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Financial Management During the Recession

Introduction and thesis

In the past decades, various economies across the globe have come face to face with the implications that arise due to poor management and regulation of financial resources. The effects of the same have been felt by all individuals socially and economically making financial management a force to reckon with. The recent financial crisis that has destabilized the greatest world economies is one such implication that has been accrued from poor financial management. This paper shall set out to establish whether the recent financial crisis was in any way affected by global financial management or by other economic factors. The causes and effects shall be discussed and policies analyzed to further seek the extent to which financial management contributed to the crisis. Recommendations shall also be offered as to how best such a crisis can be averted in the future.

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Brief background history

Financial experts and related scholars acclaim that the recent financial crisis is by far the worst since the 1930’s great depression. According to Snyder (2002), the current financial crisis has to a large extent been brought about by failed capitalism and the failure of the US government to monitor this capitalism through proper and effective management of the financial systems. In addition to this, there have been other possible economic reasons that have led to the same such as poor economic policies, ineffective global business interactions, inflation and income inequality within the economies. Also, the US dollar has been depreciating in value over the past few decades leading to failures of businesses and a general decrease in effective demand and disposable incomes within the households (Dymski & Isenberg, 2001).

Causes and effects of the recession on the economy

2007 to date financial crisis is believed to have been caused by the United States housing bubble which was at its peak in around 2005 and 2006. Roberts (2008) asserts that this was brought about by poor credit management through the reduction of the borrowing rates whereby the federal reserves lowered the rates from 6.5% to a record low of 1.0%. This encouraged people to borrow loans and most of them reinvested the money in the real estate market which after 2005 seemed lucrative due to the changes in building and construction policies. Due to these low interest rates, the housing industry in America attracted many investors into this sector and as a result, the amount of mortgage-backed securities (MBS) and collateralized debt obligations (CDO) which got their values from house prices and mortgage payments increased significantly. Horowitz (2001) concedes that as the housing prices declined many financial institutions and investors who had borrowed to capitalize on the opportunity recorded high losses to an extent where other institutions had to close down. In addition to this, most houses were worth less than the mortgage loans attached to them and as such this consumed much wealth from the consumers and the banking institutions that gave out these loans. Total losses in this sector are estimated to be in the trillions of dollars throughout the world. If proper financial management and credit regulatory measures were exercised while awarding loans and restricted investment in the housing sector employed, then the supply of houses would have been controlled and as the law of supply states, the lower the supply, the higher the prices and this would have minimized the chances of the financial crisis taking such devastating toll in our economies.

Another factor that led to the crisis was the increase in debt burden that ensued before the crisis. Statistics reveal that the amount of household borrowing in relation to their annual disposable income was at 127% in 2007 as compared to 77% in 1999. Also institutions and many governments attested to having great debt burdens which due to ineffective financial management, led to the financial crisis. Mishkin (2001) forecast that poor debt management may in the long run lead to a financial crisis within the organization or an economy at large. This statement was therefore proven to be a fact during this crisis. The debt burden consequently led to high inflation rates and high costs of living in most countries around the world. On the same note, most banks in a bid to have a competitive edge had lowered the collateral requirement attached to the loans. Many banks up to date offer loans with amounts higher than the collateral provided as such if the clients cannot pay off their debts the banks are left with hefty debts which after accumulating leads to their foreclosures.

In 1981, the debts owned by private investors and households in the US were at 123% of the GDP. This figure rose up to 290% in August 2008 yet there were regulations set to monitor this level within a specific limit. This left people with less disposable income as much of their money goes into servicing these loans. Consequently, the investments level went down and so did the GDP leaving the government with inadequate financial resources to improve and facilitate key economic changes. Also, some of the top investment banks in the US had increased their financial leverage significantly. This made them more susceptible to a financial shock and as the depression set in, it left most of them put under receivership, closed or in need of government support. This reduced the number of investments in the US and also lowered the GDP level even further.

High unemployment rates all over the globe also had a significant contribution to the financial crisis. According to Rehman (2009), the recent increase in unemployment levels reduced total demand significantly. As a result, many industries recorded high losses and had to cut down on production levels. In addition to this, many people withdrew money more than they saved a tendency which led to inflation and the banking sector making huge losses.

The global economic crisis resource center (2009) states that the regulatory changes made in the Gramm-Leach-Bliley act in 1999 which removed all barriers to competition between the various types of banking institutions had a hand in the financial crisis. This act allowed financial institutions to take part in the three financial markets; banking, investment and insurance. As a result the competition between these firms became unhealthy leading to the development of financial products such as the shadow banking system that intentionally went around the set regulations and contributed highly to the US financial crisis.

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Financial management policies and theories and their contribution to the recession

Banking policies such as credit ratios, bank rates and credit rates play a very important role in managing finances. However, during the recession, it was evident that these policies are not put into effect by many business entities. In some cases, these policies had been neglected in a bid to encourage borrowing and have a competitive edge against other banking institutions. A good example is collateral versus amount ratio. On the same note, fiscal policies such as price legislation and taxation which could have been used to regulate prices and investments were also poorly implemented creating loop holes in the financial management systems which consequently contributed to the recession. Khan and Hildreth (2004), states that a financial crisis can be averted if the major financial analysts and managers set their organizational goals and missions using theories that are realistic and achievable in nature. They state that firms should not only focus on short term targets but devote their resources to achieving financial greatness in the future. Lack of such insight contributed highly to the recession.

The drafting of budgets is one of the key policies used to monitor and report the financial plan, capital structures implemented and debt ratios of businesses around the globe. However, statistics provided by the World Bank’s world development indicators indicate that most emerging economies had a high debt to total debt ratios (World Bank, 2009). This means that incase of a recession, firms in those economies were at a great risk of a financial crisis and insolvency which indeed was evident during the recession.

In addition to this, many firms were domestically financed in terms of stock and bond trading. Due to financial globalization, many firms since the early ’90s were extensively floating their shares and bonds in the domestic and international stock markets in a bid to expand their capital structures. However, firms that rely on domestic financing have a short maturity period on debts and minimal access to long term debts as opposed to those with access to international stock markets (Shmukler & Vesperoni, 2003). Most emerging economies rely on domestic financing due to difficulties in accessing international markets as well as their size (small) and profit base. Consequently, in the wake of the recession, these firms incurred high losses and others were foreclosed.

Jansen and Beulig (2009) acclaim that the subprime mortgages contributed highly to the US financial crisis. In their book they insist that this crisis was brought about mainly due to loose monetary policies and regulations governing the banking systems and housing sector in the US. They however do not factor in the effects of unemployment and low wages as partial contributes to the crisis. This book helped in the evaluation of mortgages as part of the underlying causes of the financial crisis. It helped identify the problem and in the basing of a solution for the same.

In their book “the governance of financial management,” Carver (2009) in full detail equip the readers with strategies that can be implemented to ensure effective financial management. In addition to this, they offer explanations as to the importance of the value of a budget as compared to the mere numbers that the budget represents. They also discuss effective fiscal policies that were useful in this research especially during the analysis of policies as contributors to the financial crisis.

Collyns and Kincaid (2003) go beyond price legislation as a means of curbing inflation. They say that poor saving habits and high spending on disposable incomes also increase inflation. Also they suggest that scarcity leads to an increase in prices due to increased demand which is also a form of inflation. On the same note, the authors agree that poor lending policies increased the money in circulation which in turn led to increased inflation and overspending; key contributors to the financial crisis. This book proved to be useful in this research because it provided detailed information about the causes and effects of inflation during financial management and planning.

Global financial management analysis

Statistics indicate that the impacts of the current financial crisis have been felt by all nations across the globe. The worst hit by this crisis is the developing countries that depend on support from other nations in order to sustain themselves. The World Bank and IMF have also been accused of promoting and increasing the debt burdens of such countries whose general income cannot foot such immense loans. In addition to this, the number of countries working with deficit budgets is alarmingly high indicating that there is a general problem in financial spending and resource allocation (Baumol & Blinder, 2007). The increase in global inflationary rates(lots of money in circulation and rapid increase in general price levels) shows that there is poor management of finances within the social realms and poor price legislation which was originally designed to curb inflation on both the local and global perspectives.

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On the same note, many firms incurred losses due to poor financial decision making structures in regards to the choice of capital structures to implement. As mentioned earlier, the debt ratios should be monitored and balanced effectively if a firm intends to survive through the economic hurdles. However it was evident throughout the period that this fact was ignored and firms borrowed more than they could chew which led to high debts through out the economies. In addition to this, firms opted for stocks instead of bonds which meant short term debts and extra expenses in terms of dividend payments.

Also, there is an increase in poor investment decisions. A case in point would be the Dubai financial crisis in 2009. In this case, evidence indicates that almost all investments in this economy were geared towards the tourism sector (hotels and travel). When the recession hit, the Dubai economy went down in a slump to an extent where there were speculations that its economy could not sustain itself. The same scenario was evident in other economies which depended heavily on the tourism sector or other specific sectors. This shows that there is a general lack of diversity in such economies and failure in the sectors that they rely on would mean financially cripple them and collectively; the world economy.

Recommendations

With the above insight in mind, there is a need to reconfigure and redesign the regulatory and financial management systems in place in the financial industry. According to Brigham and Ehrhardt (2008), it is always important to have some sort of financial forecast report which would help analyze the financial situations of the various economies. These forecasts include budgets and financial statements which monitor the allocation of finances and the distribution of the same in various sectors and departments. However, for this to work, retraining programs have to be initiated so that financial supervisors are equipped with the knowledge of how to avoid and effectively solve financial issues that may lead to yet another financial crisis.

Strict lending policies (credit ratios and bank rates) are the only effective remedies that can check on the high inflation and debt burden that is being experienced in all countries around the world. Also, high financial discipline needs to be exercised by all if the world wants to recover fully from this crisis and as such it is the duty of everyone to change their saving and spending patterns for the better of the whole economy (Herigstad, 2006). On the same note, new financial regulations and deregulations ought to be drafted and made public so that everyone understands what they are supposed to do and the consequences of deviating from the set rules and regulations to their future.

There should be a change in the education system as regards to the modeling of self employed citizens. The world is currently characterized by inequalities, unemployment and lack of resources. Many of the people experiencing these difficulties are highly educated but lack the opportunities to better themselves due to the shortage of employment opportunities in the labor market. Due to the current situation, the education systems should concentrate more on equipping the students with entrepreneurial skills which will enable them be self employed and give them an equal chance to fight for resources. Griffin (2007), reiterates that these skills have been known to enhance innovativeness and creativity in people which consequently improves productivity and the financial status of an economy through increased GDP.

The government should try and regulate the number of investments that are in the various sectors by imposing high tax rates in order to avoid overexploitation of resources which leads to scarcity as well as over supply of similar or differentiated commodities in the markets. Additionally, policies should be established that demand accountability of allocated finances from the various ministries and sectors. This will avoid incidences of misappropriation of funds, embezzlement and poor management of the same. They should also establish stricter price legislation policies to check on inflation and its related impact on global financial management (Mankiw, 2008).

Conclusion

Efficient and effective financial management is core to the development, survival and success of every business venture. As such, financial managers and analysts should ensure that all aspects governing financial resources are well maintained and updated in order to avoid yet another financial crisis. If the recommendations stated are implemented, the global community will then be well on its way to recovery from the depressive state it’s in thereby securing a healthier economy for the future generations.

References

Baumol, W, J & Blinder, A, S. (2007). Macroeconomics: Principles and Policy. Cengage Learning.

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Brigham, E, F & Ehrhardt, M, C. (2008). Financial management: theory and practice. Cengage Learning.

Carver, J & carver, M. (2009). The Governance of Financial Management. John Wiley and Sons.

Collyns, C & Kincaid, G, R. (2003). Managing financial crises: recent experience and lessons for Latin America. International Monetary Fund.

Dymski, G, & Isenberg, D. (2002).Seeking shelter on the Pacific Rim: financial globalization, social change, and the housing market. M.E. Sharpe.

Global Economics Crisis Resource Center. (2009). Global Economic Crisis: Impact on Finance. Cengage Learning.

Griffin, R, W. (2007). Fundamentals of Management. Cengage Learning.

Herigstad, S. (2006). Help! I Can’t Pay My Bills: Surviving a Financial Crisis. St. Martin’s Press.

Horowitz, S, A. (2001). The political economy of international financial crisis: interest groups, ideologies, and institutions. Institute of Southeast Asian Studies.

Jansen, L, H & Beulig, N. (2009). US Subprime and Financial Crisis – To what Extent Can You Safeguard Financial System Risks? GRIN Verlag.

Khan, A & Hildreth, W, B. (2004). Financial management theory in the public sector. Greenwood Publishing Group.

Mankiw, G. (2008). Brief Principles of Macroeconomics. Cengage Learning.

Mishkin, F, S. (2001). The economics of money, banking, and financial markets. Addison Wesley.

Rehman, S, S & Askari, H. (1998). Financial crisis management in regional blocs. Springer.

Roberts, L. (2008). The Great Housing Bubble. Monterey Cypress LLC.

Shmukler, S, L & vesperoni, E. (2004).Financial Globalization and Debt Maturity in Emerging Economies. Web. 

Snyder, F, G. (2002). Regional and global regulation of international trade Studies in European law and integration. Hart Publishing.

World Bank. World Development Indicators 2009. Web.

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