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The Global Financial Crisis – The Case for UK

 

Introduction

The global financial crisis from 2008 to 2009 recently is a serious financial meltdown causing the Great Recession around the world – and its impacts are particularly negatively felt by the developed countries in the West. In this report, the various challenges due to the financial crisis will faced by the UK government will be discussed, and the impacts due to such a crisis to the UK economy and financial landscape will also be discussed.

 

Purpose of the Study and its Rationales

The recent financial crisis is a changing the economic and business nature of the world and it impacts are felt by governments, businesses and people around the world. The financial crisis is not something to be ignored by people around the world, as the impacts and the consequences are significantly affecting almost everyone around the world directly or indirectly. For this, business people, investors, economists or government around the world should and indeed have strong interests in understanding the root causes and the effects of this financial crisis. By having comprehensive understanding on the crisis, it is then only possible that people can incorporate the effects and possibilities of financial crisis in the future in their decision making process. Government or central banks around the world have huge responsibilities in this context, where they should aggressively understand the root cause causing such a financial or economic disaster to implement relevant regulations or policies in preventing any crisis from happening in the future. Perhaps, with better understanding on the nature of such financial crisis, the central banks can mitigate the negative impacts due to the financial crisis, even if the financial crisis is hardly predictable or cannot be prevented. There are two objectives in this report. Firstly, this report aims to investigate the methods and approaches in which the UK government handles the challenges presented by the global financial crisis. Secondly, this report will investigate the impacts due to this financial crisis towards the UK economy and financial landscape.

 

Background

Starting from the year 2007, the economic and financial landscape around the world has been facing turbulent changes. The financial crisis started when the investment banks in US, greedily packaged the subprime mortgage to be sold to other investors around the world. The subprime mortgages, which are highly risky, are re-packaged into various tranches with AAA credit rating (but in fact that the riskiness of these assets remain). However, regulatory agencies and credit rating agencies do not exercise their responsibilities in overseeing such an act. Eventually, the re-packaged mortgage backed securities are sold to the public, hedge fund, banks and etc around the world. Most of the purchasers of such kind of assets are from the Western countries. In the year 2008, things started to change. The mortgage borrowers are not able to repay the debt, as the pricing or house or real estate started to fall. Many of the borrowers default – essentially triggering the collapse of the housing bubble and holders of the mortgage backed securities see the value of these securities drop significantly. Banks suffer huge losses and the economy crisis or bubble burst.

 

UK Government in Handling the Challenges from Financial Crisis

As the bubble burst, the economy suddenly comes to a halt – where liquidity crisis and credit crunch happens. Bank run is about to happen, and both consumers and business confidence level drop significantly. In other words, banks starts not to trust others banks or corporation or households and stop lending. This significantly reduces the money supply in the economy significantly. The reduction of money supply and the negative feedback loop, if not being tackled, will cause great recession or even prolonged depression in the country.

Facing the biggest burst of bubble since the Great Depression, the UK government and Central Bank relied on the lessons and arguments presented by John Maynard Keynes in the 1930s. As a result, the Central Bank of UK implements an expansionary monetary policy immediately. The money supply in the country is increased – while at the similar time, the country finance large-scale government spending by borrowing. The Central Banks reduce the interest rate buy buying up short term Treasury bonds, to induce the banks to lend more to the marketplace – in order to prevent liquidity crisis from happening. The Central Bank of UK even implements more aggressive monetary policy – which is called ‘quantitative easing’.

Apart from that, bail-out from government is also implemented. Firstly, the government bailed out the beleaguered banking sector around January 2009, and then the government eventually also provided the state support to the automotive industry. In the bail-out package, the package includes a state-backed insurance scheme for tax payers to underwrite an indeterminate amount of UK banks’ toxic assets, as well as a whopping US50bn fund to finance the quantitative easing by the Bank of England.

 

Impacts of the Financial Crisis to UK

Due to the crisis, many damages have been done. The stock market plunged significantly and the house prices drop. The consumer confidence drops as well. People no longer spent as much and they start saving. This has exerted a deflationary pressure in the country. Perhaps the worst affected economic section is the housing market. The entire housing market has been under immense financial strain since the credit crunch. Mortgage availability is reduced – and this had negatively influencing the first time buyer of mortgage (Elphicke, 2010). Not only that, besides the share prices in the most exposed (to toxic assets such as CMO, CDO and etc.) banks in UK plummeted, the sterling also suffered badly – primarily due to the concerns about the contagion between the banks and the deteriorating economy. People have concerns if any future bail-out will be required, and of the government able to afford to a bail-out without causing the depreciation of the sterling anymore (Giles, 2008).

One of the obvious impacts of the financial crisis is that the UK government is currently running huge budget deficits, due to the money and capital spent in bailing out the various banks or investment banking-related entities. As the budget deficit and the degree of increase of the government debt are catching the public eyes, there have been greater concerns to reduce the government debt. Austerity in the budget is being planned. It is argued that debt reduction is needed, so that the younger generations will not have to bear the burden of current debts, as well as a preparation for the future financial crisis. Government is practicing great caution is exercising any fiscal stimulus in the future to avoid being overly burden with debt in the future (Pimlott, 2010).

Besides, as the crisis has caused great damages to the country, the government is also implementing many changes in the rules and regulations in governing the financial services sector in the nation. The UK Financial Services Act 2010 is also established. To explain, the Financial Services Act 2010 is a legislative response by the government to significantly reform and enhance the financial regulation. It aims to amend the Financial Services and Markets Act 2000 in order to provide the UK Financial Services Authority new objectives and duties. Not only that, there are also plans to create a Financial Policy Committee by the government, which will be given the responsibilities to prevent asset bubbles and managing systemic risk in UK (Masters, 2010). This committee is formed in order to prevent a repetition of the financial crisis where many banks require government rescue – specifically, to prevent a dangerous build up of debt in both households and the banking sector.

The public is also becoming angry with the irresponsible investment banking businesses and management. The critiques against moral hazard are wide spread. The entire financial industry is frequently blamed for providing lavish bonuses and compensation to the top management in the various banks (Murphy, 2010). A recent survey has also found that the various investment banks in the country are also using lesser ‘guaranteed’ pay packages to attract new talents, while at the same time has abolished controversial ‘multiyear’ guarantees – after politicians and regulators constant open critique on the size of bonuses awarded to the top management (Murphy, 2010). Apparently, the rewards or compensation for the employees in the financial services sector is reduced as compared to the years before the bubble burst. In UK specifically, the workers in the financial sector are now subjected to stricter remuneration regime in the world, where as much as 60% of bonus payments are deferred over several years in the future.

Nonetheless, the economy in UK is recovering. However, according to Kirby and Barrell (2010), the UK economy is expected to recover more gradually this recession as retrenchment in government and household sectors are happening in this Great Recession. Besides, due to continuing weaknesses in private sector investment caused by the financial crisis, the economy is undergoing heavy recovery process. The situation is not expected to change fast particularly the unemployment in the Western country, UK included, is still high.

 

Conclusion

Overall, we have discussed the recent financial crisis in the report presented above. The financial crisis started out in US and soon proliferated to other places around the world – which is frequently named as the contagion effect by the economists. The banks and public in UK and Europe are also badly hurt, as many of them have direct or indirect holdings on the toxic assets. In fact, the investment banking and banks in UK and Europe have been also practicing such kind of irresponsible acts of repackaging subprime mortgage backed securities into various tranches – some of the with AAA credit rating. The public and the purchasers of these securities are largely unaware of the high risk involved.

Once the bubble burst, the Central Bank – namely the Bank of England as well as the government had implemented drastic strategies and policy to avoid the nation’s economy to turn into a serious depression. Particularly, the Bank of England has been implementing expansionary monetary policy to increase the money supply in the country. Not only that, the Bank of England had also provided much bail out and guarantees as well as assistance to the problematic banks. The government has also spending huge amount of money to increase the aggregate demand of the economy – and at the same time try various policies to maintain the confidence level of public on the economy and the banking system in the nation.

The financial crisis, undeniably, has done many damages to the economy. The impacts due to the financial crisis include the fall of assets prices, particularly on the share prices of those banks that are being affected by the subprime mortgages. Not only that, the UK government is also running a high budget deficit and government debt had increased tremendously. This force the government to revert to fiscal austerity after the recession is over. The negative effects are largely long lasting – even until today, the sterling has still never returned to its previous level and the consumer confidence in the country remains weak. Unemployment is still staying at a high level. However, there are some good impacts due to the crisis as well. The government is now focusing on implementing policies and regulation o govern the financial sector in a more prudent manner.

 

Areas or Topics for Future Research

Many areas of research related to the topic above should also be researched. In the future, a research on the boom-bust model of the formation of financial bubble that will eventually leads to financial crisis should be researched. Apparently, most of the financial crisis has some characteristics that can be observed by the discern investors, businessmen or government authorities. Not only that, another areas deserve our attention is the corporate governance issues particularly in the financial services sector in the country. Moral hazard is obviously detrimental to the health of a society. Without proper rules and regulation or practices overseeing the financial and banking entities, it is pretty certain that similar financial crisis will be recurring in the future.

 

References

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Daniel Pimlott.  (2010, July 28). Austerity Budget unlikely to trigger recession. Financial Times,3.

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