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Corporate Financial Management

Global Financial Market

The global economy is massive and it is growing. Global financial system helps to boost economic growth. The global financial system is huge. It includes various types of financial institutions, as well as financial markets in stocks, bonds, commodities, and derivatives. Global financial system enhances economic growth by creating money, facilitating specialization and promoting trade (Alexakis et al., 2019). It also facilitates risk management, enabling individuals and firms to be insured against adversity in bad states of the world. Thus, it increases investment and global economic growth. It mobilizes resources globally and further improving the effectiveness with which local challenges are met.

The global financial system is highly interconnected. This interconnectedness rises its complexity and the need for international harmonization of regulation. Firms use the global financial markets to raise capital (Sathye, 2020). The depth and liquidity of the global financial markets help companies reduce their capital costs and also improves the access to financing, invest more, and grow.

The global financial market leads to global trade through the help of financing mechanisms outside the banking system, for example, trade credit. Large projects, including those for infrastructure, are often financed through private-public partnerships involving project financing. Banks as well as financial markets are regulated, and in both cases regulators face tensions in enforcing regulations that pull in opposite directions (Gasbarro et al., 2020). Regulatory actions to achieve financial stability in the face of these tensions lead to greater interconnectedness in the financial system.

Bank regulation has multiple goals, and it is being increasingly harmonized, but the danger is that regulation may go too far. Finally, market-based financing, commonly know as shadow banking—financial intermediaries other than commercial banks (e.g., mutual funds, investment banks, and hedge funds)—is growing more rapidly than traditional banking.

Global Financial Crisis

Global financial crisis refers to the crisis that affects everyone all over the world. It has its impact on many countries at a particular period of time. It is that period of time where everyone experiences severe difficulties and hardships, including commercial banks, financial institutions, companies, industries and even consumers (Gülşen & Özmen, 2020). There was extreme stress

in the global financial markets during the period of mid 2007 and early 2009. This was considered as one of the most severe crisis, after the Great Depression of 1930s. This period is associated with the period of downturn in housing markets of United States. As the global financial market is defined by its interconnectedness, this interconnectedness lead to the affect of this downturn to all over the world. The downturn of US housing market was the catalyst of global financial crisis. Due to the linkages of global financial market, this spread from the United States to the rest of the world.

The start of the crisis is linked to the depreciation in the sub prime mortgage market in the United States (Lane & Milesi-Ferretti, 2018). This was followed with the international financial crisis when the investment bank Lehman Brothers collapsed. These brothers took huge risk, thus impacting at the global level. There were great bail outs and many fiscal policies and monetary policies used to prevent the international financial crisis. But, the crisis ultimately lead to global financial crisis. This immediately impacted the Asian markets, that is, China, India, Japan etc.

Sub Prime Mortgage Crisis

The reason for this crisis was the bubble created in the housing market in United States. After the collapse of this bubble in the housing market, there was a huge decline in the prices of houses. This lead to mortgage delinquencies and the devaluation of the entire house related securities. This sub prime mortgage crisis was ahead the financial crisis in the world (McDowell, 2019). This crisis was due to the banks when they sold quite many mortgages to cater the demand for mortgage-backed securities that was sold with the help of secondary market. What basically triggered default was the fall in house prices (Theodore, 2020). And the risk was all over spread to the owner of these derivatives like mutual funds, pension funds and corporations. The banking crisis of 2007 and the global financial crisis of 2008 lead to the great recession in the world after the great depression of 1930s.

The causes of sub prime mortgage crisis are many. But many people blame different levels to different bodies like to financial institutions, government housing policies, agents or consumers. The first reason was the increase in sub prime lending. The other reason is the rise in housing speculation. The percentage of lower quality sub prime mortgages were rising during this period and there were higher ration observed in many parts of United States. The investors with high credit ratings were also more likely to default. There was a steep rise in the ratio of household debt to disposable personal income.

When there was fall in the housing prices in United States, the borrower tried to refinance their loans. But it became quite difficult and the mortgages rate began to revise and with higher interest rates. The securities which were backed with mortgages or even sub prime mortgages, that was greatly held by the financial firms all over the world lost their value. Also, now suddenly the global investors stopped purchasing mortgage backed debt due to lack in the willingness and capacity of the private financial system to support lending (Mehdian et al., 2019). When these concerns were spread all over the world, there was tightening of credit all over the world and thus the economic growth slowed down.

Causes Of The Global Financial Crisis

There are many factors which contributed towards the international financial crisis and people are still debating over the specific reason.

Before the years of the global financial crisis, the situation and the health of the economies were quite favourable. The economic growth was stable and strong. The rate of interests were low and the unemployment rate was also not high. Even the rate of inflation was low. These all lead to the increase in the house prices in United States. The expectations that the house prices will continue to rise in the future, lead to the more borrowings for purchasing and building the house in the United States. Even in the European countries, property developers started borrowings to build houses (Fratzscher, 2012).

The banks were ready to provide the loans even if the risk was too high. This was due to the increased competition between the lenders and at that time, it seemed profitable for the lenders to provide loans as the market was stable and the economic environment was good. Thus, the cause was that excessive risk was taken after noticing favourable economic environment.

The another cause of the global financial crisis was the excessive borrowing by banks and other financial institutions. At that time, it seemed profitable for the banks to lend. Therefore, to cater the needs, they started borrowing and purchased mortgage backed securities. Although, it was an asset for the banks but it could also lead to potential losses (Arrieta-Paredes et al., 2020). As, the housing prices fell, banks and financial institutions all over the world faced huge losses as a result of large borrowings. Even after that, they started borrowing for short term period which worsened their conditions.

Also, the error was in the regulation of the mortgage backed securities. It was too lax. The regulation of the institutions who sold mortgage backed securities were insufficient. They sold the complex and very opaque mortgage backed securities to investors. Even after the global financial crisis got over, the institutions could not find out the bad loans which were given to the investors during the boom period. They were unable to find the extend to which these loans were given to the investors (Balakrishnan et al., 2016). They could not find the many ways through which the mortgage losses were spreading all over the world.

Yield Curves

Yield curve defines the relationship between the yield (interest rates) of bonds which have equal credit quality with different maturity rates. The slope of the yield curve tells us the situation of future economic activity and the change in the interest rates. The maturity rate tells us the term of the debt which is given to the borrower.

Generally, the yield curve is upward sloping. This means that as the maturity rate increases, more interest rates are charged. But, this marginal increase is diminishing (Demirgüç-Kunt et al., 2020). The slope of the yield curve is a very powerful predictor of the future economic growth and the business cycle.

Importance of Inverted Yield Curve

Inverted yield curve is observed when long term yield falls below short term yields. This is the case when investors are ready to accept lower yields for long term debt of low risk because they think that the economy is going to enter in recession in the near future (DesJardine et al., 2019).

The inverted yield curve is treated as an indicator for the economic recession. When the short term yields are more than long term yields, it is believed that the market is going in recession and the long term look is poor. It is also expected that the yields of long term fixed income shall continue to fall.

It is believed that the yield curve is seen as a way to forecast the turning point of the business cycle (Moosa, 2020). Alternatively, the yield curve is basically the expectations by the investors of the future interest rates and their preferences of liquidity.

It has been seen that, the yield curve has been inverted before any recession in the United States. The inverted yield curve shows that the people predict that the short term interest rates will fall in the future. Thus, in reality the interest rates start falling and therefore, inverted yield curves are followed by recessions.

Consequences of Global Financial Crisis

There was an increase in the non repayment of loans by the borrowers after the fall in the price of houses in the United States. It was difficult for the borrowers to repay the amount as the price of houses fell too low. Thus, the number of failures rose during this period (Crotty, 2009).

Also, after this fall in the price of houses in the United States, there were fall in the purchase of mortgage backed securities by the investors. This led to the fall in the prices of the mortgage backed securities.

This problem in the United States were spread all over the world. This was due to the interconnectivity of the countries in the global financial system. Many foreign banks were also dealing with the United States housing market (Arnold, 2009). Also, United States’ banks have many operations in other countries' banks. Therefore, there was a spillover effect.

During this time, the financial institution like Lehman Brothers also failed along with other institutions. This created a panic in the global financial market. Lenders were not willing to give and the investors were taking out their money. An environment of fear was created. As a result, many countries including United States fell in deepest recessions.

How Was Australia Affected?

Australia had a relatively strong economy and it showed strong economic performance during this period of crisis. Although, there was a break in the economic growth, the unemployment has also risen along with the increased uncertainty but Australia didn’t notice a large downturn due to the global financial crisis. This was due to the small exposure of Australian banks to the US banks and also to the US housing market. Even sub prime loans held a small share of lending in

Australia. Besides, there was a large policy response introduced during this period so that the economy does not face downturn.

Repetition of Global Financial Crisis

According to my opinion, recessions are always coming and our in their way. In fact, the coming recession is more big and dangerous than the previous ones. Recently, the shape of yield curve of the United States was inverted which portrays the upcoming recession. There are many reasons for the financial crisis to occur again. Some of them are, moral failure, insufficient regulations, excessive risk taking by the institutions, ponzi schemes, rapid rise in debt, lower interest rates for prolonged period of time, fraud, economic shocks and many more.

References for Global Financial Crisis

Alexakis, C., Izzeldin, M., Johnes, J., & Pappas, V. (2019). Performance and productivity in Islamic and conventional banks: Evidence from the global financial crisis. Economic Modelling, 79, 1-14.

Arnold, P. J. (2009). Global financial crisis: The challenge to accounting research. Accounting, organizations and Society, 34(6-7), 803-809.

Arrieta-Paredes, M. P., Hallsworth, A. G., & Coca-Stefaniak, J. A. (2020). Small shop survival–The financial response to a global financial crisis. Journal of Retailing and Consumer Services, 53, 101984.

Balakrishnan, K., Watts, R., & Zuo, L. (2016). The effect of accounting conservatism on corporate investment during the global financial crisis. Journal of Business Finance & Accounting, 43(5-6), 513-542.

Crotty, J. (2009). Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’. Cambridge journal of economics, 33(4), 563-580.

Demirgüç-Kunt, A., Peria, M. S. M., & Tressel, T. (2020). The global financial crisis and the capital structure of firms: Was the impact more severe among SMEs and non-listed firms?. Journal of Corporate Finance, 60, 101514.

DesJardine, M., Bansal, P., & Yang, Y. (2019). Bouncing back: Building resilience through social and environmental practices in the context of the 2008 global financial crisis. Journal of Management, 45(4), 1434-1460.

Fratzscher, M. (2012). Capital flows, push versus pull factors and the global financial crisis. Journal of International Economics, 88(2), 341-356.

Gasbarro, D., Le, K. S., Schwebach, R. G., & Zumwalt, J. K. (2020). Market response to syndicated loan announcements from high‐profile failed and acquiring banks during the global financial crisis. Accounting & Finance, 60(1), 435-470.

Gülşen, E., & Özmen, E. (2020). Monetary policy trilemma, inflation targeting and global financial crisis. International Journal of Finance & Economics, 25(2), 286-296.

Lane, P. R., & Milesi-Ferretti, G. M. (2018). The external wealth of nations revisited: international financial integration in the aftermath of the global financial crisis. IMF Economic Review, 66(1), 189-222.

McDowell, D. (2019). Emergent international liquidity agreements: central bank cooperation after the global financial crisis. Journal of International Relations and Development, 22(2), 441-467.

Mehdian, S., Rezvanian, R., & Stoica, O. (2019). The Effect of the 2008 Global Financial Crisis on the Efficiency of Large US Commercial Banks. Review of Economic and Business Studies, 12(2), 11-27.

Moosa, I. (2020). Stock market contagion in the early stages of the global financial crisis: the experience of the GCC countries. International Journal of Banking and Finance, 7(1), 19-34.

Sathye, M. (2020). The Impact of the Global Financial Crisis on Australian Banking Efficiency. International Journal of Banking and Finance, 12(2), 1-22.

Theodore, N. (2020). Governing through austerity:(Il) logics of neoliberal urbanism after the global financial crisis. Journal of Urban Affairs, 42(1), 1-17.

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