Financial & Economic Crisis
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WTO predicts global trade to fall 9%
03 Apr 2009
The World Trade Organization forecasts global trade to decline by 9% during 2009. Developed countries will see their exports fall by around 10% during the year, while poorer nations’ trade levels will drop by 2-3%. According to WTO Director-General Pascal Lamy, this will be the biggest fall in world trade since World War II and any protectionist measures taken by individual states will only further worsen the situation. Global trade will be one of the hottest issues on the agenda during the G20 summit in London on 2 April. The WTO experts note that the forecast might need to be updated during the year depending on various factors including the depth and severity of global recession. Some positive signs include February increase in trade levels for Singapore, China, Taiwan and Vietnam. Read more...
UK government debt hit £750bn in 2008
28 Mar 2009
The Office for National Statistics data shows that the British government’s debt rose to £750.3bn in 2008, which represents more than 50% of Britain’s GDP (gross domestic product). At the same time, the government’s net borrowing reached 5.4% of the GDP. According to the EU’s Maastricht Treaty, deficits should not exceed 3% of GDP mark and debt should not go over 60% of GDP respectively. The European Commission set targets for five member countries to reduce their budget deficits. The UK is required to meet the 3% target by 2013-14. The above debt figure includes the rescue package of Northern Rock, however does not include the bank bail-outs as well as treasury bills provided to the Bank of England in 2008. Read more...
US budget deficit will reach $1.8 trillion
20 Mar 2009
The Congressional Budget Office forecasts the US budget deficit to hit $1.8tn (£1.25tn) this year and total a massive $9.3tn between 2010 and 2019. The President Obama’s $3.55tn budget plan designed to address issues in education, healthcare as well as to lower greenhouse emissions appears to be the main contributor to the huge deficit estimated by the Congress, however as announced by the White House it will not change the President’s political agenda. The forecast for the US economy is just as gloomy – a 3% contraction in 2009 with a 2.9% growth in the following year and 4% growth for 2011. The current government’s objective is to cut the deficit in half by the year 2013. Some experts believe that the public spending programs need to be cut as simply unaffordable in these turbulent times. Read more...
Norway government pension fund lost $92bn
16 Mar 2009
The Norwegian Government Pension Fund lost 633bn kroner ($92bn or £66bn) on its investments during 2008. Being the world’s second biggest sovereign wealth fund after the United Arab Emirates, the fund is worth $330bn. The main contributing factor to the fund’s losses was a dramatic drop in equity prices worldwide. The following financial crisis in the banking sector and the resulting problems in the real economy have further affected the fund’s performance. The pension fund’s shares fell by around 20%, while its bonds rose only by 1.6%. On the other hand the fund’s international division known as the oil fund was performing well. With Norway being the fourth largest gas and oil exporter worldwide, there have been some significant inflows of funds during the record energy prices of the summer months. The favourable currency movements during the year also provided a source of growth for the pension fund. Read more...
Federal Reserve chairman warns of stagnation
08 Mar 2009
Federal Reserve chairman believes the US government needs to act now to stabilize financial markets. He warned the US Senate Budget Committee that if more aggressive steps are not taken, the US will be facing a prolonged economic stagnation which in turn would lead to lower production, employment and income levels as well as worsening fiscal situation. According to Mr Bernanke the US government has made some progress since autumn last year however more aggressive measures need to be implemented to revive the economy. Read more...
Insurance giant AIG reports $61.7bn in losses
04 Mar 2009
Insurance company AIG reported a $61.7bn (£43bn) loss in the last quarter of 2008 which represents the biggest quarterly loss in the corporate history. Following the news the stock markets fell sharply over concerns about the health and stability of the financial system. The giant insurer was already given $150bn in financial support from the US government marking it the biggest bail-out of an American company. Another $30bn is due to come in as part of the revamped rescue package. Both the Federal Reserve and the Treasury are confident that the provision of funds will stabilize the financial system warning that the cost of inaction would be extremely high. The rescue deal involves restructure of AIG’s operations and the Federal Reserve taking shares in two international units. Read more...
Global Financial Crisis Overview
The Global Financial crisis of 2007–2008 initially referred to in the media as a "credit crunch" or "credit crisis", began in August 2007, when a loss of confidence by investors in the value of securitized mortgages in the United States resulted in a liquidity crisis which prompted a substantial injection of capital into financial markets by the United States Federal Reserve and the European Central Bank. The TED spread, an indicator of perceived credit risk in the general economy, spiked up in August 2007, remained volatile for a year, then spiked even higher in September 2008.
Although America's housing collapse is often cited as having caused the financial crisis, the financial system was vulnerable because of intricate and overleveraged financial contracts and operations, the US monetary policy making the cost of credit negligible therefore encouraging such over-leverage, and generally a hypertrophy of the financial sphere.
One example was credit derivatives - Credit Default Swaps (CDS), which insure debt holders against default. They are fashioned privately, traded over the counter outside the purview of regulators. The U.S. government's seizure of the mortgage companies prompted an auction of their debt so that traders who bought and sold default protection (CDS) could settle contracts. The auctions are used to set a price by which investors can settle the contracts with cash rather than having to physically deliver a bond to their counterparties. Sellers of protection pay the face value of the contracts minus the recovery value set on the bonds.
Scope of the financial crisis
After affecting banking and credit, mainly in the USA, the financial crisis evolved into a global general financial crisis verging on a systemic crisis. Mechanical phenomena such as domino effect, and also psychological contagions, made it spread at the same time worldwide and into many financial and economic areas including:
- Financial markets, stock exchanges and derivative markets in particular, where it developed into a market crash.
- Various equity funds and hedge funds that went short of cash and had to get rid of assets.
- Insurance activities and pension funds, facing a receding asset portfolio value to cover their commitments,
- Impact on public finance due to the bailout actions.
- Forex, at least for some currencies including Icelandic crown, various Eastern Europe and Latin American currencies.
The initial liquidity crisis can in hindsight be seen to have resulted from the incipient subprime mortgage crisis. One of the first victims outside the US was Northern Rock, a major British bank. The bank's inability to borrow additional funds to pay off maturing debt obligations led to a bank run in mid-September 2007. The highly leveraged nature of its business, unsupportable without fresh infusions of cash, led to its takeover by the British Government and provided an early indication of the troubles that would soon befall other banks and financial institutions.
Excessive lending under loosened underwriting standards, which was a hallmark of the United States housing bubble, resulted in a very large number of subprime mortgages. These high-risk loans had been perceived to be mitigated by securitization. Rather than mitigating the risk, however, this strategy appears to have had the effect of broadcasting and amplifying the crisis in a domino effect. The damage from these failing securitization schemes eventually cut across a large swath of the housing market and the housing business and led to the subprime mortgage crisis. The accelerating rate of foreclosures caused an ever greater number of homes to be dumped onto the market. This glut of homes decreased the value of other surrounding homes which themselves became subject to foreclosure or abandonment. The resulting spiral underlay a developing financial and economic crisis.
Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial. Financial institutions, which had engaged in the securitization of mortgages such as Bear Stearns, fell prey afterwards. Later on, Bear Stearns was acquired by JP Morgan Chase through the deliberate assistance from the US government. Its stock price fell from the record high $154 to $3 which was the acquisition price by JP Morgan Chase, subsequently the acquisition price was agreed on $10 between the US government as well as JP Morgan.
On July 11, 2008, the largest mortgage lender in the US, IndyMac Bank, collapsed, and its assets were seized by federal regulators after the mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures. That day the financial markets plunged as investors tried to gauge whether the government would attempt to save mortgage lenders Fannie Mae and Freddie Mac, which it did by placing the two companies into federal conservatorship on September 7, 2008 after the financial crisis further accelerated in late summer.
It then began to affect the general availability of credit to non-housing related businesses and to larger financial institutions not directly connected with mortgage lending. At the heart of many of these institution's portfolios were investments whose assets had been derived from bundled home mortgages. Exposure to these mortgage-backed securities, or to the credit derivatives used to insure them against failure, threatened an increasing number of firms such as Lehman Brothers, AIG, Merrill Lynch, and HBOS. Other firms that came under pressure included Washington Mutual, the largest savings and loan association in the United States, and the remaining large investment firms, Morgan Stanley and Goldman Sachs.
Emerging global financial crisis
Beginning with bankruptcy of Lehman Brothers on September 14, 2008, the financial crisis entered an acute phase marked by failures of prominent American and European banks and efforts by the American and European governments to rescue distressed financial institutions, in the United States by passage of the Emergency Economic Stabilization Act of 2008 and in European countries by infusion of capital into major banks. Afterwards, Iceland almost reached a point of bankruptcy. Many financial institutions in Europe also faced the liquidity problem that they needed to raise their capital adequacy ratio. As the financial crisis developed, stock markets fell worldwide, and global financial regulators attempted to coordinate efforts to contain the financial crisis.
The US government threw the $700 billion plan which was attempted to purchase the underperforming collaterals and assets. However, the plan was vetoed by the US congress because some members rejected the idea that the taxpayers’ money will be used to bail out the Wall Street's investment bankers. The stock market plunged as a result - the US congress amended the $700 billion bail-out plan and finally passed the legislation. Unfortunately, the market sentiment continuously deteriorated and the global financial system almost collapsed.
While the market turned extremely pessimistic, the British government launched a 500 billion pounds bail-out plan aimed to injecting capital into the financial system. The British government nationalized most of the financial institutions in trouble. Many European governments followed as well as the US government. Stock markets appeared to have stabilized by the end of October. In addition, the falling prices due to reduced demand for oil, coupled with projections of a global recession, brought the 2000s energy crisis to temporary resolution. In the Eastern European economies of Poland, Hungary, Romania, and Ukraine the economic crisis was characterized by difficulties with loans made in hard currencies such as the Swiss franc. As local currencies in those countries lost value making payment on such loans became progressively difficult.
As the financial crisis developed during September and October, 2008 there was a "flight to quality" as investors sought safety in U.S. treasury bonds, gold, and strong currencies such as the dollar and the yen. This currency crisis threatened to disrupt international trade and produced strong pressure on all world currencies. The International Monetary Fund had limited resources relative to the needs of the many nations with currency under pressure or near collapse.
Real gross domestic product - the output of goods and services produced by labor and property located in the United States decreased at an annual rate of 0.3 percent in the third quarter of 2008, according to advance estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased by 2.8 percent. Real disposable personal income decreased by 8.7 percent.
Global financial crisis: Timeline of events
- Liquidity crisis emerged on August 9, 2007.
- Northern Rock sought and received a liquidity support facility from the Bank of England on September 14, 2007.
- Record high US stock market on October 9, 2007 with Dow Jones Industrial Average (DJIA) at 14,164.
- January 2008 stock market volatility.
- On February 22, 2008 Northern Rock was taken into state ownership.
- Bear Stearns takeover in March 2008.
- Federal takeover of Fannie Mae and Freddie Mac.
- Global financial crisis of September–October 2008 beginning with the Bankruptcy of Lehman Brothers.
- Large losses in financial markets worldwide throughout September- October 2008.
- Emergency Economic Stabilization Act of 2008 was passed.
- The three major banks of Iceland were nationalized. Banks in several other countries were partially nationalized.
- October 24, Pre-Washington Summit held in Beijing between European Union and Asian states.
- October 26, IMF offered lines of credit to several states, including $16.5b to Ukraine, and sizable loans to Hungary and Pakistan.
- October 27, Hong Kong stock market crash with stocks falling another 13%.
- October 28, Hong Kong stocks rebound at 15%.
- October 29, Hungary received $25 billion rescue deal.
- November 20, US stock market Dow Jones Industrial Average (DJIA) 7,507
Predictions for the financial crisis
A number of commentators have suggested that if the liquidity crisis continues, there could be an extended recession or worse. The continuing development of the economic crisis prompted fears of a global economic collapse. The financial crisis is likely to yield the biggest banking shakeout since the savings-and-loan meltdown. Investment bank UBS stated on October 6 that 2009 would see a clear global recession, with recovery unlikely for at least two years. Three days later UBS economists announced that the "beginning of the end" of the crisis had begun, with the world starting to make the necessary actions to fix the financial and economic crisis: capital injection by governments; injection made systemically; interest rate cuts to help borrowers. The United Kingdom had started systemic injection, and the world's central banks were now cutting interest rates. UBS emphasized the United States needed to implement systemic injection. UBS further emphasized that this fixes only the financial crisis, but that in economic terms "the worst is still to come". UBS quantified their expected recession durations on October 16: two quarters for the Eurozone, three quarters for the United States, and four quarters for the United Kingdom.
Nouriel Roubini, professor of economics at New York University and chairman of RGE Monitor, predicted a recession of up to 2 years, unemployment of up to 9 percent, and another 15 percent drop in home prices. Moody's Investors Service continued in October, 2008 to project increased foreclosures for residential mortgages originating in 2006 and 2007. These increases may result in downgrades of the credit rating of bond insurers Ambac, MBIA, Financial Guaranty Insurance Company, and CIFG. The bond insurers, meantime, together with their insurance regulators, are negotiating with the Treasury regarding possible capital infusions or other relief under the $700 billion bailout plan. In addition to mortgage backed bonds, the bond insurers back hundreds of billions of dollars of municipal and other bonds. Thus a ripple effect could spread beyond the mortgage sector into the financial system should there be a major downgrade in credit ratings or failure of the companies.