Finance

Leading economists around the world have called the 2007-2010 credit crises the most horrible financial crisis ever since the 1930s Great Depression. So far, the financial crisis has led to the collapse of several businesses, great reduction in the wealth of consumers, which is estimated to run into several trillions of dollars. The financial crisis has also had a lot of effect on the several government commitments as well as a significant reduction in the level of economic activity. Several causes have been attributed to the current crisis, with varying weights being assigned to the various causes by the experts. Both regulatory and market based solutions are either under consideration or are being implemented, while substantial risks are still evident for the global economy for extended period of time up to 2011.

Causes of the global debt crisis
The current global financial crisis began in America as a prime mortgage lending crisis and it soon spread to Asia, Latin America, South East Asia and Europe. Today, this crisis has become an issue of world concern as it has affected almost all countries. The global financial crisis is believed to have been caused by the busting of the housing bubble in the United States in the years 2005 and 2006. During this period, the default rates on adjustable rate mortgages and sub prime mortgages increased rapidly. Prior to this scenario, loan incentives accompanied by easy terms of lending and rising housing prices which had persisted for a long time had encouraged many investors to take difficult mortgages believing that they could refinance the loans at favorable terms. However, as the interest rates started increasing and housing prices dropping between the years 2006 and 2007 in various parts of the United States, refinancing the loans became difficult thus increasing defaults. Foreclosure activities also increased due to expiry of easy initial terms. Investors had anticipated that homes prices would increase but this never happened and the adjustable rates mortgages increased. Mortgage loans became more expensive than the homes which provided an incentive for foreclosure. This foreclosure which started in year 2006 is a key factor in the ongoing global economic crisis. This is because it drains the financial strength of financial and banking institutions as well as the wealth of the consumers.

Different factors have been outlined as the possible causes of the ongoing financial crisis including homeowners inability to pay their mortgages, resetting of adjustable rate mortgages, predatory lending, overbuilding during the house boom period, high levels of corporate and personal debts, borrowers overextending and lack of government regulation on the financial markets. However, two major causes of the financial crisis are predatory lending practices by mortgage brokers and influx of money in the mortgage bond market from banks and private sector. The financial crisis was preceded by prolonged and stable financial state, strong global growth and growing capital flows. This made many market participants to seek for higher yields without considering or fully appreciating the risks which could arise. As such, investors were careless or did not take proper precautionary measures to hedge themselves in cases of eventualities. This period was also characterized by weak underwriting standards, financial products that were complex and opaque, unsound practices of risk management and an excessive leverage which created weaknesses and vulnerabilities in the whole system. Regulators, supervisors and policy makers in most advanced countries failed to appreciate the risks that were evidently building up in the vulnerable financial markets. They also did not keep pace with the ongoing financial innovation and they failed to notice the systematic ramifications which were occurring in the domestic regulatory actions.

The housing boom which had persisted in the United States from the year 1994 to the year 2006 had encouraged investors to enter the mortgage bond market. Between the year 1997 and 2006, housing prices had increased by over 120 which attracted foreign investors to the country. The continued trend of increasing housing prices made investors to take risky mortgage agreements such as the adjustable rate mortgages. These terms of agreement are also major contributors of the current global debt crisis. More loans were offered to high risk borrowers at adjustable rates. The borrowers believed that the loan could be repaid back as the housing prices increased. Decrease in prices of homes towards the year 2007 however led to automatic adjustment of the loans in an upward direction. Loans became more costly than the houses leading to foreclosure and an increase in default rates. The investors were afraid and anxious of the falling housing prices opting for foreclosure to cut down losses.

Various steps aimed at addressing the current global debt crisis have been taken by the United States central bank, the Federal Reserve and other central banks from different countries. The Federal Reserve has put in place efforts to aid and support the function of market liquidity as well as monetary policies for pursuing macro-economic objectives. To do this, the federal reserve has partnered with other central banks and undertaken open market operations to make sure that the liquidity of member banks is maintained at all times. Member banks are given short term loans which are collateralized by their governments securities. The interest rates (also known as discount rates in the United States) charged on these loans has also been lowered by these central banks.

Several lending facilities have also been created to enable the Federal Reserve lend directly to non-bank institutions as well as banks against some types of collateral which has varying credit quality. These include team assets loan facility and term auction facility. The term auction facility is a program in the US which enables the Federal Reserve to auction funds of certain amounts to depository institutions against several collaterals. With an aim of increasing the dollar liquidity in the world, the federal reserve coordinated with central banks to enable them lend simultaneously to institutions (depository in nature) that are outside the feds jurisdiction and those which it could not previously lend to directly.

The United States government also passed an act known as the emergence economic stabilization in the year 2008 which contained a 700 billion for funding a program known as troubled assets relief program. This program was used to give banks loans in exchange with divided preferred stock. There are other initiatives that various governments and central banks have undertaken to correct the debt crisis. They include, purchasing some collapsing financial institutions with an aim of recusant mortgage loans, creating various lending facilities and giving economic stimulus to individuals and financial institutions so as to increase investment.

While the above steps are viable for reliving the debt crisis in the world, they may also have negative impact especially in the US. Use of debt to finance the global crisis would increase the national deficit to a level that could not be sustained in the future. The efforts of the federal government to aid the global financial system is only leading to new and significant financial commitments which are either in form of loans, loan guarantees and investment. This does not amount to direct expenditure which can only help improve the economy hence the strategies may not aid the recovery of the US economy.

Conclusion
The current global financial crisis has been staggering. Cost of global economy is exceeding trillions of US dollars and various institutions have succumbed to its forces. The underlying forces are still being studied and they have revealed that regulatory controls and existing compliance are inadequate. Though several initiatives have been undertaken by governments, more needs to be done to correct the situation and to ensure that such a crisis does not occur in the future.