The Global Financial Crisis and the Imf

Table of Contents 1. 0 Objectives2 2. 0 Introduction2 3. 0 Types of pecuniary Crisis2 3. 0. 1 Banking Crisis2 3. 0. 2 Speculative Bubble3 3. 0. 3 International Crisis3 4. 0 Causes of the fiscal Crisis 2007-20083 4. 0. 1 Loose Monetary Policy. 3 4. 0. 2 Global Im respites. 4 4. 0. 3 reliance Boom. 5 4. 0. 4 Asset Bubble. 5 4. 0. 5 fiscal Innovation5 5. 0 encounter of pecuniary Crisis6 5. 0. 1 Impact to U. S monetary System. 6 5. 0. 2 stinting Growth Rates. 6 5. 0. 3 Personal Finances of US Citizens. 7 5. 0. 4 High Unemployment Rate. 5. 0. 5 Impact on the IMF9 6. 0 Policy reaction9 6. 0. 1 Term auction bridge Facility (TAF). 9 6. 0. 2 Economic stimulant Act 2008. 10 6. 0. 3 Initial Cuts in Interest Rate. 11 7. 0 IMF Response to the Crisis12 8. 0 Conclusion14 9. 0 References15 1. 0 Objectives Objective of this topic is to giving a s act just about the recent global fiscal crisis 2007 which discussing about the causes and impacts of the crisis and bursting charge mainly in th e unite States. Then, it testament focus on the insurance chemical reaction of the country towards the crisis.Role of the International Monetary Fund (IMF) is in any case precondition attention to understand how it clobbers as the international lender of ut closely resort. 2. 0 Introduction pecuniary institutions which play an important business office in the economy, act as in depotediaries between borrowers and lenders. Channelling of funds to individuals or sign of the zodiac that hand over bright investment opportunities experiences place in the fiscal grocery stores. Without pecuniary intermediaries, it is difficult for companies to ope set business. The economy also brush aside non ope tramp efficiently if the monetary system does not perform the role swell up. dictatorial put on the diffusion channel is a risk that could be ill fortunes of monetary institution that freezing up peachy market and eveningtually slues the supply of capital to the economy . The unify States experienced this systematic failure during 2007 and continues to struggle its consequences until 2009. Financial crisis overhaul when an economic encounter recession or depression caused by lack of liquid state in monetary institution. In this circumstances, financial institutions lose immense part of their note value. Financial crisis is not the resembling as economic crisis which necessitate the accurate economy.A financial crisis can occur in a single sector and not always affect different sectors. The causes of financial crisis be different with the type of crisis. The financial crisis 2007-2008 started in August 2007 as a subprime mortgage crisis concentrated in the get unitedly States. The crisis became global but originally started in the financial sector of the unify States and soon became global economic crisis. Mostly economies in the world were abnormal by this crisis because the United States economy can be thought as powerful economy in the world. 3. 0 Types of Financial Crisis . 0. 1 Banking Crisis Banks normally function by providing deposit accounts to quite a little who want to make nest egg and it can be withdraw anytime. The depones then use these deposits to make contributes and charge kindle to borrower which are paid over a long peak of time. If all the depositors want to withdraw money at one time, the banks will face lack of cash f low-down and will be bankrupt. This perspective is called banking crisis. 3. 0. 2 Speculative Bubble Some large number buy rakehell by speculating the price, hoping that price of the root will profit in the prox.Therefore, if most investor buy melody speculatively, chances that the stock price will increase are be very noble. When all the investors want to sell at the kindred time, then the price will likely to fall. When price of a stock is much than its certain price plus dividends and interest, then the stock is utter to show a emit. 3. 0. 3 Internati onal Crisis This crisis occurs when a country is force to devalue its currency. This can happen either because of speculative attack or a country is default in paying its debt. When this occurs, all countries that were calling with this country will be alter.Investors also will lose the value of their investment because the currency has been devalued to lower rate. 4. 0 Causes of the Financial Crisis 2007-2008 4. 0. 1 Loose Monetary Policy. Monetary constitution implemented by the federal official official Reserve plays an important role in determining the interest rate. It is believed that soft or weak monetary constitution implemented by the U. S Federal Reserve is among the cause to the crisis. After the internet or dotcom bubble in 2000, loose monetary policy is applied by the U. S Federal Reserve. The federal funds rate dropped from 5. 8% in January 2001 to 1. 73% in January 2002 and remained low for several forms as shown in map 1. This policy thus encourage U. S consu mption, reduced scrimpings and created high current account deficit. The Federal Reserve had made mistake by its decision to keep the federal funds rate too low for too long. The policy therefore responsible for creating the credence boom and hold bubble. In other words, with a low federal funds target, banks take advantage on cheap funding and made cheap loans available. From year 2000 to 2006, total debt outstanding for the U.S has increase by $13. 5 trillion. The debt to gross domestic crossing proportion is increased to 350%. This high level of debt made firms and theater of operationsholds more exposed to unfavorable economic shock. some other than that, the Federal Reserve and regulators made mistake in the failure to control the poor underwriting standards in the mortgage markets. The poor underwriting practices can be seen done no down fees, no verification of income, addition and occupation by borrowers. Credit that was widely available suggested poorer loan qual ity. chart 1 Loose monetary policy Source Adapted from The EconomistChart 1 shows that the actual interest rate brutal below the Taylor rule, that is the interest rate what historical experience suggest policy should be adapted. The run along of business loaded downward to 1 percent in 2003 to 2004 and then rises until 2006. The Taylor rule line shows what interest rate would make believe be if the Fed followed the policy that worked well since the archean 1980. 4. 0. 2 Global Imbalances. The recent financial crisis happens when there is a great deal liquidity in world capital markets. It is ascribable to the large payment imbalances between the main countries and regions in the world economy.Global imbalances occur when there is huge and continuing current account deficit in the United States. The current account deficit is financed by plenty of flows of capital from emerging and fossil anoint exporting countries. As the consequences, the global imbalances encourage fin ancial natural process that would not be good in long time without the development of thick-skulled global financial markets. High levels of global liquidity happens when countries such(prenominal) as China built up current account surpluses and foreign central supports, maintaining artificially low exchange judge and a positive saving investment balance.Because of this liquidity level, global real interest judge fell which contributed to credit expansion and rising plus prices that drives to the crisis. 4. 0. 3 Credit Boom. Credit boom happens when banks and mortgage brokers encouraged mortgage gross sales because they realise fees in proportion to the volume of mortgages they wrote. Banks earned large fees by securitizing mortgages, selling them to capital markets in forms of mortgage backed securities (MBS) and collateral debt obligations (CDO). Since banks distributed these mortgages to capital markets as asset backed securities, it has low risk upon the process.Compared to corporate bonds that had low interest rate during the time, these complex and risky crossings is highly demanded by institutional investors such as hedge fund and insurance companies. Mortgage sales expanded even to those who could not afford them as the banks only focused on earned large fees. When the housing price bubble evaporated or interest evaluate rose it turned out to be large defaults. Home sales peaked in late 2005 meanwhile home construction pass and housing prices crepuscule in early 2006. When the subprime mortgage crisis started in 2007, the entire market began to collapse.The crisis began in the United States, but because the mortgage based financial products has been dish out around the world it soon became global financial crisis. 4. 0. 4 Asset Bubble. Another factor to the financial crisis is an asset bubble that leads to unsustainable leverage. before the start of the crisis, the U. S governing implemented a public policy that encourages homeownership. Because of low interest rate, it has led to mortgage add and domiciliateholds were encouraged by the banks to borrow causing asset (house) price to increase.The borrowing is allowed up to the all-encompassing value of their property with little regard to their ability to service the debt. adoption is encouraged because of the low interest rate made by monetary policy makers. The demand for housing is cerebrate to money market interest rates. Thus, the accommodative policy conducted by the Federal Reserve contributed to the build up of housing demand and asset prices. The term sub-prime mortgage come when modify activities is also approved to people who did not meet the credit requirements that whitethorn default to payments. 4. 0. 5 Financial Innovation.Usually, banks and other agents innovate to avoid order and boost returns by taking greater risks. When asset prices increase more rapidly, initiation also accelerates as expected gains grow bigger. The main innovation is th e process of securitization. This complex securitized pools of loans promising high returns with low risk. Thus, in the United States, ballooning mortgage loans to riskier borrowers pop the questiond the basis for an ever-larger inverted pyramid of structured products. As the housing prices increasing, lenders provide mortgage lending easily.However the mortgage were securitised, that is repackaged and exchange as financial instruments to investors for immediate cash. This led to excessive and irresponsible mortgage lending. The institutions that originated the mortgages such as commercial banks, savings and loans eventually did not holding the mortgages because it has been sold to investors by the investment banks. This innovation has caused massive distortions in incentives and risk trouble in the financial organizations. It was an instrumental in lace the increase in leverage.Starting in 2003, banks involve rapidly in backing activities, investments and hedging operations th at hard to assess risks. When asset prices began to fall, financial organization brought down together and spread panic among investors worldwide. This development has caused massive distortions in incentives and risk solicitude arrangements within financial organizations. 5. 0 Impact of Financial Crisis 5. 0. 1 Impact to U. S Financial System. The U. S government has closed 22 banks including Lehman Brothers, majuscule Mutual and Indymac.Other than that, it has rescued Freddie Mac, Fannie Mae, Bear Stearns and created a bailout fund around $700 one thousand thousand to purchase stakes in effected banks. This step is taken in order to restore confidence in the financial markets. However, this $700 billion r crude fossil oily Asset Relief Programme (TARP) failed to restore market confidence. Nearly $8. 5 trillion or around 60% of its gross domestic product has been committed by the U. S government to proscribe the collapse of its financial system. 5. 0. 2 Economic Growth Rates. The effect of 2007 crisis can be seen all the way on the downturn economic ontogenesis globally.As shown in Figure 1, countries in the world are experiencing a downturn in economic activity as the effect of financial crisis. These declines in economic activity get been followed by losses of trillions of dollars in equity markets and a credit grind that are affecting households and businesses worldwide. Financing activities such as world heap and oil exploration has been slow during the time of crisis. As shown in chart 2 below, real forget rate measured by GDP across the world has been decreased. Real growth rate in report by the World Bank is 3. 9% in 2007 dropped to 1. 3% in 2008.As the crisis became worsen, economic growth dropped much lower rate to -2. 2% in 2009. The U. S economy has a large proportion in world economy therefore it has slightly similar trend in the growth rate. The U. S real growth rate in 2007 is 1. 9% dropped to -0. 4% and -3. 5% in 2008 and 2009 resp ectively. Chart 2 GDP real growth rate (%) Source Adapted from World Bank data 5. 0. 3 Personal Finances of US Citizens. People lease struggled to repay their debts as the direct consequences of the financial practices that produced the crisis. The value of house dropped dramatically for individuals who owned house before the crisis broke out.This caused some people repaying mortgages that are worth more than the current value of their house. Eventually, many another(prenominal) people ended up losing the house that they bought in years before the crisis broke out. There were high rates of foreclosure in some area of the United States as borrowers cannot repay the loans. Other than that, individuals in the US also suffered from the loss of growth and income that their savings and investments would rescue produced. This is because interest rates for savings have dropped sharply. Investors and companies experiencing losses as the stock in many companies dropping rapidly.Retirement plans that are usually based on mutual funds and performance of the stock market results not as they had planned as the stock market crashed. They may need to work longer or retirement plans is less than expected before. Moreover, it has become more difficult to borrow money. While expensive loan services have been expanded, people find it hard to obtain low cost loans or credit cards. 5. 0. 4 High Unemployment Rate. The US gross domestic product which is the total amount of goods and services produced by the country was reduced as the effect of the crisis.Companies in the country struggled to cope with the crisis, however lots of people have lost their jobs. Based on chart 3, the uneployment rate grew from 4. 7% in 2006 to 10% in 2010 which was the highest rate in the last some decades. In addition to lose income, unemployment made it worse for many people because it has become difficult to find new job. Many companies are not willing to hire new employer and even a fresh graduat es have to compete to find employment. This become a serious problem for many young citizens in the country. Chart 3 Unemployment rate in the US SourceAdapted from U.S. Bureau of Labor Statistics 5. 0. 5 Impact on the IMF The damage caused by the financial crisis is a challenge for the IMF. This is because, its financial resource is not in line with the global economy over the other(prenominal) decade. The United States and other advanced industrial economies are at the core group of the crisis. However, the IMF would not have enough resources to provide financial assistance if these countries desire for process. Therefore, the IMF resources need to be increase or the risk would become worse in the future. 6. 0 Policy Response 6. 0. 1 Term sell Facility (TAF).The Term Auction Facility is introduced in December 2007 so that banks can borrow from the Fed easily. Thus the banks can bid immediately for funds from the Fed. This is because investors are not willing to lend when afr aid about the condition of many financial institutions stirred by the crisis. Consequently bank funding markets were put under severe pressure. The main objective of the TAF was to reduce the spreads in the money markets and in that way increase the flow of credit and lower interest rates. As a result, the TAF helped by encouraging the distribution of liquidity when bank funding markets were under stress.The spread between the capital of the United Kingdom interbank offered rate (Libor) and the overnight indexed swap (OIS) for loans of one-month maturity or longer increased to unusually high levels in the late 2007. It is believed that the increase in the LiborOIS spread is caused by the heightened risk perceived by investors at the time. Since Libor affects interest rates on a wide variety of loans and securities (for example, home mortgages and corporate loans), the sharp spike in the spread was disruptive to the debt market and negatively affected the economy.The chart 4 and th e table below also showed six announcements related to the TAF program. Chart 4 The TAF facility provided term funding through day-after-day auctions to eligible depository institutions. By providing term funds to banks at on a regular basis scheduled auctions, the TAF may have assured lenders of continued access to future funding and thereby reduced their uncertainty regarding anticipated funding needs. The TAF was a facility designed by the Federal Reserve during the crisis to improve liquidity conditions in various asset markets that is crucial to improve short term funding market. . 0. 2 Economic Stimulus Act 2008. The Economic Stimulus Act 2008 is a response made by the government through several package totalling over $100 billion to individuals and families in the United States. The economic stimulus is designed to boost the U. S economy and bar further recession. In this programme, the government provide tax rebates to low and heart and soul income taxpayers and tax incen tives to stimulate business investment. The purpose of the incentives is that the people will have more money to lead thus increase consumption and the economy.By doing so, the government would expect that it will recover the economy. However it is not as hoped because they spend little although the incentives were given. This can be shown through chart 5. The top line shows personal disposable income increased at the time of rebate. However, the lower line shows consumption did not increase as expected. Chart 5 cast up in income 6. 0. 3 Initial Cuts in Interest Rate. The third policy response to the crisis is sharp reduction in the federal funds rate. When the crisis began in August 2007, the rate was 5. 25% and went down to 2% in April 2008 due to the cut.The lower interest rate then reduced the size of adjustable rate mortgage that was cause of the crisis. The most significant effect of this response is the depreciation of dollar and rise in oil price. In the early 2008, oil pr ice increased almost two fold from $70 per barrel in 2007 to over $140 per barrel. High oil price hit the economy as gasoline price increased dramatically and automobile sales plunged. On the other side, the policy reduction in the federal funds rate that cuts interest rate helped raise oil and other commodity prices thus prolonged the crisis. Exchange rate also has influence to the rise of oil price.As shown in chart 6, reduction of the federal funds rate at top line in July 2007 drives the oil price at the bottom line upward until July 2008. Chart 6 Cut in interest rate and increase in oil price 7. 0 IMF Response to the Crisis The main role of the IMF is to identify the risks that be global economic and financial stability and to develop policy responses. The IMF has a worldwide membership and its mandate is to promote economic and financial stability. It is has been provide forum for discussion of international economic issues and help to reach dissolvent on policy responses.I n response to the financial crisis, the IMF boosted their lending to developing countries to help them cope with the crisis and to sustain the economic recovery. To meet ever increasing financing needs of countries hit by the global financial crisis and help strengthen global economic and financial stability, the Fund has greatly expanding its lending subject since the start of the global crisis. It has done so both by obtaining commitments to increase quota subscriptions of member countries and securing large temporary borrowing agreements from member countries, including recent pledges of $456 billion.Countries affected by the crisis can borrow funds from the IMF. Other than that, there is also debate about reforming the IMF. The reformation issues focus on the need to balance the traditional functions of providing short-term financial assistance and promoting external balance stability in member countries. To achieve the objective, there is a need for a wider responsibility of c risis prevention, supporting financially for countries that, although not suffering actual reserve shortage, are in danger of external shocks and liquidity runs. This measure would prevent more severe impact to member countries as the effect of financial crisis.Since year 2008, the Fund has introduced effective instruments to prevent sudden falls in investors trust and the eruption of liquidity crises. As a result, borrowers were able to cope with the global crisis, avoiding large scale banking crises and disruptive exchange rate movements and defend social spending. To prevent the crisis, the IMF has lending arrangements signed by the IMF and low and middle-income countries during the crisis. These lending arrangements take part from January 2008 and June 2010. The size of the loan arranged by the IMF is larger for country that is more exposed to the crisis especially for large country.As a result this measure can prevent more severe contagion of the crisis to other countries. 8. 0 Conclusion The U. S. economy has suffered a few major shocks in recent years during the crisis. At the start, these shocks include a large declining in house prices and a spike in the prices of oil and other commodities. The decline in house prices reduced the value of mortgage backed securities. Because of leverage, this endanger the ability of many of financial institutions, including major investment banks. These shocks have have to put the U. S. conomy and many economies throughout the world into a global financial crisis and a deep recession. It is likely the worse since the Great Depression in 1930sRegulatory failure is a main responsibility for the crisis. It is shown that weak regulatory in the financial system leaving the consumers inadequately protected. To cope with this crisis, the IMF had played an effective role. It has come out with a financial assistance by providing loan arrangements to the member countries. 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