Intermediaries and Government in Financial Crisis
It was the global economic crisis, which led to the Great Recession of 2008 that opened the world to the importance of housing markets in the overall economic performance. There were already indications that the housing industry had a major impact on the economy, but it was not clear. Lenders had become more flexible lending terms considering the bubble in the housing markets. They did not care much to carefully consider the background of their borrowers. And it was this subprime mortgage lending business that initiated the global economic crisis. Many of the European governments rushed to make decisions that would save and lead to the economy's subsequent recovery.
There were different inventions geared toward economic recovery. The largest number dwelt on restructuring the financial system with a little spending from the government to stimulate the economy. It was unfortunate that many markets had already failed, but those that received funds from the government soon regained balanced and continued operating with slow but certain recovery. Some governments took the initiative to stabilize the national housing markets, though this decision depended on whether, and how by how far their national housing markets were affected. Some may say the crisis was expected, whereas others may look at it as something that came out of nowhere.
Nevertheless, this is the norm for the modern economy. Economic fluctuations caused by business cycles are a natural occurrence that must just happen. Many have learned to live with it since it is the main indicator of a healthy economy. But the most interesting aspect is how governments and intermediaries react to these issues. And the decisions they make must have a long-lasting effect on the economy. Hence, around 2010, the house prices stabilized, in most European nations, except for a few countries like Spain and Ireland. Some countries were already witnessing a rise in these prices, which made their economy recover even faster. This may pause the question of why Spain and Ireland were the most hit economies. The best answer comes from looking back at the housing production and steady rise in housing prices within these economies between 2000 and 2007. Those who had invested in these projects found it hard to sell and recover their investments, a condition that exerted more pressure on the markets.
The Netherlands government even put up cautious price recovery in 2010, but it only lasted a few months. From the dawn of 2011, going forward, there was a fall in the housing prices in the Netherlands, unlike what was happening in other economies. They started recovering gradually in 2013, mainly because there was a steep decrease in mortgage interest rates. In 2017, major cities like Amsterdam and Utrecht witnessed a steadier increase in housing prices, more than what happened in 2008. The yearly growth rates were recorded at 10%.
All these figures and literature indicate that governments and intermediaries greatly impact the general financial economy. Even in the general economic development, it is they who make decisions that affect the general growth. It could be hard to describe economic stability and health without mentioning these two parties.
How financial crises impact intermediaries
A bank is the most common financial intermediary that offers loans and deposits as well as payment services. They play a vital role in economic growth by providing loans to borrowers and collecting deposits from savers. Banks stock money, they are money keepers and handlers, whereas, people need money, which means people need banks in any economic environment. Since people cannot safely keep their money at home, banks step as the ultimate shelter providers for the money. We cannot say accountants are also intermediaries because they don't keep the money; they only ensure that users' books are in perfect order. Also, accountants do not lend money, like banks. Banks are divided into three major groups, commercial banking, investment banking, and central banks.
Commercial banks serve the most basic and traditional role of banks because they take deposits and grant loans. There are two types of commercial banking: retail banks and wholesale banks. The retail banking aspect includes financial serves given to consumers, usually on a small-scale nature. For instance, when one wants to deposit or withdraw money from their personal savings accounts, they go to the retail section where every transaction is carried out. Mostly, retail banks are called High Street Banks because they are networks of large branches, where some can have more than a thousand branches. They are usually located in the main shopping streets. Wholesale banking is a type of commercial banking found in major financial centers across the globe. Their main customers are larger companies and other banks in the world. Such banks are found in cities like London, New York, Frankfurt Hongkong, and Tokyo, with a few branches in other main economic centers. Retail banks borrow from and lend to individuals and firms, while wholesale banks deal with other banks and governments in their countries and overseas.
Investment banks are majorly U.S. creation, which is why they cannot be combined with commercial banks as the same service provider. These banks have their main role as helping firms and governments raise funds in the main market either through stock or bonds issuance. They do not deal with small scale consumers and do not lend money either, but thy work as financial advisory, underwriters of security issues, traders, and investors in securities on behalf of the bank or their clients. They also handle asset management and other security services. But most importantly, they are financial intermediaries who deal with other key players in the economy for sustainability. This also means their decisions are very crucial in business cycles.
The central bank is generally a financial institution that oversees the monetary system on behalf of a nation. When we talk about monetary policies, we are referring to policies that central banks come up with during an economic crisis. They can hold this supervisory role for a group of nations where applicable. Their main goal is to foster economic growth while avoiding inflation. They decide how money flows in an economy by giving banks regulations and guidelines about how much they can keep and how much interest to take from borrowers. In words, central banks manage monetary policy with the goal of achieving price stability. Apart from this, they prevent liquidity crises, issues of money market, and financial crises. They are also responsible for ensuring the seamless functioning of the payment systems.
There have been a number of financial crises over the past four decades, but the 2007 -2009 crisis has been termed the most serious on. It caused the Great Depression, in leading economies, with its biggest threats characterized by major business failure, reduced consumer wealth by significant amounts, substantial financial expenditures by the governments, and slowed economic activities. The main cause of this crisis was the bubble in the U.S. housing industry, which peaked between 2005 and 2006. There was a substantial rise in default rates subprime and ARM. Also, loan incentives increasing with things like in the trend of rising house prices, which encouraged borrowers to go for more favorable loan terms.
When the interest rates began rising from increased borrowing, house prices started dropping in most parts of the U.S. between 2006 and 2007. As such, refinancing was very difficult. Borrowers started failing to meet their target obligations, triggering an increase in defaults and foreclosure activities. A significant amount of foreign money has been flowing into the U.S. in the years, leading to the start of the crises. The inflow was combined with lower interest rates between 2002 and 2004, which created a more suitable condition for easy credit. And for this reason, it was hard to avoid the housing and credit bubbles that kept swelling over the period. When the crises hit, world stock markets had fallen, large financial institutions fell, or were brought to their knees. These issues called on governments and financial intermediaries to come up with rescue packages to bail out of their financial positions.
The world economy has always been faced with threats of a financial crisis since the Bretton Woods system's departure. Hence, its scope and development have been on a constant rise and fall as a way to keep the market flourishing. Also, every time a global financial crisis hits, its impacts and effects take some time to cool off. We know that the effects of the previous global crises are being felt even today. Even though many economies have stabilized, there are still some areas where the impact still rings as though it just happened.
Impacts of the Global financial crises to the financial markets
When the U.S. subprime mortgage market collapsed, and the subsequent reversal in the housing boom occurred, it led to a ripple effect around the world. As if that is not enough, there were other weaknesses in the global financial system that have just surfaced. Many financial products and instruments have become extremely complicated, such that when things start unraveling, trust in the system falls significantly. The whole system seems so twisted that investors have not a way of telling where the next good news will come from.
The biggest receivers of these effects were the money market. The crisis hit its most critical stage in September 2008, a time that saw and equivalent a bank run on the money market mutual funds. This is the same body that frequently invests in the commercial paper issued by corporations to fund their work. A week before the fall, withdrawals from the money markets were at $14.5 billion compared to $7.1 billion a week before.
The financial institutions were also hit terribly by the unfortunate events. In the beginning, only companies directly linked in home construction and mortgage lending were affected. Firms like the Northern Rock and Countrywide Financial felt the impact first, and it was thought they were the only ones who would have to bear the pain. More than 100 mortgage lenders fell into bankruptcy because they could no longer receive financing through the credit markets. Increasing concerns about the investment bank Bear Steams would collapse in March 2008 increased across the market, leading to its fire-sale to JP Morgan Chase. By September, the crises were already at its peak, with several major institutions falling, entering acquisition, or faced government takeover.
The crisis also had adverse effects on wealth. The relationship between a decline in wealth declines in consumption and business investments, and government expenditure represents an economy's true face. Most Americans lost an estimated more than 25% of their collective net wealth. But at the beginning of 2008, the larger U.S. index, the S & P 500, had fallen by 45% from its peak in 2007. Housing prices were now 20% lowers that there 2006 high and continued dropping for the month. Generally, the total losses came to an overwhelming $8.3 trillion. Such impacts leave a huge mark on the general economy.
These effects extended to the global economy. There was a rapid development that spread that soon got to the rest of the world. The result was a fallacy in a number of European banks, a decline in several stock indexes, and a huge drop in the market value of equities and commodities. Assets were sold to repay obligations that could be refinanced under the frozen market credit market. All stakeholders, including political leaders, national ministers of finance and central bank directors, came together trying to reduce the fears, but the crises increased.
As the heat continued piling up, intermediaries like banks put brakes on mortgage lending. This initiated rigorous adjustments in many economies. Central banks came up with different monetary policies as governments created fiscal policies to reduce the impact of the crises as well as ensure a safe future for their economies. And as we have seen from the beginning, financial crises keep happening as part of the economic phenomena. It is upon economic analysts to suggest the best ways of ensuring economies rise from these failures.
Author: James Hamilton