Causes and consequences of world economic crunches.
'The great depression of 1929, the economic crunch of 1987 and that of 2007-2008 are some of the modern days world economic collapse ever witnessed in this and the last generation. This paper will examine the causes and consequences of the economic collapse and compare and contrast them to see what was similar in the causes and compare the consequences of them to the world economy, social and political dimensions.''
World financial markets have been hit hard by economic crunches in the 20th and 21st centuries which left many multinational and national financial institutions counting losses and even filing for bankruptcy. Economic depression is usually affecting all nations regardless of their economic stability and at times calls for drastic measures to some countries to be bailed out by other nations in international unions. The great depression of 1929, the economic crunch of 1987 and that of 2007-2008 are some of the modern days world economic collapse ever witnessed in this and the last generation. This paper will examine the causes and consequences of the economic collapse and compare and contrast them to see what was similar in the causes and compare the consequences of them to the world economy, social and political dimensions.
The great depression is one of the darkest periods of the American economy with some economists think that it started on famous Black Tuesday of October 1929, which send economic shock waves all around the world. The stock market crash in America has made people think it started way before the 1929 and by 1933; thousands of banks had been closed due to the biting economic situations. It can be noted that the world had just come out of a major World War and many of the nations were in the process of national building and stabilizing of their economies (Dabrowski, n.d.). The main receiver of the blows of WW I, the United Kingdom, was among the nations which were hit hard because she depended on the support of the United States to rebuild her economy.
The economic crunch of 1987 has been billed as one of the unprecedented economic situations of the world and has elicited much debate on why and how it had to happen. The 1987 economic crunch has given financial institutions slang, the "Black Monday." It was an economic collapse which started in Hong Kong, spread all across Europe, and found itself in the United States but leaving a trail of the devastation of economic uncertainty if not collapse of banking and other financial institutions (Carlson 2006).
The next economic crunch to be discussed is that of 2007-2008 which was a global credit crisis, where global financial markets seized to function and resulted in a series of the collapse of global world markets which lasted for four weeks. While the impact of the economic crisis is still widely unknown, it followed a precipice of major financial institutions failure and the insignificant interventions by governments around the world to stabilize the world economy.
Causes of the economic crunches.
The causes of the global credit crisis are currently known and understood. However, there are major initiatives all around the world to reform and regulate world finances, which has far much greater consequences on the world economic crisis in the future. In reality, the 2007-08 financial crisis was caused by excessive lending, borrowing, and investment. This was coupled by a chain of incentivized regulatory and economic factors. In the context of the United States, the debt crisis was due to the borrowing and lending for mortgages in the 2005-2006(Dabrowski, n.d.). Excessive borrowing was precisely in all the global economic asset classes including corporate lending, commercial real estate, national equities, and commodities. These excesses in borrowing and lending were not specific to the United States but other world economies were also responsible for the same. It was fueled by excessive investment on the lending and borrowing of a wide range of investors all over the world.
In the United Kingdom, the 2007-08 was still caused by the same problems in managing of borrowing and lending by investors. The rising unemployment’s triggered a series of a sharp rise in mortgage defaults. The poor quality of subprime mortgages were the conditions for the mortgages was as a result of having the borrower with low credit and which was secured by low-value property ("Will the UK recovery outpace other major economies?", 2009). Banks then became concerned with the value their mortgages was bringing and as a result resulted to some banks being wary to lend other financial institutions, especially where the markets were short term.
This confidence problem led to cash problems in for many insurance companies and banks worldwide. This resulted in some banks in the United States such as the Bear Stearns had to be bailed out by other financial institution with the assistance of the federal government. The problem deepened when the world oil prices peaked to be sold at $147 per barrel, and in the summer of 2008, two other banks had to be rescued by the United States government (Dabrowski, n.d.). The filing of bankruptcy by the Lehman Brothers Bank which was the biggest bank in America had adverse effects in that the failure of the bank went down with liabilities of around $600 billion. England nationalized the Bradford and Bingley building society and the struggling Royal Bank of Scotland Group. The most common phenomenon of the debit crisis in 2008 was that banks were adversely affected and had to be bailed out by the government.
Therefore it can be deduced that the economic crisis of 2008 was caused by subprime, financial instability, and leverage where there was magnified gains and magnified losses (Dabrowski, n.d.).
In the 1987 economic crunch, as opposed to the 2008 debit crisis was primarily caused by technological aspects which had become prevalent in those times. The popularly understood cause of the 1987 economic crash was due to program selling by traders (Ohanian, 2010). The reaction to the computerized trading which was a requirement by portfolio insurance hedges is understood as the reason for the economic crunch. Economist Dean Furbish is of the opinion that the drop in pricing was an s result of light in trading volumes. As the computers became more available, the program trading became more prevalent in Wall Street firms. As the crash bit, many of the stakeholders blamed the strategies used to sell the market stocks still blindly. Others have theorized that it was a result of the change to normalcy in the stock markets after a speculative boom that October (Ohanian, 2010).
The United Kingdom cause of the 1987 crisis was as result of dependence on the effects of stock markets in the United States Wall Street. Many of the traders at were unable to go to their desks due to the uncertainty bubble which had been caused by the program trading failure in the United States (Carlson 2006). The United Kingdom then became a victim of circumstances at it was caught up in the myriad of the weakness. The bubble that had been created by the Wall Street ballooned when after lunch of that Monday, panic engulfed trader as they tried to sell orders. This resulted in flooding of traders tried to cash in their orders based on the profits made over the previous years (Carlson 2006). This can be termed as market psychology where the panic caused by traders in the United Kingdom stock market resulted in flooding of in selling of the stocks and the overvaluation of stocks as traders tried to sell them on the black Monday using profits of the previous year. The difference in the crisis of the United States of America and that of the United Kingdom was that, in the United Kingdom, it was as a result of overvaluation and market psychology while that of the United tastes was as result of blind selling of stocks through program trading (Carlson 2006).
The cause of the depression of 1929 was a result of was as a result of the stock market crash which had soared through the 1920s, and more people were willing to add more money in the stock exchange. When the stock market crashed, they were forced to pay up the assets, where many people had borrowed to buy and pay up stocks (Ohanian, 2010). When it crashed, many of them couldn’t repay their loans and lenders were left without returns. This is the same thing which happened to the 1987 economic crunch when traders in the United States were selling up stocks blindly, and in the United Kingdom, investors were hurriedly selling up stocks at the previous year’s profit margins. The difference in the stock market crash of 1929 and that of 1987 was that, in 1987, capital markets relied heavily on the program trading on a fixed external input while that of 1929 was based on the precept of paying up stocks as long as share prices when on going up.
The other cause of 1929 economic crash was the failure of banks, where smaller banks especially in the rural areas in the United States had extended loans to farmers and were unable to pay the loans. Meanwhile, the big banks of the United States had inadvertently given massive loans to recovering countries of the WW I. when the economic situation became desperate; most of the European nations stopped repaying their loans and defaulted the outstanding balance. As a result, many of the banks filed for bankruptcy, others were pushed out of business, and many of the investors withdrew their deposits in panic ("Will the UK recovery outpace other major economies?” 2009). The fears and panics almost entirely closed down the county are banking systems.
The other cause of the great depression was government inaction as the depression continued, the federal government reserves did not attempt to lend money to banks at low interests rates and lending money into the economy through public works projects funded by the federal government. In the United Kingdom, the cause of depression was a little different because it was affected by both the recession happening in America and the collapse of the Austrian Credit Anstalt Bank (ohanian, 2010). This was primarily because of the inability of the foreign countries to repay their loans. The primary cause was the financial instability that was caused borrowing which had been done by the country to finance the activities of the WW I, which resulted to Britain losing much of their foreign investments, this made the United Kingdom to be depending on exports and made it vulnerable to the trends of the world markets.
The causes of depression of united states and that of the United Kingdom were similar in a manner that they were adversely affected by the aftermath of WW I and collapse of the banking sector. It is also similar to the economic crisis of 2008 where banks were the main culprits for depression and debit crisis. The similar aspect was the lending and borrowing of banks in both times were banks loaned out money to entities, either in mortgage or money and had to face cases of defaulters of repaying of loans ("Will the UK recovery outpace other major economies?", 2009). In the three economic crisis eras, the most similar causes was failure of stock markets which was coupled with panic activities if selling of stock or withdrawing of deposits (the great depression and 1987 economic crunch), and the failure of banks and other financial institutions especially in the period of depression in the United States, and United Kingdom and the credit crisis of 2008.
Consequences of the economic crisis.
The 2008 debt crisis elicited a lot of consequences a well as responses from different stakeholders, where at the rising interest rates, the downgrade of structured products and subprime delinquencies began to shake the confidence of various investors in the emerging financial paradigm. In summer 2007, the tide had changed and resulted to the freezing of markets in August 2007, cut in interest rates, equity market correction and seeming return to dormancy in the United States stock market (ohanian, 2010). This was coupled with global commodities and capital markets being moved into new levels as money was being pushed out of debit into other financial ventures. At the same time, in the United Kingdom, the collapse of the North Rock in September created the onset of global credit crisis due to loss of confidence, adverse selection and changes in investor preferences. These conditions were recipes for the weakening of global credit markets(Chandrasekhar, 2012).
The other notable consequence of the 2007 debit crisis was the collapse of banks and other financial institutions such as the Bear Stearns of the United States, which was the fifth-largest bank in the country, where it faced adverse liquidity problems resulting to the Federal Reserve Bank to provide emergency funding through an intermediary. As one of the causes of the 2007 debit crisis was mortgage defaults, the Freddie Mac and Freddie Mae who were the logical concerns to for market participants (Cochiti, Stephen and Piti 2010). The firm posed a grave risk because it was one of the largest firms who played a central in United States mortgage markets. A default by the company would have caused serious series of financial crisis and severe economic crisis since the country would be unable to wade itself out of the financial debt. The filing of bankruptcy by the Lehman Brothers bank send systemic crisis in the American economy, with more than $ 600 billion in assets, $650 billion in liabilities and with a whopping 100,000 creditors all over the world. This was a classic case of balance sheet recession as consumers remained heavily indebted (ohanian, 2010).
By September 18th, the series of events which happened due the debit crisis were proving too much for the world financial markets could handle and the economies began to collapse, creating a wave of uncertainty, adverse selection and loss of confidence (Cecchetti, Stephen and Piti 2010). It was triggered by the loss accrued from the collapse of Lehman. In the United States, the Reserve Primary Bank issued a statement where it indicated that it had lost $785 million in assets and that it would not be able to pay its customers in full. In the United Kingdom, the government issued a statement Lloyds TSB will be taken over by the HBOS, in the precept of saving it from failing.
The other aspect was cut in interests rates in the UK where the central banks were on a spree to cut the interests rates to 0.5% from 5% to make borrowing cheaper and spur the consumption of investments (Cecchetti, Stephen and Piti 2010)“. Also, there was fiscal policy expansion which had been precipitated by the evaporation of government deficits resulting to budget deficits. It is worthwhile noting that in contrasts with the 2007-08 debit crisis and the great depression of the 1930s, there was avoidance of a significant number of banks going bankrupt was avoided since during the great depression, and 500 united states banks collapsed (Field, 2009). The other contrasts were the in 2007-08, there were no major trade wars since, in the 1930s, there was formation of tariff wars developed as various countries developed strategies to protect national industries.
The other difference was the fact that during the great recession, the United States had the federal balance even balanced and condition of the state finance stable. However, during the 2008 debit crisis, the incoming government of President Obama, found that the government budget was already in deficit and the inception of the crisis had been steady over the time (Field, 2009).
The monetary policy in both of the economic crisis seem to differ in some aspects, in that during the first three years of the great depression; the federal reserve reinforced and even tolerated a substantial shrinkage of the monetary supply. The federal government pulled out money from problematic banks to avoid accruing losses instead of pumping liquidity into the financial system to prevent liquidity shortages. By contrasts, in the four months that preceded the 2008 debit crisis, the FED poured a substantial amount of money into the banking system(Field, 2009). This proves that the monetary policy that had been done in the great depression had been internalized and a different approach was being taken to avoid the economic crunch.
The most common aspect of the 2007-08 and the great depression was that of unemployment. In the United Kingdom, the rate of unemployment was at the peak of 10%, and youth unemployment was even higher in these countries. In the United States, some multinational companies had closed doors leading to losing of thousands of jobs. The other similarity is that in the depression of 2007-08 and that of the 1930s was that many of the banks which had failed had to be bailed out by the other financial institutions or governments (Dabrowski, n.d.).
In conclusion, the global financial crisis has affected many people and entities in the world. There are several similarities and differences in the manner in which the economic collapses were caused and difference on the same, none the less, the causes whether similar or different resulted in the creation of a different financial situation in the world with several financial institutions and banks closing shop. Many individuals lost deposits in banks. Various financial and necessary government agencies should always take drastic actions by regulation to avoid these economic crunches to avoid loss of vital investments and deposits by hardworking citizens.
References
Carlson, Mark,(2006) “A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response,” Finance and Economics Discussion Series No. 2007-13, Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington, DC.
Cecchetti, Stephen G., and Piti Disyatat. (2010)“Central Bank Tools and Liquidity Shortages.” Federal Reserve Bank of New York Economic Policy Review 16, no. 1.
Chandrasekhar, C. (2012). Critical Perspectives on the Great Recession. Development And Change, 43(2), 603-613. http://dx.doi.org/10.1111/j.1467-7660.2012.01770.x
Dabrowski, M. The Global Financial Crisis and its Impact on Emerging Market Economies in Europe and the CIS: Evidence from Mid-2010. SSRN Electronic Journal. http://dx.doi.org/10.2139/ssrn.1687623
Field, A. (2009). The Great Depression, the New Deal, and the Current Crisis. Challenge, 52(4), 94-105. http://dx.doi.org/10.2753/0577-5132520406
ohanian, l. (2010). Understanding Economic Crises: The Great Depression and the 2008 Recession. Economic Record, 86, 2-6. http://dx.doi.org/10.1111/j.1475-4932.2010.00667.x
Will the UK recovery outpace other major economies? (2009). Economic Outlook, 33(3), 5-12. http://dx.doi.org/10.1111/j.1468-0319.2009.00725.x
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