Financial crisis

 

What similarities (2007-2009 crisis) exist between experiences in Canada, USA and the host country (Australia)?

Financial crisis in 2007-2009 has been the worst economic disaster that has created a great recession throughout the world. The Great Recession has caused a loss of more than $2 trillion and global economic growth has dropped by 4%. This financial crisis has been caused due to reduction in housing prices and affordable housing programs in the United States. The foreclosure rate has been increased and the “Community Reinvestment Act” of the US has pushed the banks to make investment at subprime level (Tangpornpaiboon&Puttanapong, 2016).  Highdelinquency and default rates with subprime credit, mortgage, credit, hedge fund and “collateralized debt obligation (CDO)” are highly responsible for the housing bubble. The United States has faced this crisis at a high point due to its lack of regulation and fraudulent practices that have increased debt burden.

Housing investment has seen a massive inflow of foreign investment in the US and the GDP deficit of the country has reached 6%. The regulatory structure of the U.S. regulatory structure helped fuel the housing bubble and it has undermined the effectiveness of its regulation of financial conglomerates. The financial crisis has cost an estimated $648 billion to the US because of slower economic growth as per Congressional Budget Office (CBO). The U.S. lost $3.4 trillion in real estate in 2008-2009 (Pewtrusts.org, 2020). Alongside, $7.4 trillion has also been lost by the US in stock wealth that has $66,200 on average per U.S. household. It has caused high unemployment that has been 5.5 million. Mortgage loan companies namely Fannie Mae and Freddie Mac have also been responsible for this global crisis because the housing market has collapsed due to their guarantee of the majority of mortgages. Declining housing prices reduces the level of wealth and spending and for this reason, the US households and banks have lost about $5,800 in income.

Figure 1: Effects of crisis on GDP of Canada and the US

(Source: Canadian encyclopaedia, 2020)

Though almost similar conditions have been identified in Canada and this country has not experienced bank failures like the US. However, the lower interest rate has made it easier for households to carry large mortgage debt in Canada. Lack of confidence in bank solvency, low credit availability and low investor confidence has led to plummeting stock prices.  The housing markets of Canada have suffered and unemployment is reached to the peak at June 2008 resulting in foreclosures and evictions. The unemployment rate has been fluctuated around 6% in 2009-2009 whereas the US unemployment rate has reached 9.8% (Canadian encyclopaedia, 2020). It has closed imports and exports and according to Capital Expenditure Price statistics, the residential price index has reduced.

Figure 2: Changes in the US and Australia stock prices

(Source: Treasury.gov.au, 2020)

On the contrary, Australian housing market has not experienced a bubble and this country has recorded better growth outcomes due to resilience in Australian financial system. The housing construction has never exceeded demand and there has been less competition in the financial services market. However, the local economy's financial market has faced issues and the unemployment rate has increased by 5% in 2009. There have been large declines in equity prices that have reduced wrath in Australian households by 10% in 2009 (Australian Bureau of Statistics, 2020).  Australian dollar has also depreciated rapidly and declined by 30% in 2008 as well as enhanced liquidity rate according to Reserve Bank of Australia (RBA). Lehman bankruptcy occurred and foreign exchange market became illiquid.

What lessons were learnt from the financial crisis of 2007-2009 and what steps have been taken to date regarding the improvement of the banking regulatory systems?

Financial crisis has slowed down the economy that has tightened credit and declined international trade. The housing prices have dropped more than the price during this period. The banking sectors have changed their business models and market structure as well as assess the stability requirements and market efficiency. The evolution and stability of banking sector includes,

●      Changes in the market structure and capacity by introducing capacity metrics and expanding in large emerging market economies (EMEs).

●      Shifting in bank business model with less capital-intensive activities and commercial banking (Bell &Hindmoor, 2018)

●       Bank profitability or return on equity has declined across countries

●      Resilience of the banks have been increased to gain stability for the future risks by implementing new monetary policies

Changes in the bank's asset portfolio are observed and the US becomes more selective in international banking activities. A regulatory reform has been identified after the crisis because banks of the US and the European countries have faced sluggish revenues and legacy costs associated with misconduct. Accommodative monetary policies have been taken by the banks worldwide to strengthen their risk management. It has been identified that the Federal government of the US has spent $700 billion of taxpayer money to mitigate the financial crisis and stabilize the market through the “Troubled Asset Relief Program (TARP)” according to the CBO (Chen et al., 2016). This is approximately $2,050 per U.S. household on average. It focuses on buying troubled assets from large financial firms to restore confidence of credit markets. 

The policy makers of Canada, big six chartered banks such as “National Bank of Canada”, “Royal Bank of Canada”, Bank of Montreal”, “Canadian Imperial Bank of Commerce”, “Bank of Nova Scotia” and “Toronto-Dominion Bank” have observed the risk behaviour. Stronger regulatory environment has been created by the Canadian banks to reduce the insolvency crisis and restore liquidity and stability in financial markets (Lombardi &Siklos, 2016).  In addition, measures like “Insured Mortgage Purchase Program (IMPP)” have been taken that have allowed banks to interchange illiquid mortgage assets with the help of bonds issued by the “Canadian Mortgage and Housing Corporation (CMHC)”. The Bank of Canada has decreased its targets for overnight rate from 3% to 2.5% and policy rate of the banks have been decreased to 0.25% in 2009. A “two-year stimulus program” has been introduced for infrastructure spending as a fiscal policy and made their federal budget in balance for economic development.

“Organisation of Economic Cooperation and Development (OECD) of Australia has adopted the “Single Regulator Model'' and “Twin Peaks Model'' to handle the financial crisis. The Australian government has undertaken an aggressive stimulus package and improved tax policies to avoid recession. Significant macroeconomic policy has been created by RBA and cut interest rates by 100 basis points in response to the financial crisis. The Government has announced a stimulus package of $10.4 billion and that has been 1% of Australia GDP to gain financial stability (Treasury.gov.au, 2020). According to the World Economic Forum, financial development is possible by creating financial stability, financial access banking and non-banking financial services as well as changing institutional, market and business environments.

 

 

References

Australian Bureau of Statistics. (2020). 1301.0 - Year Book Australia, 2009–10. Abs.gov.au. Retrieved 12 August 2020, from https://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/1301.0Chapter27092009%E2%80%9310#:~:text=The%20effect%20of%20the%20crisis,than%20in%20many%20other%20countries.&text=The%20most%20obvious%20impact%20of,per%20cent%20by%20March%202009.

Bell, S., &Hindmoor, A. (2018). Are the major global banks now safer? Structural continuities and change in banking and finance since the 2008 crisis. Review of International Political Economy, 25(1), 1-27.

Chen, Q., Filardo, A., He, D., & Zhu, F. (2016). Financial crisis, US unconventional monetary policy and international spillovers. Journal of International Money and Finance, 67, 62-81.

Lombardi, D., &Siklos, P. (2016). The Bank of Canada and the global financial crisis: quietly influential among central banks. East Asia-Arctic Relations: Boundary, Security and International Politics, 119.

Pewtrusts.org. (2020). The Impact of the September 2008 Economic Collapse. Retrieved 12 August 2020, from https://www.pewtrusts.org/en/research-and-analysis/reports/2010/04/28/the-impact-of-the-september-2008-economic-collapse#:~:text=That%20equates%20to%20an%20average,income%20for%20each%20U.S.%20household.&text=Jobs%20%E2%80%93%205.5%20million%20more%20American,the%20September%202008%20CBO%20forecast.

Tangpornpaiboon, S., &Puttanapong, N. (2016). Financial contagion of the global financial crisis from the US to other developed countries. Journal of Administrative and Business Studies, 2(1), 48-55.

The Canadian Encyclopedia. (2020).Recession of 2008–09 in Canada | Thecanadianencyclopedia.ca. Retrieved 12 August 2020, from https://thecanadianencyclopedia.ca/en/article/recession-of-200809-in-canada#:~:text=Although%20the%20effects%20on%20Canada,responses%20by%20Canadian%20policy%2Dmakers.

Treasury.gov.au. 2020. Australia's response to the global financial crisis | Treasury.gov.au. Retrieved 12 August 2020, from https://treasury.gov.au/speech/australias-response-to-the-global-financial-crisis#:~:text=In%20Australia%2C%20the%20first%20significant,rates%20by%20100%20basis%20points.&text=The%20Treasurer%20left%20for%20the,and%20World%20Bank%20Annual%20meetings.