The Financial Crisis in the USA in 2007

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Topic: Business & Economics
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Introduction

The phrase financial crisis has been applied in wider aspects in recent days with an array of state of affairs is where some financial organizations or assets unexpectedly go down of a large portion of their value. Throughout the centuries, civilization has evidenced financial crises coupled with banking panics as well as numerous recessions, and the lingering recession would turn into economic depression.

An economic downturn durable for several financial quarters or else more is typically denoted as a recession. Post-Keynesian economist Minsky, Hyman, has presented his theory of financial crisis under an institutional setting of the global financial system (Wolfson, Martin H., 6).

Minsky’s theory of financial crisis argued that comprehensive exclusion of capital controls, a noteworthy boost of financial deregulation in domestic markets, and the multinational vendors, particularly IMF[1], enabled them to get involved with durable crises.

At the beginning of the recession in 2007, the USA has passed an inflexible economic phase that already has an impact on the global economy. This paper requires an impact on the world economy during the post-recessionary period by means of comparison among the financial crisis of the USA among major countries in the world.

Changes in financial markets with the change of financial variables, interest rates, price of financial assets are covered here briefly. In the case of major countries here, emphasize stock market prices and interest rates of Australia, China, Japan, and Canada at the beginning of the financial crisis of the USA in 2007. As the requirement of the paper, here assemble a literature overview and empirical perspective along with relevant graphs.

Literature review

Operate financial activities the country and an organization need to involve in a number of terms those closely involve in financing. Financial variables, financial assets, interest rates, financial markets, financial institutions are the factors that foster financial movements. A short description of these aspects is presented in bellow-

Financial variables: Financial variables are the facts that involve in- boom or recession price categories. Risk, return, interest rates, financial assets, financial markets are under financial variables. Each component is interrelated in financial activities.

Financial assets: Financial assets are also termed as security. Financial assets include- shares, debentures, and bonds in terms of financial papers. With the aim of gathering necessary funds, these assets are issued, bought, sold, and traded. Leasing is another way of owed these assets. Shareholders are the heart and soul of an organization, and except for them, investment in the different projects could not be possible.

Interest rates: In short, interest is a cost, and the relationship between corporate profit and interest rate is proportional. Lower interest rates brought profit, and a higher interest rate reduces profit growth. In the share market, higher interest rate boosts the stock prices.

Another important fact is that an increase in interest rates declines reserves. So, all of the economic tasks of a country interdependent on the interest rate and holds a competitive atmosphere between the share and bond market.

Financial markets: Within the last few decades, financial markets enlarge its boundaries and go into the global market. Several tasks are required in managing financial markets- forecasting and planning, decide to invest and financing standard, coordinate and control, and finally, transaction among financial markets.

Financial markets are categorized into two forms- developed stock markets and emerging stock markets. United States, Japan, United Kingdom, France, Germany, and all developed markets included 31 countries that are under developing stock markets. On the other side, China, Korea, Argentina, Brazil, and another 78 countries are considered as emerging stock markets.

An overview of the financial crisis of the USA after 2007

The term “recession” refers to the downturn. The recent downturn of the US termed two viewpoints- by the economist and by the NBER[2]. The NBER denoted the current depression as “recession,” and on the other hand, economists evaluated this by the fluctuation of monthly GDP (Gross Domestic Product).

At the beginning of the recessionary period in 2007, the USA faced a tough financial crisis that has an enormous consequence on all economic phase. Other than this, the USA had faced a recession four times within the past thirty years. NBER published a report that recession continued a circle and took place every eight years, and its average lifetime is approximately nine months.

At the end of 2007, the USA stayed at 50: 50 propositions toward the inside of a recession. Within the last 12 years, share price valued cheapest regarding as the valuation changed in recession. In the light of economists, potential events go into recession are- interest rates, fluctuation of oil prices, instability of major currencies, changeability of commodities, etc.

Speed of the recession, either sentimental or go-slow, depends on major financial activities and managerial decisions like- employment ratio, investment criteria, and impact on funding and spending. Experienced in the recent recession, the Federal Reserve reduces interest rates, and now it is lowest compared to the last eight years. Not only in interest rates, but recession also devalued the US dollar, and for this, they need to enlarge exports.

In this recessionary period, most of the economic areas are go down from their level, but the non-housing sector holds a flexible point still now. In September 2008, economic growth was 1.2 %, whereas their expectation was 1.5%, and typical economic growth was 2.2 %. This recession affects on US housing sector most as other areas. For instance, contribution in GDP by housing was 6.2% before the recession, but now it is hardly (4.4 – 4.9) percent.

In 2008, the fund rate of the US Federal Reserve was fallen 2% from 4.25% though the US economy needs not to depend on consumers in essence. In December 2008, employment was increased only by 18,000, which was the smallest in the last decade. A consequence of this health circumstances would be questioned next.

In the downturn, involvement in the world economy is only 5 percent, whereas, in the last six years, the US contribution in the world economy was 10%. In the case of export-import US biggest trading partner in Europe, and this partnership covered about 22%. With the stepping up of China and the impact of depression, most export-import areas are covered by China and the partnership ratio of US vs. Europe has decreased. At present, China covers almost 23% of US foreign trade activities, and in Canada, this percentage is about 18%.

Effects around the world

  • Changes in financial asset prices,
  • Changes in Interest rates,
  • Changes in financial variables.

Impact of the financial crisis in Asia

The threat of the impact of the financial crisis on Asia has been spread out among all countries on this continent. Most of the countries insist on the US government to make available a momentous pledge as well as bailout correspondence for the US economy due to it has an incidental effect of encouraging overseas entrepreneurs and assist effortlessness concerns for the Asian economy.

India, China, and Japan, are seriously affected by US recession, for example, by March 2009, India’s economic growth will have slowed quickly to 7.1%, China’s growth is expected to slow down to 8%, though Japan has suffered its own crisis from the 1990s for current crisis its industrial production fell by 10%, and car import has reduced 45%.

Some of the analysts of Asia argue that Asia has been significantly isolated from the western financial system, and thus the sub-prime mortgage crisis would not suppress the Asian Economy. A number of Asian countries have evidenced speedy development as well as assets creation in most up to date years. But this prediction would be wrong as the western countries have a great deal of investment in Asia.

The most Alarming threat is that the Asian country’s foreign currency reserve has been kept largely is the US dollar. For the political economy of the US on the Asian countries at once, do not allow them to be covert their foreign currency reserve in gold or eurozone.

Thus, they have no rescue package to keep apart themselves from the US credit crush. Some of the Asian leaders have already been addressed for the effectual and wide-ranging restructuring of the IMF’s financial policy for this region.

Recessionary effect on Gulf Countries

The Gulf Countries like UAE, Kuwait, and Saudi Arabia have also affected by the US financial crisis because the oil price has dropped by up to 50%. The Kuwait Times (2008) reported that the NBK[3] has determined that the country is going through inflationary stress.

The annual report of Central Bank of Kuwait has mentioned that the CPI[4] of the country Kuwait has jumped at 10.1% and the domestic interest rate has been cut at least 50 basis points reported on January 23, 2008, and this interest rate shaped 5.75% instate of 6.25% of the previous year.

In the fiscal year 2007-08, the interest rate for consumers deposit for KD and USD declined 4.507% and 4.646% correspondingly next to 5.013% and 5.209% in 2006-07, and these data may help to understand the whole situation.

Most of the oil-producing countries are Non-tax countries where the individuals are not taxed. In these Gulf countries, the oil sector has contributed 50% of its GDP share; therefore, the US recession has a greater impact on the macroeconomic factors of these countries for close cooperation and US dollar pegging. However, Saudi Arabia and UAE have already started to contribute US recession by investing in defect fallen banks.

Recessionary Impact on Interest rates & Unemployment

The inflation has been turning faster into the dilemma of the looming recession and derived into the way to a pointed turn down in demand as well as economic motion worldwide. The recent global financial crisis is the main cause of Unemployment all over the world, especially industries, banks of the UK, USA, UAE, some Asian countries like China, Japan, India, and few gulf countries like Kuwait.

Growing joblessness has turned to increased redundancy at the highest of this decade. CNN News (2008) has quoted Alistair Darling, the finance minister of the UK, and added that the country has been passing through the most terrible economic crisis among the past 60 years, which would be deeper and long-lasting.

In China, 20 million, in India 6 million, and in the UK, 8 million employees lost their job. Though to protect this situation, US President Barack Obama has passed the rescue package, and Bush had passed the bailout bill, but both are unexpectedly failed to solve the problem.

Recessionary impact on Global Stock Market

Treanor, J. (2008) reported that the credit crunch sinks its teeth into the stock markets, and the stock market already been crouching down. The small retailers have been disparaging and blamed for thrashing the share prices downstairs.

The market falling is not a new thing for the stock market. Nevertheless, it is flattering more and more contentious in the market downturn. The stock-market customers are buying shares with the general prediction that the market would gain its normal values, but the market is going away downwards.

Treanor, J. (2008) also reported that the course of action is very straightforward. Just a broker borrows some shares from a large metropolis investor, those who take charges for their services. The broker then goes to the market and sells out the shares. Later while the price falls, the broker buys back them more and more, and then he is recurring the shares to the equitable vendor. The variation of the two prices would generate his profit.

For instance, in March 2008, the share price of the HBOS Banking group plunged a disgusting 17% in the same day’s trade, which has evidenced a dangerous scenario in the history of the share market. The retailers have been liable for driving this downwards.

The specialists argued that the retailing is not in opposition to the existing rules, but the trading influenced by rumors has seriously driven the market downwards. The regulatory authorities like FSA and SEC have steeped to stabilize the market by hunting the notorious traders who were taking the opportunity of false rumors. They scanned the e-mail exchanges and trapped mobile phone records but failed to identify anybody to blame.

Moreover, another reason for market downwards was identified as some of the companies were in a huge shortage of emergency cash requirements and carried out an urgent cash call from the market, which affected the market to go downward.

At the end of all this investigation, it was founded that the investment banking corporation JP Morgan Stanley was one of the retailers of 2.4% of the HBOS and amounted more or less £350 million. Still, the market is unstable and going downwards.

James C., (2008) made comparison of stock market prices and interest rates in the major countries like Australia and China after financial crisis of USA: Compare to recession in 2001, Australia holds a stable place now whereas economists forecast that recession affected the US economy about (40 – 50)% and there was a strapping chance reach it at 100 percent.

With the effect of GST introduction, Australia was able to avoid recession in December 2000 when its economy was going slow from 5.2% to 1.5%. Compare to the recession of 2000; now US share prices are lowest whereas it was overvalued in 2000. In the case of interest rates, it was 6.5% in 2000, and now it is 5.25%.

In the US economy, recent recession grasps mostly sub-prime components and the housing areas. In short, recession affects a versatile effect on the US economy as well as in the world. Modes of financial activities and managerial decisions determine the velocity of the current recession.

People cut down their budget of food and gasoline, and banks bring down the lending amount. On the topic of recession, fear builds a self-fulfillment impression in people’s minds as well as the organization.

On the other hand, the present Australian balance sheet is strong than before, and their trading commotion mostly depends on China. Trade between Australia and China is now 15% whereas it was 7% in 2001 and trade between Australia and the US decreased by 4% within the last seven years.

There was an indirect impact of the US recession on Australia- they require less supply from Australia than before, and this enables them to spend little. These trading activities between Australia and the US greatly affected China and Japanese business. However, now China involved in 16% of US trading operations. Compare to trade in Canada of China and Mexico are respectively- 12 and 11% in total of 18%.

With the speeding up of China and lessening of share prices, involvement in the global economy of the US has decreased by about 20%. Another impact of the recession is that- it reduced the US’s involvement ratio in global GDP at the lowest form compare to the last 60 years. On the other hand, this ratio enlarges at (5 – 15) percentage within the last 40 years of China, especially in the last seven years.

In terms of world economic growth, over the last six years, the US participates 10 percent in terms of 0.5-point percentage. Recent recession down this and other side China is capable of enlarging this percentage into 35 in terms of 1.7 points. This is the consequence of slow down the US economy from 2.5% to 1.5% during 2008, represents a versatile impact of the recession on the global economy.

After conquering the last recession in 2001, at this instant, Australia’s corporate profit is sixteen times higher, the unemployment ratio is only 4.5% in terms of 2 points, and the government’s bank loan is lowest than the last decade. When Federal Reserve reduced interest rates with the aim of back the image in the housing industry and economic growth, but Australia, the recent interest rate is highest than in the last 11 years.

US recession generates an enormous fear in investors’ minds, and in October 2008, share prices fall 9.4 percent, and it was the biggest fall of Dow Jones within the last five months.

The price-earnings ratio of the US share-market dramatically has gone down by 4.85%, and now is placed at 15.95%, whereas it was 20.8 percent over the last 13 years. In Australia, share markets hold 15.7 as their long-term average, and their price-earning ratio is 14 percent. However, they attained a historical record in November 2008, but it decreased, and now ASX 200 is 7.6%.

Conclusion

After the great depression in the 1930s, the recent recession is a threat around the world. The share price of major countries is affected by this recession. Compare to the last recession in 2001, this depression declines the share prices.

Boosts of technological development were the prime fact of the last recession. In that time, Australia suffered much to compare to other major countries. However, in an instant, most sufferer countries because of the recession in the United States (US).

Explain the post-financial crisis in 2007 of the USA, this paper take account of a theoretical overview along with an empirical perspective.

An overview of the financial crisis, its effect around the world, stock market scenario, recessionary impact comparison among the USA and other major countries like Australia, China, Japan, and Canada, India has described here briefly. Rumor is another fact that plays behind declining share prices. Hopefully, the USA and other major countries that affected by this recession would overcome successfully very soon.

Bibliography

James Craig, US Recession in 2008?, Economics.

Gander P. James, Extreme Value Theory and the Financial Crisis of 2008, Economics Department, University of Utah.

Kilmister Andy, The Economic Crisis and its Effects, IV Online magazine. 2009. Web.

Panday, I. M., Financial management, 9th Ed, 2007, Vikas Publishing House Pvt. Ltd. India, New Delhi, ISBN: 81-259-1658-X, page- 1-5.

Treanor, Jill (2008), What is a short position? The Guardian. Web.

Scott Besley and Eugene F. Bingham, Essentials of managerial finance, 13th edition, 2007, Thomson South Western, USA, NY, ISBN: 0-32423278-0. Page-15, 71-75.

Shah Anup, Global Financial Crisis 2008.

Wolfson, Martin H. Minsky’s Theory of Financial Crises in a Global Context, Journal of Economic Issues, Vol. XXXVI No. 2002.

Worldbank.org, Afghanistan at a glance. Web.

Appendix

More rate cuts to come.
Figure 1: More rate cuts to come.
Slowdown but no recession.
Figure 2: Slowdown but no recession.
Back to earth.
Figure 3: Back to earth.
All depends on the us consumer.
Figure 4: All depends on the us consumer.
Jobs are still being added.
Figure 5: Jobs are still being added.
The china powerhouse.
Figure 6: The china powerhouse.
Less sensitive.
Figure 7: Less sensitive.
Declining importance.
Figure 8: Declining importance.
Dragon awakes.
Figure 9: Dragon awakes.
US shares cheapest in 12 yrs.
Figure 10: US shares cheapest in 12 yrs.
Attractive australian valuations.
Figure 11: Attractive australian valuations.