Corporate and Wholesale Finance - 12BSP053
“Since 2007 to mid 2009, global financial markets and systems have been in the grip of the worst financial crisis since the depression era of the late 1920s. Major Banks in the U.S., the U.K. and Europe have collapsed and been bailed out by state aid”. (Valdez and Molyneux, 2010) Identify the main macroeconomic and microeconomic causes that resulted in the above-mentioned crisis and make an assessment of the success or otherwise of the actions taken by the U.K government to resolve the problem.
By Alistair Walters – A913910
Five years on from the beginning of the worst financial crisis he world has seen we are still in a perils state of low or negative growth and low interest rates. It is clear that there were a number of factors both macroeconomic and microeconomic that created the situation and that the responses by the British government have been mixed at best. Although able to avert a full-scale meltdown of the financial system the British government has been criticised for its ‘backseat’ approach by many. This paper will explore the Macroeconomic and microeconomic causes of the crisis and how the British government has responded, assessing the success of their approach and considering whether the criticism of their policy is justified. Macroeconomic Factors One of the major causes of the global financial crisis was the global financial imbalance of payments consisting of huge deficits in the western world and massive surpluses in OPEC nations and the Far East. The surpluses were invested in western economies that were seen as stable with good potential returns. It meant that the Wests deficit was being financed by foreign 10 years up to the crash. Exhibit 1.22: UK current account deficit
The Turner Review Chapter One: What went wrong?
investment. Fig 1. Shows the growth in the UK current account deficit in the 33
Exhibit 1.23: US current account deficit and gross capital flows
The surpluses in these countries caused an influx of cash on to the worlds capital markets forcing interest rates down, as the availability of wholesale Review The Turner capital was so great. “The massive flows of capital… into western financial markets pushed down interest rates and encouraged risk-taking on an extraordinary scale” (King, 2010). It is clear that the global imbalance of This in turn has driven a reduction in real risk-free rates of interest to historically low levels payments created give rise to the foundations of the financial crisis. (Exhibit 1.3). In 1990 an investor could invest in the UK or the US in risk-free index-linked government bonds at a yield to maturity of over 3% real; for the last five years the yield has been less than 2%The other important Macro economic factor that needs consideration is long and at times as low as 1%. 13
Chapter One: What went wrong?
period of low real interest rates caused have in turn driven two effects: These very low medium- and long-term real interest ratesby the capital influx mentioned earlier. • Firstly, they have helped drive rapid growth ofwere also causedsome developed monetary Furthermore, low interest rates credit extension in by long-term countries, particularly in the US and the UK – and particularly but not exclusively for residential mortgages policy decisions driven by a fear of deflation, as argued by Liang (2012) falling (Exhibit 1.4) – with this growth accompanied by a degradation of credit standards, and fuelling property price booms which for a time made those lower credit standards appear costless. rates were more driven by policy decisions that inflow of capital. Fig 2...
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