In 2008, stock markets around the world tumbled like dominos around the world, exposing the vulnerability of global economic connections. It demonstrated that crisis in one nation, and resultant panic, can spread across the globe. This was recently demonstrated by how the US financial instruments, designed to spread and protect the risk by including all types of home mortgages, resulted in stock-market plunge the world over. To complicate the things further, the rating agencies, banks, and investors didn’t take into account the fall in house prices on which were dependent many fancy debt instruments. Consequently, as the wages and house prices fell, the US consumers lost confidence. This resulted in tightening of availability of credit from around the world, dampening the economic activity. The situation was further complicated by the rising of oil prices, massive debt, and slow job growth in the US. Meanwhile economists had limited knowledge and experience in solving the complicated derivative investment packages or restoring trust to the market so as to avoid long-term recession.
Around the same time, the anxiety spread about the possible recession in US, stock indices world over went into sharp decline. This prompted the Chinese investors to scrutinize their stock market. Conventional wisdom suggested that the Chinese investment was the world’s next over-valued bubble. However, their analyst believed that market will continue to grow, especially in light of the forthcoming Olympics – which are considered as an economic stimulus – and with average household savings remaining at 70% mark. The Chinese had confidence in their government will be able to stabilize the markets, and the indeed did.
The nations which had significant saving accounts in US, including Singapore and Saudi Arabia, are devoting billions further in rescuing US’s banks troubled due to sub-prime mortgages. The article quotes Wall Street Journal, “After flooding the world with capital that fed both economic growth and excesses, battered U.S. financial institutions now are turning to countries and companies that not so long ago were suffering through their own disasters”. This happened because the lending system comprised of government regulators, appraisal firms and credit rating agencies failed to detect and respond to the impending sub-prime mortgage crisis. The lending agencies presumed that the home prices would only rise, gave too many loans with low introductory interest rates to borrowers who lacked the kind of income for payments that were come later. Both the borrowers and the lender incorrectly presumed that the homes will be sold off at a premium or refinanced at a later date. Due to decline in home prices, many home owners neither able to pay the regular premium or sell off their homes. In addition, they are other burden such as, credit-card, auto and other loans, to pay off.
Going into further details we find that among other countries like, Japan, Korea, Singapore, Saudi Arabia and Kuwait – had come to the rescue of the U.S. economy. A list of player contributed around $19.1 billion towards Citigroup Inc. and Merrill Lynch & Co. This showed the dramatic reversal in fortunes of these organizations that once flooded the world with capital, which fuelled economic growth. This bailout becomes a major milestone in another long standing trend, which is subsidization of U.S. economy by foreign investors. For example, the Asian countries buying the U.S. Treasury Bonds to finance latter are debt. Also, the oil rich Middle Eastern countries buying into these battered banks. The irony being that traditionally it has been the U.S. economic wealth that has come to the rescue of these nations. The overarching reason being the big losses were incurred from bad bets, which were hedged against the housing market.
Against this background, Citigroup announced a first-quarter loss of around of $9.83 billion, and agreed to write down value of assets valued $18.1 billion. In the same vain, Merrill fourth quarter losses are expected to be around $15 billion. The combined losses are expected to be in tune of 0.7% of U.S. GDP. Surprisingly, despite such dismal situation, neither of the banks had any problem in raising money. Investors such as U.S. Pension Fund were lured by the offer of 9% dividend on $6.6 billion in preferred stock. Similarly, Citigroup offered 7% dividend on $12.5 billion on preferred shares. In particular, the Citigroup’s new CEO feels that it will help in putting their best foot forward. Despite this cash infusion of billions of dollars the uncertainty remains whether Merrill and Citigroup will be able to come out green. Credit markets are still performing poorly, and consumers are still struggling with mortgage and other related debts.
This cash infusion by foreign nations has had its repercussion on the domestic politics as well. The Presidential hopefuls were expressing their concerns and expressing their desire to know more about it. The demand was for greater transparency, and U.S. regulatory authorities asking relevant questions. However, politicians were aware that any alternative to foreign cash infusion will have negative consequences elsewhere, such as in domestic cost cutting measure, which may affect various programs and have further consequences on the economy. As far as a common investor was concerned, they didn’t care who own the Wall St. so long as banks don’t pull back on lending. These measures have saved the day for the Wall St. and the U.S. economy, but the long-terms implications were uncertain.
While the U.S. economy was in recovery mode, repercussion were being felt world over. The resultant meltdown of the global markets was in reality the first truly global financial crisis ever since the word “globalization” came into use. While Latin American and Asia had suffered previously, the crisis this time around was wider. The fundamental problem being that the financial innovation of the U.S. has outpaced the ability of either private managers or government regulators to monitor what was going on.
Going into specifics, one can infer that the each and every part of the U.S. financial system has become fee-oriented, and in that process has forgotten its fiduciary duty. Mortgage companies created a new home loan for a fee, and promptly sold them. Banks then classified these mortgages into different classes, and sold them to hedge funds and even the central banks. All this was done without analyzing the risks involved. On the other hand the buyer of the mortgages relied upon the rating agencies. All this worked fine till the point when the property prices began to drop. Further, the lack of underwriting standards allowed for the cases where even the income wasn’t checked began to make an impact on the overall situation.
Also, the problem wasn’t restricted just to the sub-prime mortgages, but also encompassed adjustable-rate mortgages, home-equity loans, second mortgage, credit-card debt and even regular mortgages. So, when the property value fell, many owners found that the actual value of the property was less than their debt. It was at this point that it made sense to walk out of the property and allow for foreclosure. One of the reasons for panic was that nobody knew how many foreclosures there would be, and how much will these depress the real-estate values and cause additional debt crisis. Banks who held on to their loans had less equity capital relative to their loans, which was need to remain within the financial standards.
There were other factors as well. The Iraq war as paid up by the tax cuts, out of the belief that government deficit doesn’t make a difference. As the housing and stock prices fell, the worth of the families declined and so did their consumption. This further compounded the problem.
The current global recession is prompting the national governments world over to resort to protectionism, even though it is proven to harm the economy. What makes the current move insidious is that it is more subtle and difficult to detect. According to the authors, measures are being taken “that abuse legitimate discretion allowed by various international trade agreements”. These measures are expected to have the same impact as outright protectionism. Although retaliation against foreign partners hasn’t been the main motivating factor behind such hidden protectionism, there is urgent need to stop the rise of such protectionisms. It is feared that it may prompt retaliatory measures, and the following spiral would be further exacerbate the downward spiral.
Also, in the current financial crisis, the world had high hopes on Brazil, Russia, India, and China – also known as BRICs – to help lift the global economy out of the recession. According to the author, while many of these countries may have more positive growth prospects than the developed world, they have more economic strength than their GDP and stock market indices can reflect. However, these countries do underperform on many key indices like; corruption; “ease of business”; global competitiveness; and social stability. In addition, there are other hurdles ranging from demographic challenges like dwindling population to an imbalanced economy. As the same time, it would be a faulty proposition to see them as a block, as they only commonality is their desire to see the dollar a bit more affordable. Little was accomplished at their recent meeting and their currency issue remained vague. Therefore, it can be inferred that the notion of BRICs as an engine of growth has outlived its idea.
If stock market was any indication of the health of U.S. economy, the outlook wasn’t good. A day earlier, The New York Times reported disappointment by investors over lack of any returns over the period of last one decade, which was due to asset bubble and instability in global economy. The previous decade had witnessed high returns due to the burst of globalization. The current unsustainable debt has led to a vicious cycle worldwide prompting measures to reduce consumer spending and government revenues. With still a lot of structural crisis in the capitalist world economy, the author predicts a lot of fluctuations until big fixes are made.
However, there are many advocates who point out the need to monitor and control globalization, particularly in light of how the debt crisis in one country spread quickly around the globe. He points out even economic interdependence is the order of the day, the governance structure is unable to keep pace. He contends that the developed countries are balking from sharing power with the emerging economies, and their leaders are resisting pressures from domestic interest groups. At the same time, attempts to reform the international organizations, ensuring fair representation, and creating accountable procedures have not been as successful as expected. In total, the gap between globalization and governance has only widened. There are warning signs to suggest numerous impending global crises, which can only be resolved through cooperation. It is therefore suggested that world leaders should prepare their domestic audience for steps they’ll have to take to address the global crises.
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