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Table of Content

Contents                                                                                              Page

 

Abstract………………………………………………………………2

 

Introduction……………………………………………………………2

Unfolding of the financial crisis………………………………………3

 

GCC markets and the financial crisis …………………………………4

 

Implications of the financial crisis…………………………………….5

Decisive policies……………………………………………………… 6

 

Conclusion…………………………………………………………….6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Financial Crisis 2007-2009

Abstract

This project report focuses on the financial crisis that occurred between 2007 and 2009. The paper encompasses the general aspects of the financial crisis. First, it discusses the main factors that caused the financial crises. Many theories have been developed by intellectuals and international organizations in explaining the crisis that had faced the world since the Great depression. The paper looks at these theories in details. Second, the paper is curtailed to include the various implications on the financial markets. In explaining this, the paper focuses on the types of financial crisis and their various implications on the financial markets. Notably, the paper gives weights to the gulf area markets. There is a hypothesis that explains why the gulf area is not highly exposed to the financial crisis. The paper will discuss my stand on the same by looking on both sides of the argument. However, the impact will be discussed on all GCC financial markets with particular interest on Qatar.

Introduction

A financial crisis is explained as a situation when parties to financial contracts lose trust in their financial institutions. The loss of value of the financial institutions makes customers lose trust by withdrawing their assets and terminating their contracts. The belief that financial assets are substantially worth less than what was previously thought forces the institutions to take stringent steps. Financial institutions like banks, cease to advance funds to others, demand early repayment of loans, they liquidate holdings of financial assets and increase collateral agreements. The result of these measures is a frozen economy. The frozen financial markets are characterized by fall in trading volumes. Customers contribute more to the crisis by withdrawing their assets. The measure makes the balance sheets of the financial institutions be adversely affected. In the end, corporate bankruptcy is widespread. Moreover, they lose confidence in the public eye and restoring their credibility requires government intervention.

The financial crisis can be happening in a super power country, therefore making the crisis be felt in all parts of the globe. The economic and financial global transmission shock from state to state makes the world experience a financial crisis. The following are the some of the reasons that explains how economies get affected. First, losses on financial assets held outside the country, triggers lose of confidence in the financial institutions and affect investments. Second, financial market participants raise risks and take measures due to the negative developments in other countries. Third, firms provide supply for people outside through exports. The financial crisis makes the level of exports to go down and reduce national incomes. The effect is felt by participating nations in the trade tariffs. This translates to shock in the economies in general. The cut in international supply due to trade-related channels across borders has developed an effect where there are reduced orders and sales.

Government policies act as the fourth reason that explains spread in economic and financial crises. Government policies seek to develop domestic economy at the expense of international nations. The government devalues its currency, subsidize exports to win contracts, raises tariffs and trade barriers, tax foreign firms’ more than domestic firms and restrict government contracts to domestic firms. The begging policy makes the financial crisis reach dangerous levels. The importance of discussing how financial crisis became a global crisis forms the underlying foundation in explaining the 2007-2009 financial crises. Understanding what it is, how it spread, whom it affected lays the knowledge of elaborating the global financial crisis.

 

 

Unfolding of the Financial Crisis

The financial crisis began in early 2006, when the sub prime mortgage market in the US began to display an increasing rate of mortgage defaults. Banks gave more loans on potential homeowners therefore making housing prices to rise. There was easy availability of credit in the US due to the successive boom in the economy, which led to housing construction boom and enhancement of debt-consumer spending. The interest rates were very low and this encouraged many investors to invest on the booming business. Consequently, housing and credit booms financial agreements called the collateralized debt obligations derived their value from mortgage payments and housing prices. This financial innovation, enabled institutions and investors invest in the US housing business. The crowding in the sector, made house prices to fall and major global financial institutions made losses due to loans issued to invest in the sub prime securities.

Furthermore, the interest rates rose and home ownership reached a saturation point. The borrowers defaulted on their loans and later in 2007, one or two sub prime lender was declared bankrupt. The landslide continued worsening as the financial firms and hedge funds owned most of this securities, their situation would worsen if more firms defaulted in their loan repayments. As the days advanced, the financial market could not solve the global crisis. The international market froze due to the prevailing fear in the economy of solving the liquidity problem. By this time, the central bank and the government had intervened. All over the globe, the government came up with measures to try to reverse the financial crisis. Central banks of several countries resorted to coordinated actions to offer liquidity support to financial institutions.

As the government tried to solve these liquidity problems, the private lending froze completely in a number of important credit markets. A remarkable lender, Lehman Brothers, the largest investment bank in the world failed and filed for bankruptcy. The other causalities affected were insurance companies, entire banking investment industry, commercial banks, large mortgage lenders and savings and loan enterprises. As a result, non-financial businesses were unable to get access to the financing and credit leading to deteriorated performance, the effect spread to most parts of the globe. The real economy exhibited challenges due to fall in investment expenditure. The decline resulted from the decline in consumer spending on durable goods and fall in business investment. In 2008 the GDP fell while the consumer spending was very low consequently, the economy was in recession. The economic growth declined to a rate of 6% annually. Congress enacted laws to assist the financial institutions. The plans were aimed to decrease the severity of the recession by treating its cause.

The effects were felt globally due to financial and trade linkages. Many foreign investors had invested in the US booming housing market. The fall in value mortgages securities made the investors to try to liquidate their holdings. Despite their efforts, the assets prices fell and they became frozen because of lack of buyers in the market. Credit became scarce and the international banks raised their interest rates based on how they rented money to one another. Ominously, banks trusting no one resulted to making no loans payments. The measure affected businesses because their cash flows were at stake. Shares prices plunged throughout the globe. Nonetheless, confidence was at stake in US financial institutions. Additionally the economic slow down in the US resulted in decline of imports from its major trading partners. When export sales declined, foreign GDP fell also leading to recession worldwide. US being the locomotive of the economy at that time, the global crisis were a major concern.

 

 

 

GCC Markets and the Financial Crisis

Gulf Cooperation Council countries were able to sustain their countries during the global financial crisis of 2007-2009. The oil price boom led to large fiscal and external balance surpluses in the GCC countries. The 2003 to 2008 oil price boom made the countries ability to withstand the impact of the global financial crisis. The countercyclical policies and the strong financial sector made them contain the impact. Nevertheless, the crisis has revealed some vulnerability in the regions financial markets that need to be addressed to limit future disruptions. At the time of global crisis, the leveraging process took hold and oil prices and production fell. The GCC external and fiscal surpluses declined markedly, stock and real estate plunged and credit defaults spread as sovereign debt widened. Moreover, external funding for corporate and financial sectors tightened. Consequently, estimates of $ 2.5 trillion in projects at different stages in planning and implementation by 2008 were on hold by 2009. Despite the blow, the banks remained profitable despite the adverse conditions. Generally, the banks showed their potential in absorbing potential losses. Other nations were greatly affected the crisis.

The oil boom was characterized by massive economic activity, credit growth, investor confidence, consumer confidence and rise in GDP. Presence of enough liquidity fueled inflation, decline in credit growth and increase in asset prices. The shock brought about by the crisis was surpassed by the government increase in level of spending and great financial measures. The stimulus package passed on by Saudi Arabia stimulated investment among the G-20. The measures have helped sustain growth in the GCC and has had positive spill over effects in the neighboring countries. This contribution greatly influenced the gulf area be able to reverse the global economic down turn and made them be in the front line of global demand.

There is an argument that the gulf area has less exposure on the financial crisis because of their economic outlook and major developments. I believe that the gulf area can be enjoying these economic accomplishments but they are short term therefore not sustainable. There are massive investments in the gulf area soil and this necessitates more external funding in terms of loans and mortgages. Most GCC countries, in particular Qatar experienced significant increases in banking system credit to the private sector during the 2003- 2008 credit and asset price boom. Real average credit growth was up to 23 % a year. The result was increase in bank advantages in issuing credit growth and double ratios for private sector credit to the non-oil sector. The GDP growth was up to 122% by 2008. In Qatar, the boom was characterized by low interest rates and massive economic activity that supported the higher demand for real estate and equities. Qatar with some GCC countries such as Kuwait enjoyed a period of lending securities. Most of their substantial growth was fueled by foreign liabilities and domestic deposits. The two increased due to the advancement of inflation.

GCC banking systems declined due to the maturity mismatches on the balance sheets and asset-liability mismatches. The declines were also caused by higher bank advantage and intense capital standards. The economies of this region suffered a great economic downturn during the global financial and economic crisis. For instance, Qatar suffered great credit losses, slow economic activity and fall in asset prices while lacking enough foreign financing. The capital adequacy ratio fell greatly. The effect of this in the gulf area region has been felt by the increase in government debt. The global shocks tightened financial conditioning making oil productions to fall immensely. Across the gulf area, economic activity contracted in between 2007 and 2009. The contraction was accompanied by decline in credit, broad money and inflation. Policy actions by the authorities have helped moderate the effect of the crisis. However, its full impact is still felt mostly in the financial sector.

Implications of the Financial Crisis

Government responded quickly and massively in addressing the consequences of the financial crisis. First, they substituted private debt-led demand, which was on a stand still with public debt-led stimulus. Most countries implemented fiscal policies in form of tax cuts and increase in government spending. According to statistics, the fiscal stimulus package amounted to 2009 GDP growth of 1.7%. Second, monetary authorities reduced interest rates to historically low levels. This was done to stimulate loans and credit injections. The support to banks made, attempted to save the inter-bank credit and generally the risk of collapse of the financial system. Capital injections, outright nationalization, loan guarantees solved the paralysis of banks. Third, an attempt was made to look at the solutions to aggravate the collapse in trade and demand. Most developing nations relied on exports to drive their economies. The financial crisis had led to cut of wages. The wage deflation was solved by forming pacts that would solve the deflation.

However, the financial crisis focused on addressing the crisis without first solving the root causes. Some economists term this as curing the symptom without treating the causes of the crisis. Overall, the measures succeeded in solving the economic crisis and a significant increase in jobs. However, the root causes were not addressed. The dysfunctional financial system was not completely addressed. The financial reforms were not completely functional in bailing out banks. First, the inter-bank credit would not functional well. Banks do not trust each other well. Therefore, volume of credit in the real economy in developing countries has greatly decreased. Many enterprises are faced with lack of enough funds and access to credit is difficult. Second, moral hazard problem was created by bailing out banks without implementing further reforms. Incentives were offered due to bank sizes that had failed. Third, unreformed financial system makes international capital inflows volatile. The capital inflows being more volatile have led to more financial crises. Fourth, claims that today profits will be tomorrow investments have necessitated the drive to save and invest. The non-financial economy is driven by the financial sector, which is expanding. The increase of profit has fallen to the hands of the financial sector that has weak measures of investing the money. Investing in physical capacity has led to increase in risks on the sustainability of this sector.

Since the wake of the financial crisis government debt have increased significantly. The leveraging process was successful in decreasing private debt but the public debt is at stake. Furthermore, the monetary policies have been pushed to the limit with at least no interest rates and increase in liquidity. Central banks have been tired of limiting the credit crunch. Governments have sought the austerity package rather than the stimulus package. The investors who were saved by the government support became reluctant in financing the government deficits. The effects go all over the world by weakening the economy that was underway recovering. The slowly growing economy has made demand be at stake and this threatens the markets that depend solely on exports as the driver of economic growth and job creation. The crisis brought about depressed employment growth and income inequalities. Therefore, the austerity package has brought about social discontent in the economy. Employment is at stake and the confidence in the government is slowly diminishing. Confidence on the government is on the decline because people are always on the lookout for markets lumps. The measures taken in solving this global crisis did not successfully address the underlying problem of the financial crisis.

The financial crisis has had adverse effects on developing states and world. For example, Africa is faced with almost every social challenge. Food crises have been a major concern since the financial crisis. The world was not able to support African states after the crisis. Poor states got less money for development and poverty continued striking. Saving the west, have had implications that are adverse on the world. Loss of confidence in the worlds super powers have created a concern in most states to take stringent steps in trading and doing business with them. There is need to have measures that reforms international monetary system. This is a motive to support the developing nations, which are the pillar of future advancement.

Decisive Policies

To avoid the financial blows, the governments under this region need to enforce stringent laws to counterpart the implications of the global crisis. As time goes by, inflation falls in the region and developments are on the rise due to oil prices. The area is booming but these developments can bring about slow recovery of regional equity markets. Some policies can be taken to counter the implications of the global crisis. First, the GCC countries need to clean up banks balance sheets and restructure the non-financial sector. Clear communication would help wipe out investor uncertainties and reduce market volatility. GCC countries can encourage periodic reviews in banks assets quality and in addition to stress testing, determine if the level of capital support is sufficient. Recapitalization can be based on private sector capital injections to minimize moral hazard. The authorities can reverse public sectors injections as market conditions prevail. A well-laid out framework will enhance banks ability to address emerging hazards quickly and efficiently.

The GCC can secondly, restructure the non-financial sector to ensure the support of viable entities while ensuring smooth transaction between the financial and non-financial sector. Stability of these two sectors will ensure stability of the financial system as a whole. Thirdly, GCC countries need to ensure corporate governance and transparency. The causes of the global crisis were lack of transparency and good governance in the financial institutions. The lenders risk aversion has continued to put pressure on businesses to enhance disclosure. GCC financial markets can accomplish this by encouraging family business to go public and declare their wealth. This would act as the first step to transparency and governance in the affiliated enterprises. Financial soundness will enhance banking system are sound and fast. Delays increase speculation and complicate market ability to conduct timely analysis. Lastly, the global crisis period was characterized by excess liquidity and asset price bubbles. To counter this implication, reserve requirements should actively be used to tackle any resumption of speculative inflows and overheating pressures and asset price inflation. Capital gains tax property should be considered.

Conclusion

The global crisis has had immense implications on all sates of the world. The financial system was challenged at this period. Importantly, credit serves as source of finance for all businesses in the universe. An economy cannot function without a strong banking system Therefore, the connection between the financial and non-financial sector needs to be healthy. The financial crisis led to lose of confidence in the financial institutions. In the gulf area, oil production made the region enjoy a period of economic boom. The period was not to last for long as the global crisis hit. Crowding in the economy made the region undergo economic downturns such as asset price decline, banks filing for bankruptcy, closures of business, stagnation of development and inflation. In spite the authorities stepping up to solve the situation, they ended up with debts and the same private sector failed to help limit the government deficit. The economy has slowly recovered and nations strive each day to reform their financial sector. Improving financial strategies has helped the government avert the dangers and implications of financial crises.