THE GLOBAL ECONOMIC MELTDOWN Economies of the world all have their periods of rise and fall. No economy can experience total stability over a period of time- there must be some forms of rise or fall in the stability of the economy. Today, virtually every country in the world is affected by what happens in other countries. Some of these effects are a result of political events, such as the overthrow of one government in favor of another. But a great deal of the interdependence among the nations is economic in nature, based on the production and trading of goods and services.
This interdependence among nations is attributed to the world economy. Hence, Global economy can be said to be the interdependent economies of the world’s nations, regarded as a single economic system. As a result of the interdependence between economies of the world, there now is a cause-effect relationship between what happens in one country and the state of other countries. The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008.
Around the world stock markets have fallen, large financial institutions collapsed or were bought out, and governments in even the wealthiest nations had to come up with rescue packages to bail out their financial systems. The root of the crisis is in banking rather than in securities or foreign exchange. The crisis started in the U. S in august 2007 with sub-prime mortgage crisis and households found it increasingly difficult in making higher payment on adjustable mortgages.
The crisis spread to Europe and has become global with countries not originally affected now experiencing second-round effects. Following a period of economic boom, a financial bubble—global in scope—has now burst. However, what people are concerned about is that those responsible for the financial problems are the ones being bailed out, while a global financial meltdown will affect the livelihoods of almost everyone in an increasingly inter-connected world. CAUSES OF THE GLOBAL ECONOMIC MELTDOWN To the untrained eye, economic activity in any given episode seems to be a jumble.
But economists have noticed certain regularities in the way in which an economy behaves; in particular, business-cycle theory does provide some guides to how an economy responds to economic restraint or to economic stimulation. The subprime crisis came about in large part because of financial instruments such as securitization (where banks would pool their various loans into sellable assets, thus off-loading risky loans onto others). For banks, millions can be made in money-earning loans, but they are tied up for decades. So they were turned into securities.
The security buyer gets regular payments from all those mortgages; the banker off loads the risk. Securitization was seen as perhaps the greatest financial innovation in the 20th century. *Banks borrowed money to lend out so they could create more securitization. Some banks didn’t need to rely on savers as much then, as long as they could borrow from other banks and sell those loans as securities-bad loans would be the problem of whoever bought the securities. *Some investment banks got into mortgages, buying them in order to securitize them and then sell them on. Some banks loaned even more to have an excuse to securitize those loans. Running out of whom to loan to, banks turned to the poor; the sub prime, the riskier loans. Rising house prices led lenders to think it wasn’t too risky; bad loans meant repossessing high-valued property. Sub prime and “self-certified” loans (sometimes dubbed “liar’s loans”) became popular, especially in the US. Some banks evens started to buy securities from others. *Collateralized Debt Obligations, or CDOs, (even more complex forms of securitization) spread the risk but were very complicated and often hid the bad loans.
While things were good, no-one wanted bad news. When asked what if someone raised concerns, Peter Harn, one of the innovators of CDOs, an even more complex version of securitization, told the BBC such people would likely lose their job; anyone trying to slow down would have seen a decline in their market share compared to others, for example. *High street banks got into a form of investment banking, buying, selling and trading risk. *Investment banks, not content with buying, selling and trading risk, got into home loans, mortgages, etc without the right controls and management. Many banks were taking on huge risks increasing their exposure to problems. Perhaps it was ironic that a financial instrument to reduce risk and help lend more securities would backfire so much. *Loose regulatory regimes and several unregulated financial markets and products. NIGERIA as case study-Effects of the Global Economic Meltdown Perhaps ironically, Africa’s generally weak integration with the rest of the global economy meant African countries were not to be affected by the crisis, at least not initially. The wealthier ones who do have some exposure to the rest of the world, however, faced some problems.
In the long run, it can be expected that foreign investment in Africa will reduce as the credit squeeze takes hold. In recent years, there has been more interest in Africa from Asian countries such as China. As the financial crisis is hit the Western nations the hardest, Africa still enjoyed increased trade for a while. African countries could face increasing pressure for debt repayment, however. As the crisis gets deeper and the international institutions and western banks that have lent money to Africa need to shore up their reserves more, one way could be to demand debt repayment.
This could cause further cuts in social services such as health and education, which have already been reduced due to crises and policies from previous eras. In the Nigerian economy, the effects of the economic meltdown are detailed below: • Commodity prices collapse-especially oil price. • Declining capital inflows in the economy. • De-accumulation of foreign reserves and pressure on exchange rate. • Revenue contraction (possible burst syndrome) • Limited foreign trade finances for banks Capital market downturn, divestment by foreign investors with attendant tightness and possible second-round effects on the balance sheet of banks by increasing provisioning for bad debts and decrease in profitability. • Counter-party risks as pertains to external reserves. CONCLUSION In very simple terms, the Federal Reserve inflated the money supply believing that it will result in more economic growth. This however, was not the case. So, all the extra money which was poured into the economy brought about a massive economic malinvestment. When all that investment eventually failed to balance the books, all hell broke lose.
Securitization was an attempt at managing risk. There have been a number of attempts to mitigate risk, or insure against problems. While these are legitimate things to do, the instruments that allowed this to happen helped cause the current problems, too. In essence, what had happened was that banks, hedge funds and others had become over-confident as they all thought they had figured out how to take on risk and make money more effectively. As they initially made more money taking more risks, they reinforced their own view that they had it figured out.
They thought they had spread all their risks effectively and yet when it really went wrong, it all went wrong. They created more risk by trying to manage risk. Now the only major solution in order to bring the economy to its former state of okayness, is to let companies fail by withdrawing all the excess money in circulation and start the whole economic process from scratch. Instead of taking this route however, the government took even more loan trying to sustain all those malinvestments by pumping even more money in the economy. In trying to solve the problem, they are overdoing the cause of the problem.