SHAKEELA BANU MBA

GLOBAL ECONOMIC CRISIS

The global economic crisis is commonly believed to have begun in July 2007 with the credit crunch, when a loss of confidence by US investors in the value of sub-prime mortgages caused a liquidity crisis. This, in turn, resulted in the US federal bank injecting a large amount of capital into financial market. By September 2008, the crisis had worsened. As stock markets around the globe crashed and became highly volatile.

According to one influential school of thought, Paul krugman, there were global imbalances, the phenomenon of huge current account surpluses in china and few other countries co-existed with the unsustainable large deficits in the US. The imbalance was caused by the propensity of the countries with high savings rate to pack their savings often at low yields, in the U.S. The flood of money from these countries into the U.S. kept interest rates low, fuelled the credit boom and inflated real estate and other asset prices to unsustainable levels.

It all began with American dream, that every American should have a home. Regardless of who you are and what you do, if you are an American, you should have something called a home. Real estate business was in a boom, financial agents thought that there wasn’t a better time to give away loans. The house hold sector was given a boost with increased monetary supply by commercial financial companies, and people were given loans regardless of the credit rating they received. . There was easy availability of credit at low interest rates. The boom in housing sector made both banks and home buying believe that the price of a real estate would keep going up. Banks went out of their way to lend to sub-prime borrowers who had no collateral assets. All this was fine as long as housing prices were rising but the housing bubble burst in 2007. Home prices fell between 20% and 35% from their peak, mortgage rates also rose. Sub-prime barrowersstarted defaulting in large numbers; the banks had to report huge loses. 

Sub-Prime Mortgage

The practice of lending money to people with weak or limited credit history is called Sub-Prime Lending. A mortgage is simply a loan on a house, and a mortgage rate is the interest rate on such a loan.

Sub-Prime lending covers different types of credit including mortgages, Auto-loans and credit cards. Since subprime borrowers often have poor or limited credit histories, they are typically perceived as riskier than prime borrowers.

Sub-Prime lending became popular in the US in mid-1990‟s, with outstanding debt increasing from 33$ billion in 1993 to $ 332 billion in 2003. December 2007, there was an estimated $ 1.3 trillion in sub-Prime mortgage outstanding. This substantial increasing in attributable to industry enthusiasm; banks and other lenders discovered that they could make hefty profits from origination fees, bundling mortgages into securities, and selling these securities to investors. Banks and lenders believe that the ricks of sub-prime loans could be managed, a belief of raising home prices and the perceived stability of mortgage backed securities. But rising home prices was only for a brief period, there was a gradual decline of home prices leading to heavy losses.

Home values declined, many barrowers realized that the value of their home was exceeded by the amount they owed on there mortgage. Borrowers began to default on their loans, which drove home prices down further and ruined the value of mortgage backed securities.

 Great depression and Global Economic Crisis

The stock market crash on October 29 1929 set in motion a series of events that led to the great depression, but in fact, the American economy and global economy had been in turmoil six months to black Tuesday and a variety of factors before and after that fateful date in October caused the great depression. October 29, 1929 is often marked as the start of the great depression in America, a dark day when the US stock market crashed. Over a two day period, the market lost 24% of its value.

The great depression was a global economic crisis that may have been triggered by political decision or by speculation.

 The stock market collapse of 1929 worldwide there was-

·       Increased unemployment.

·       Fall in Government revenue.

·       Drop in international trade.

·       More than a quarter of the US labor force was unemployed.

Global Economic Crisis has been unprecedented since the great depression of 1929-32. The less developed countries have been severely affected. Although they are not a homogeneous group, they share some common characteristics which render them extremely vulnerable to external shocks. The commodity boom of 2003-08 allowed most of the less developed countries to increase the national saving and investment and to accelerate the growth of their gross domestic product. The subsequent “bust” has had serious detrimental impact not only on their current levels of economic activity and employment, but also on their longer term prospects for industrialization and development. The Global Economic Crisis is a wakeup call for less developed countries to reconsider their long term industrialization and development strategies. International assistance as well as reforms of policies of international organizations and donors is required. In the short term the space available to less developed countries for counter cyclical policies in response to the crises is very high.

Indian economy is being affected by the spillover effects of the global economic crisis, stock market was badly hit, industrial sector and IT sector was affected due to financial collapse of the US market.

References

1. Chidambaram .P 2008 spill- over effects of global crisis will be tackled. The Hindu, daily, November 19, 2008.

2. Global Economics outlook 2008.

3. Global Economic crisis and its impact on India- V.K Agnihotri Rajya Sabha Secretary New Delhi June 2009.

4. The Global Economic Crisis, The Great Depression of the XXI Century – By Michel Chossudovsky and Andrew Gavin Marshall