Blackwell, Oxford.
Powers, WC, Troubh, RS & Winokur, HS 2002, Report on investigation by the special investigative committee of the board of directors of enron corp. Web.
Senior Supervisors Group 2008, Observations on Risk Management Practices during the Recent Market Turbulence, SAGE, New York.
Thompson, P & McHugh, P 2002, Work Organizations: a Critical Introduction, Palgrave Macmillan, London.
Watson, T 200, ‘The Emergent Manager and Processes of Management Pre-Learning’ Management Learning, vol. 32 no. 2, pp. 221-235.
Zhang, PG, 1995, Barings bankruptcy and financial derivatives, World Scientific Publishing Company, Singapore.