Good Financial Risks Considerations Of Globalisation In The 2007 Global Financial Crisis Essay Example
Economists have described the global financial crisis that spanned two years (from 2007 to 2008) as the worst economic crisis second only to the great depression that prevailed in the 1930s.The crisis had started in the developed countries before it infiltrated the economies of the developing countries. It threatened the collapse of major global financial institutions and were it not for the aid of the national governments most would have collapsed. Economists trace the exact cause of the crisis to the bursting of the United States housing bubble that peaked in 2005-2006 (Scott, 2014).Default rates on adjustable-rate mortgages (ARM) and other mortgage types started to rise rapidly from that point forward (Sannajust, 2014). Banks began giving out more loans to prospective homeowners and consequently housing prices began to rise.
There was a housing construction boom that was the result of massive inflows of foreign funds after the financial crisis of Asia in 1997 and the Russian debt crisis. This facilitated debt-financed consumer spending. The number of financial contracts and agreement called mortgage-backed securities (MBS) that earned their value from mortgage payments, and housing prices increased which motivated investors and entrepreneurs to invest in the United States housing market. However, housing prices declined, and the major global financial institutions and companies that had borrowed money to invest heavily in the MBS started reporting significant losses. Globalisation enabled the US to eat up all the savings of the rest of the world and consume more than it usually produced (Hass, 2014).
An example of a case that suffered perhaps the most in the global financial crisis of 2007 is the global automotive industry, in particular, the General Motors and Chrysler Company that was based in the United States. Before the 2007 global financial crisis, the company enjoyed a significant market share of the world as the manufacturer of vehicles. The most major car company and indeed the largest multinational for most of the twentieth century was in its death bed with increasing attempts by the United States government to keep it alive.
General Motors has a one hundred year long history and has business operations spanning more than one hundred and fifty-eight countries. Prior to being overtaken by Toyota in 2008, it was the world’s biggest carmaker producing cars totalling more than 9 million a year in 34 different countries. It employed 234,500 people and had 463 subsidiaries. 91000 of the employees were in America where it also provided healthcare and pension benefits for retired workers (List et al., 2014). Prior to the crisis, General Motors had been suffering from three years of massive losses and debts. Its assets stood at $82.2 billion while its liabilities were at $172 billion. However, there had been a window of hope inside and outside GM after it struck a deal with The United Auto Workers union. The deals involved transferring liabilities of health care to a union-run trust fund and also to slash the pay and benefits of newly hired workers to rates resembling those of other automobile industries (Sannajust, 2014).
Some surveys were even indicating that General Motors was closing the efficiency gap with its rival, Toyota. General Motors was also manufacturing some pretty good trucks and cars during this period. These included the popular Chevrolet Malibu, Buick Enclave and the award-winning Cadillac CTS. The Chevrolet Volt was so refined that it made the then Toyota’s Prius Hybrid seem outdated. In late 200, things were looking up for General Motors market share. Its market outside the United States also provided a cheery prognosis (Cuckierman, 2014). The external market was quickly growing. General Motors was earning sixty-five percent of its revenues from the foreign markets. These markets included Latin America, China and Russia where it was earning for being among the first foreign companies to set up factories there (Bénétrix, Lane & Shambaugh, 2015).
General Motors downward spiral commenced with the weaknesses of the housing market that came with the global financial crisis of that period. The prices of houses were falling too sharply which prompted individuals both in the United States and outside to put off acquiring new cars and trucks. Also, willing buyers that had credit ratings that were below average were finding it increasingly hard to fund prospective purchases (both firs-Hand and second-hand purchases). As consumer credit tightened due to the global financial crisis, sales of cars and tracks dropped sharply.
“When house prices began to decline in late year of 2006, many financial institutions including banks and lending institutions were left with millions of dollars in securities that could not be sold because of the loss in intrinsic value, as well as the defaults occurring in mortgages. The consequence was a massive devaluation of the securities and finally the failure of several financial institutions. The surviving financial and lending institutions became unwilling to lend money to customers due to their lack of necessary liquidity and concern over the potential length of the economic recession. Without no access to credit, customers could not purchase automobiles, and car sales dropped around the globe. The lack of credit was devastating, especially to the American market where “about 90 percent of new cars are financed by financing institutions. The banking crisis also prevented General Motors from being able to provide credit, making its lending activity drop from 50% of GM car financing in 2007 to fewer than 6% in 2008” (Han, Sandford & Shea, 2014).
The financial crisis played an enormous role as General Motors became even unable to obtain credit to buy Chrysler. With the tightening of the consumer credit, the sales of cars continued to plummet. As mentioned above, it became increasingly harder for people having poor or average credit to obtain a loan to buy a car. In 2007, consumers bought new cars by using the home equity loan. The purchase totalled nearly 2 million. This type of funding became more unavailable in 2008.In addition the instability of the job market as well as the individual consumer personal finances discouraged those who already possessed working cars from applying for a new loan and payments which affected General Motors as well as other manufacturers (Kottasz & Bennet, 2014). Consequently, with the lack of improvement in the financial market there was hardly a way to increase the sales of cars.
Moreover, major automotive industries had at that time started focusing on manufacturing SUVs and large pickups that earned more profit than smaller cars that were fuel-efficient. On top of all these, the global financial crisis caused gasoline prices to rise above $4 per gallon. Consequently, the demand for the big pickups and SUVs started to decline thus profits also began to evaporate. There was a scramble to swap the big vehicles from smaller ones that led to a collapse in the residual values. The failure left General Motors finance department with huge losses due to cars that customers returned after the lease. With the fall of Lehman, the markets for cars plummeted all over the world with America being hardest hit. The crisis caught General Motors at a period in which it had struggled to restructure itself losing more than $80 billion in the process and hence was too feeble to face the crisis.
The bankruptcy of the General Motors and its consequent fall was mainly due to the lack of adequate risk analysis and management that were present at the time. The government had a habit of intervening whenever credit expansion ran into trouble. By doing so, it injected liquidity and created a system of asymmetric incentives or as George Soros called it the moral hazard. The ease of credit prior to the financial crisis generated demand that pushed up the value of the property that in turn increased the amount of credit available (Cuckierman, 2014). A metric analysis of the situation requires that one views the market as an equilibrium that comes about after the balance among all the internal forces. The common interest is best served by allowing the participants to pursue their self-interest. However, Soros adds later in his book another critical view on the same matter when asked whether the crisis and its effects were avoidable or not.
“I think it was, but it would have required knowing that the system, as it presently operates, is founded on premises that are false. Unfortunately, we have an idea of fundamentalism of the market, which is now the primary ideology, holding that markets correct themselves; and this is not true as it is generally the intervention of the authorities that saves the markets when they get into an economic crisis. Since way back in 1980, we have had about five or so crises: the international banking crisis in 1982-1983, the bankruptcy of Continental Illinois in 1985, and the failure of Long-Term Capital Management in 1998, to name only three. Each time, it’s the government authorities that bail out the troubled market or organize companies to do so. So the market regulators have precedents they should know of. But somehow this idea that markets tend to equilibrate and that the unavoidable deviations are random has gained acceptance from nearly everyone and all of these fancy tools for investment have been built on them” (It Means, 2009).
In this case, globalisation resulted in the United States sucking up all the savings of the world consume more than it had produced. The incident left few opportunities for other businesses in the market, for example, the General Motor situation. The authorities helped in fuelling the situation by intervening whenever the global financial system was at risk (Scott, 2014).
What went wrong or right in the General Motor case? In some ways, The General Motors problems started more than a century ago. In the period after 1910, the founder of GM Billy Durant purchased thirty-nine companies (Chevrolet, Oldsmobile, Cadillac and other) but ran them as separate entities. The successor of Billy, Sloan, imposed tight financial controls that restore order to the chaos that existed at the time. The company continued to expand acquiring more companies e.g. Vauxhall in Britain and Germany’s Opel. However, Sloan did little if anything to unify the company at the home headquarters. After the World War II, GM made deals with the UAW, which would later turn out to be insupportable burdens. The contents of the deals included increases in annual cost-of-living pays as well as the free health-care coverage for generous pensions and life. At that time, there was hardly if any competition, and thus GM’s large scale characteristic of operation hid any inefficiencies.
It was only in the early 1970s and 1980s after the oil crisis that faults started showing themselves. The V8 powered vehicles that dominated America got replaced by dummy wheel drive vehicles in order to meet new rules (CAFE standards).It made it impossible for General Motor to compete with the Japanese imports. By the 1980s, it was clear that Japanese were making better cars and also did so more efficiently. With the decline in the appeal of its products, so did the prices at which General Motors ask for its products? Furthermore every year General Motors spent billions of dollars on the health care of retired workers instead of coming up with new models. It also added 1400 dollars to the cost of each car in comparison to the cost of each car that the Asian and Europeans manufactured. To generate cash, the chief financial officer had to keep production high and sustain the market sales with expensive dealer incentives, heavily discounted fleets and cheap credit.
The damaged General Motors brands and hastened the bankruptcy that would occur later on (Guelsebee, Krueger, 2014). General Motors also did not have any strategy in place that would be effective in preventing the impending bankruptcy. The government set up a car industry task force to save GM and Chrysler. However, it was clear that both were not viable without the pressure of bankruptcy to coerce stakeholders. They also discovered that customers will not want to purchase something costly like a vehicle from a company that will not be around the coming year. However, after General Motors shed some of its factories, dealers and relieved some staff of hourly paid jobs as well as white collar jobs, it started rising from its fall. Currently, General Motors has gone on to increase their sales as part of newly developed strategies and is still in the recovery process.
It is imperative that significant alterations be made to ensure the full recovery of General Motors as well as in the way international government regulations handle financial crises. General Motors ought to retain the engineering resources so that it can manufacture cars that can compete competitively in the current market. In addition, the current management should strive to venture into more foreign markets by more efficient advertising and consumer friendly prices (Scott, 2014). Its activities in China should go on growing fast with the favourable market there. On an international scale, authorities should ensure that a period of contraction must always follow the increase in the volume of credit (Cuckierman, 2014). This is because some of the new credit practices and tools cannot be sustained for a long time. International financial bodies should constrain the ability of financial authorities to stimulate the economy. The rest of the world must be unwilling to accumulate unprecedented additional dollar reserves (Haas, 2014).
Few people believe that General Motors will return to its former glory. The question, however, is whether the new General Motors can succeed with the new strategies that centre on risk analysis and evaluation prior to decision-making. To avert another financial crisis, international bodies need to regulate the rate and mechanisms by which they intervene in the events of financial or economic crises. They should only intervene in situations where the situation risks causing a global financial crisis like the one that occurred in the period spanning 2007, 2008 and 2009 (Goolsbee & Krueger, 2015). Intervention is critical since there are circumstances in which no intervention may lead to total collapse of the market. Such a scenario might lead to a vicious cycle that will ultimately affect other economic fields in due time. They should come up with regulations that would govern financial institutions on the amount of credit they offer to avoid flooding of the financial market with consumers that would only focus on one product. All these measure constitute global risk analysis that is important if the world is to mitigate future global risks in the event of another financial crisis.
Bénétrix, A. S., Lane, P. R., & Shambaugh, J. C. (2015). International currency exposures, valuation effects and the global financial crisis. Journal of International Economics.
Cukierman, A. (2014). Euro-Area and US Banks Behavior, and ECB-Fed Monetary Policies during the Global Financial Crisis: A Comparison.
Goolsbee, A. D., & Krueger, A. B. (2015). A Retrospective Look at Rescuing and Restructuring General Motors and Chrysler (No. w21000). National Bureau of Economic Research.
Haas, R., & Lelyveld, I. (2014). Multinational banks and the global financial crisis: Weathering the perfect storm? Journal of Money, Credit and Banking, 46(s1), 333-364.
Han, T., Sandford, J., & Shea, P. (2014). A Note on Bubbles, Worthless Assets, and the Curious Case of General Motors. Macroeconomic Dynamics, 18(01), 244-254.
It Means, W. (2009). The New Paradigm for Financial Markets. Public Affairs, New York.
Kottasz, R., & Bennett, R. (2014). Managing the reputation of the banking industry after the global financial crisis: Implications of public anger, processing depth and retroactive memory interference for public recall of events. Journal of Marketing Communications, (ahead-of-print), 1-23.
List, M. B. S. Et al. (2014). Breaking News. Journal of Accounting Research.
Sannajust, A. (2014). Impact of the World Financial Crisis to SMEs: The determinants of bank loan rejection in Europe and USA (No. 2014-327)
Santos, L. (2014). Reorganisation of bankrupt firms the case of General Motors.
Scott, K. D. (2014). Global Financial Crises.
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