The Global Financial Crisis (GFC) of 2007 stemmed from a lack of regulation of the United States Financial System. The financial system comprises of financial institutions, markets, services and practices that allow for the transfer of money between savers and borrowers.1The lack of regulation triggered a liquidity shortfall in the United States??™ banking system, attributed to the overvaluation of assets. In the US, sub-prime mortgages were sold widely to people looking to get houses that they could not afford for a low rate. When the supply of houses outstripped the demand for them, banks increased their interest rates, making it harder for financially inept individuals to repay the loan. The businessmen that developed these mortgages tied these loans with several liquid assets that had no value, worsening the financial burden felt by many. Without repayments on their loans the banks lost all their money. Other factors that contributed towards the GFC include falling consumer spending and rising unemployment domestically within the US, tight margins on credit borrowing and extensive international trading of goods and services. Due to the highly connected nature of the global financial sector, were credit money is lent and repaid frequently to and from places around the world, the Australian economy felt the impact of this crisis. As the Australian Securities Exchange experienced a downturn, the Australian Government attempted to bail out banks in order to stimulate the economy. Throughout 2007/08 the government implemented extensive damage control strategies which effectively stabilized the effect of the crisis, making Australia the only country that stayed out of a recession. This is based on Keynes??™ Multiplier Theory whereby an initial injection of funds with generate a proportionally greater increase in aggregate demand for goods and services; increasing the demand for labour and reducing the negative outcomes which arise due to the GFC. Economists argue that if Australia felt the recession, it would be categorised as a ???mild-recession???.2 In order to prevent this Crisis from occurring again, a number of market-based regulatory solutions have been implemented within the Australian Economy and the Financial System.??As lending between banks and consumers dramatically fell due to the lack of regulation of the United States Financial System, extreme panic caused a loss of consumer confidence, making the situation worse. Due to the inability to repay loans in the United States, many people were forced into poverty. The victims of this scheme were drained of cash, and therefore had no money to spend within the economy. The ???big four??™ of the Australian financial system is extremely regulated in comparison to the American system only giving out loans where there is proof that the borrower will likely be able to make repayments on the loan. A decrease in consumer demand saw a decrease of business revue and profits. As labour is a derived demand, businesses could not afford to maintain current levels of staff, further worsening Americans??™ financial stability. A lot of American and European businesses that were largely dependent on offshore production in more expensive places like Italy and France were also affected by the lack of consumer demand all over the world, as well as the tight credit measures. Rather than collapsing under the pressure, Italian luxury fashion house Dolce & Gabbana was forced to move most of its production from the ???glamorous??? Italy and France to China due to the lack of consumer demand for their products in America. Due to the high $311 million net revenue that is generated yearly (prior to the GFC), Domenico Dolce and Stefano Gabbana could afford to lower their prices of their main Dolce & Gabbana collections in America by 20 per cent during the GFC in order to stimulate some consumer spending.3 Unlike Dolce and Gabbana, many businesses could not afford to hire people, or run production the way they always have. They were forced to close down all whilst banks further increase their interest rates. Australian businesses did not suffer as much because Australia??™s local businesses obtain funds from Australian banks, which have some of the best credit ratings in the world due to the well maintained flow of money. In addition, as Australian businesses don??™t deal with foreign banks as much as a lot of others do in the world, there was a lot less debt troubles within the Australian domestic financial system.
As American banks were short of money, they had to borrow from overseas banks. These overseas banks did not get their money back, and of course, also went into debt from borrowing. For example, a business based in Hong Kong can still be dependent on American Citibank to get funds for their business, also pulling them into debt. This chain effect established a shortage of money all over the world, making several financial institutions reluctant to lend to companies or to households, undermining confidence, and causing a fall in business investment and household consumption. Through the monetary policy, the Reserve Bank of Australia combated this impact with pre-emptive and consecutive cuts in their cash rate. The cash rate went from 5.5 to 6 per cent to 3.25 per cent in May 2008, the lowest since 1950. This is achieved through the RBA selling securities, causing an excess of borrowable funds, a decrease in market interest rates and a increase in consumption and investment spending. If the supply of money has shrunk, the circular flow will have a lot of leakages, meaning that people will save more than consume. This was a very effective response to the GFC because this made borrowing credit funds much easier and cheaper, with less money required to pay off existing debts. As Australian businesses were able to now repay their loans due to the fiscal spending package, they were encouraged to borrow and produce.
In order to combat the rising unemployment rates, diminished consumer spending and increasing inflation rate, the Australian Government implemented a number of policies. This pro-active role saw a general increase in government spending and borrowing to stabilise the business cycle. This principle is based on the Keynesian theory whereby governments are able to influence the level of aggregate demand in the economy depending on the level of their intervention in the marketplace. In October 2008, with the economy facing a recession, the Rudd Labor government introduced an economic stimulus package worth $10.4 billion. The stimulus package payments were aimed at those with a high marginal propensity to consume, ensuring that the money was spent within the economy. People with a high marginal propensity to consume include the working class, in particular those that are young and single. The improved consumer spending and demand improved employment, profit levels and saved many businesses, for example Australian Sass & Bide. As the Bureau of Statistics reported, retail figures have increased by 2.2 per cent following the Government??™s stimulus package. As labour is a derived demand, an increase in retail figures mean that more people are employed in the economy, resulting in an increase in consumer confidence. A second economic stimulus package was introduced in February 2009, with $47 billion split into payments for schools, for 20, 000 new homes, for road repairs and infrastructure, small business tax breaks and cash bonuses for every Australian taxpayer who earned less than $80, 000. The stimulus packages prevented an otherwise four-time larger contraction; sustaining employment by generating aggregate demand through increasing expenditure, avoiding a rapid economic downturn. A Nation-Building infrastructure project worth $22 billion was introduced. This project ensures long term employment opportunities as capital investment boosts the economy??™s future productive capacity. The Rudd Labor government implemented productivity-enhanced investment in infrastructure and in education and training programs, successfully lessening the effect of the GFC.
Nonetheless, the previous Australian government lead by John Howard and treasurer Peter Costello ensured that the present government inherited a strongly placed economy4. This is attributed to the fact that the Liberal party of Australia managed to return the Federal budget to surplus, maintaining the budget in balance on average in the economic cycle, approximately at 1% of GDP. The Howard government established a improved arrangement to manage the day-to-day operations of the economy, set a medium-term objective for the budget and formally accepted the interest rates set by the Reserve Bank of Australia. As Australia??™s fiscal affairs were in good order ???there needed to be no hesitation in the decision last Oct (Oct 2008) for the Government to spend big in an effort to reduce the downturn in the economy.??? When the Credit Crisis hit America, the American government conjured up big annual budget deficits, in addition to the high levels of accumulated debt. In addition, the Liberal government resisted pressure from the big four; Commonwealth Bank of Australia, ANZ, Westpac and National Australia Bank, to merge and become ???national champions???. Through this, the Australian government helped to keep its banks out of trouble. Comparatively Australia??™s financial system is airtight in comparison to the United States. In the US the responsibility in their financial system ???is shared between four or five buck-passing authorities???, proving to be an enormous problem when the Credit Crisis hit. ?
The American government responded in a similar manner to the Australian government. It aimed to improve the macroeconomic environment, promote market stability and advance structural repair. The monetary authorities reacted relatively quickly in response to the demand by financial institutions to increase access to central bank liquidity. Legislation action was taken, with the introduction of the Troubled Asset Relief Program and the American Recovery and Reinvestment Act of 2009. Both aimed to provide support for financial institutions5 and to provide stimulus to the economy6. The Department of the Treasury presented the Obama Administration proposal with an aim to reform the financial system. These include to promote regulation of financial firms, a new Financial Services Oversight Council, Stronger capital and other prudential standards for all financial firms and the elimination of the federal thrift charter7. All of these actions aim to reduce the effect of the GFC and to prevent it from occurring again in the future. However comparatively Australia??™s financial system is airtight in comparison to the US.
?Following the collapse in the housing bubble, rapid increases in a number of commodity prices within Australia were noted. As the financial crisis began to take hold in late 2008, the price of oil tripled from $50 to $147 per barrel. This increase diverted consumer spending into gasoline, ???creating a downward pressure of economic growth in oil importing countries.???8 However, due the high demand for Australia??™s coal and mineral exports, especially from developing economies like China, ensured that Australia didn??™t feel the full extent of the GFC. This high demand has a huge impact on Australia??™s place in the international share market as more people see Australian companies, i.e BHP, to be most promising. This brought about a general increase in price for Australian stocks. In February 2008 BHP climbed A$1.50 (4.1 per cent), to $38.55. As economies are injecting money into the Australian economy, more revenue was generated, more savings and therefore a larger supply of loanable funds. This increase in loanable funds placed a downward pressure on interest rates. This desire for Australia??™s coal and minerals is expected to increase in the years leading out of the Global Financial Crisis. One reason that can be attributed to this strong desire for Australia??™s raw materials is because of the geographically strategic location in comparison to the US and the UK in relation to these rapidly developing Asian nations.9 This constant desire for Australia??™s rare resources and Australia??™s strategic location will strengthen the Australian dollar and the Financial system, ensuring that if another recession were to eventuate in the world, Australia will come out unscathed.
In the wake of the GFC, a Group of Twenty countries (G20) are constantly deliberating and reforming the regulation of their financial systems. In the future, international standards will be adopted to align financial regulation.10The Australian government still implements a strong monetary policy to regulate internal demand, in a fear that inflation pressures could once again emerge. Microeconomic policies continue to allow the supply side to expand in order to accommodate future growth in demand, avoiding long term inflationary pressures.11 Dr. Ken Henry, Secretary to the Treasury argues that the GFC has enabled Australians to strengthen its financial regulation to further safeguard against further financial crisis.12 Short term responses that have occurred in the Australian Financial system and economy include measures to promote investor confidence, ???unfreeze??? and restore liquidity to capital markets, prevent destabilizing speculation and resolving troubled financial institutions. These short term changes aim to unwind the ???resulting distortions to the financial system???.13 There are many long term changes that are implemented in order to ensure strong economic growth in the future. There are several Parliamentary Committee Inquiries in progress to discuss and analyse aspects of financial regulation. These bodies, for example APRA and ASIC promote significant regulatory changes in response to the GFC. A paper discussed by Deborah Ralston looks at ???the transfer of responsibility for stock market supervision from the operator, ASX, to the regulator, ASIC???14, in addition to a need to shift consumer finance regulation to the ASIC controlled National Credit Code from the State government??™s Uniform Credit Code. Other long term changes to the financial system include capital and liquidity enhancements to raise the level of capital on an institution??™s balance sheets, to implement a cap to better monitor the build-up of leverage in an institution??™s balance sheets, to implement procyclicality measures and to re-define regulatory boundaries (macroeconomic and prudential) to enhance regulatory effectiveness.15 An international prudential standards policy for banking is set to be implemented by the end of 2010 after various committee hearings. More specific reform is still deliberated over and will be released by the end of 2010 to be implemented by the beginning of 2012.
The GFC during 2007-008 can be attributed to a number of factors. These include a liquidity shortfall in the United States and the inability of borrowers to repay loans in the United States, forcing American banks to borrow from overseas banks. The Australian economy experienced a mild-recession in comparison with other economies. The worldwide credit crisis meant that a lot of jobs were lost, forcing businesses to go bankrupt. However, due to the actions of the government, the Reserve Bank and the mining boom in Western Australia, Australia came out of the GFC relatively unscathed. The Australian Government implemented new infrastructure reforms and spending initiatives to increase the nation??™s future productive capacity to supporting employment levels at a time when it was facing the prospect of a severe downturn, as a result of the impact of the GFC. Comparatively Australia??™s financial system is airtight in comparison to the United States. As a result of the Financial crisis, the Australian economy and the Financial System has undergone reform in order to prevent long term inflationary pressures.
Wikipedia: Financial system. http://en.wikipedia.org/wiki/Financial_system. ?Referenced from: ???Economics: Principles in action???. By Steven M. Sheffrin (2003). Upper Saddle River, New Jersey 07458: Pearson Prentice Hall pp. 551 ??Ross Gittins. ???It??™s no accident Australia has avoided a severe recession this time around.??? November 13, 2009. http://www.brisbanetimes.com.au/business/its-no-accident-australia-has-avoided-a-severe-recession-this-time-around-20091113-ieu0.html Last viewed 10/08/2010
Dolce & Gabbana Discount Fashions for Financial Crisis??? http://bagbunch.com/dolce-gabbana-discount-fashions-for-financial-crisis/ 17th June (year posted unknown. Last viewed 10/08/2010
Ross Gittins. ???Give the Old Blokes a little credit??? September 16th 2009. www.theage.com.au/opinion Last viewed 10/08/2010
CRS Report RL34730, Troubled Asset Relief Program: Legislation and Treasury Implementation, by Baird Webel and Edward V. Murphy.
CRS Report R40537, American Recovery and Reinvestment Act of 2009 (P.L. 111-5): Summary and Legislative History, by Clinton T. Brass et al.
The Global Financial Crisis: Analysis and Policy Implications. Dick K. Nanto, Coordinator. Specialist in Industry and Trade October 2, 2009. CRS report for Congress.
Ross Gittins. ???Don??™t fret – oil price jump has its positives??? October 23 2004. http://www.smh.com.au/articles/2004/10/22/1098316860877.html Last viewed 10/08/2010
Ross Gittins. ???How the puny Pacific Peso became a pumped-up dollar became a pumped up dollar??? October 14th 2009. http://www.smh.com.au/opinion/politics/how-the-puny-pacific-peso-became-a-pumpedup-dollar-20091013-gvs3.html Last viewed 10/08/2010
Australian Economic Statistics. Trends, objectives and policies. 2010-2011. By Robert Price. Published by Warringal Publications, Victoria, Australia, 2010.
The Senate Economics Committee had inquiries underway into the National Consumer Credit Protection Bill, Aspects of Bank Mergers, and Bank Funding Guarantees. The Joint Committee: Corporations and Financial Services was inquiring into Financial Products and Services and into Agribusiness Managed Investment Schemes and the House Economics Committee completed an inquiry into Competition in the Banking and Non-banking Sectors in November 2008.
Financial Regulation after the Global Financial Crisis. Kevin Davis Department of Finance, University of Melbourne and Melbourne Centre for Financial Studies. http://kevindavis.com.au/secondpages/acadpubs/2009/AER-Financial%20Regulation%20after%20the%20Global%20Financial%20Crisis-09.pdf Last viewed: 12/08/2010.
The Australian financial system – emerging from the global financial crisis. Address to the Count Financial Conference, Canberra, 15 March 2010. Spoken by Dr Ken Henry AC, Secretary to the Treasury.
The Market Economy. By Tim Dixon and John O??™Mahony. 2010 Edition. Year 11 Preliminary Eonomics. Leading Edge Education Sydney, 2010
Reforming International Financial Regulation report. By the Institute of Chartered Accountants in Australia. (Unknown date of publication). Last viewed 10/08/2010?