As the world economies recover from the just ending financial crisis, the United States of America seems to have carried the largest burden with the collapse of major financial institutions, for example, the Lehman Brothers. While many attest the financial crisis to a historical crisis which is likely to occur if the necessary measures are not followed, many attribute the banking crisis, which was the igniter of the financial crisis, to greed and the devised new and easier ways of making easy money as a major driver of the economic crisis.
The new and easier ways of making money resulted into banks undergoing the following activities: credit losses, stock exchange losses, and also liquidity problems. As banks assigned credit to the customers, there were always credit risks associated with every customer that was lend money but the banks failed to investigate the credit worthiness of their customers and thus exposed themselves to bigger risks, for example, loan defaults.
With banks, investors, and other economy players being closely interdependent a crisis in the banking sector triggered a series of reactions in the whole economic system. The investors lost confidence in their financial institutions, and this made the banks be faced with a liquidity crisis and when the banks lost confidence on their debtors and among themselves thus could not lend to each other the credit crunch problem arose. These two events led to other related activities and the banking crisis in the US developed. Banks crisis are therefore brought about by loss of confidence among the economic players.
History of the Banking Crisis
The banking crisis in the United States of America dates back in the early 1870s. Before this, there had been the panics of 1819 and 1837. In 1873, the boom in the rail road construction where investments in this sector were driven by the government grants triggered this first case of depression in the USA. At this time the railway sector was the major employer out of agriculture and large amounts of cash were being invested in the sector resulting in abnormal growth of the sector. Investments were made on big projects though they did not have immediate returns thus a liquidity problem was likely to arise in future.
Some experts attribute the economic crisis of 1873 to a series of activities which among others included the economic act of 1873 which reduced the value of the money and it was in this year that Jay Cooke and company failed. Having invested million dollars in the Northern Pacific Railway Bonds, the government used contracting money policies thus making supply of money in the market limited, just as the company was making plans of borrowing credit from the bank, word spread that the company was becoming valueless, the company could not get the money and thus it filed for bankruptcy. The collapse of Jay and Cooke Company was followed by the collapse of Henry Clews and several bank closures followed thereafter. After the 1873, there was the panic of 1907 where during this period; the United States of America experienced a panic which originated from New York where customers were withdrawing their money in uncontrollable manner that the banks could not cope with. Although during this time some banks failed, the failures and losses were not that high (Calomiris, 2008).
The worst bank crisis took place in the 1930s i.e. “the great Depression”. The depression is said to have officially began in the year 1929 with the major factor attributed to the use of margin loans. The authority required a margin of 10% only and when the crash began, investors realized that in reality they were too much over leveraged and the situation was not getting better. As the market crashed, customers flooded their banks in attempts to withdraw the money they had invested in the banks and most banks collapsed overnight as they could not handle the bank runs. It is estimated that the ever highest number of banks collapse in the United States of America was during this period where an estimated over 9000 banks in the US failed. The economy was a bit stable despite some hiccups until the 1980s Savings and Loans had failed.
During the early 1980s, the recognition of money accounts lessened the attractiveness of savings accounts forcing the Congress to get rid of restrictions. This allowed the savings and Loans to increase the interest rates on deposits and consumer loans among other banking services. The assets value swelled by 50 percent and over in the 1982 -1985 period. In the year 1983 more than a third of Savings and Loans were not making profits and nearly 10 percent were bankrupt (Amandeo, n.d). It is estimated that “over 1000 banks failed” (Amandeo, Par 9). After this period, the economy was growing well and the economy was promising until the financial crisis of 2007-2009. As economic conditions appear favorable consumers, as basic economics rule, may tend to consume more than they are earning. This was happening in the US during the economic boom of 2006. Individuals tend to consume or spend more with the hope that good economic conditions will always exist. During this period of economic boom Americans were saving nothing and the urge by investors for every American to own a home and those who had to own an extra brought about the saving problem. The country’s chamber of commerce indicates that at some time saving was negative and a problem was slowly growing with no one taking concern.
In the year 2007 the expected among the economics experts and the unexpected from American citizens occurred. The prices of commodities shot up, the interest rates rose as well while the prices of the house fell drastically. The United States of America experienced its worst economic crisis since the great depression of the 1930s. The indications that the economic situation was not going to remain sweet appeared on January after the fall of Citigroup profits made its shares lose their value at an alarming rate. In the same month, shares prices fell through out the world and this was followed by several major institution collapses. A number of major financial institutions in the US reported massive losses and the months that followed saw the bankruptcy filing of several institutions, for example, the Lehman Bothers, the take over of Merrill Lynch and also the move by Goldman Sacks and Morgan Stanley sought bank status so as to receive protection from bankruptcy. In the following few days several other investment banks also went underway in one way or the other.
How the Crisis Spread
The banking crisis spread from the US to the other parts of the world through the financial sector. With trade globalization and the interdependence of world economies the banking crisis spread very quickly. The over reliance on market liquidity by banks made their balance sheets more susceptible during the crisis period.
The banking crisis exposed the weakness of the world’s financial system despite coordinated measures by governments in enacting monetary policies and stimulus packages which sought to arrest the crisis. It began in the developed economies and quickly spread to emerging markets and developing economies. Investors pulled capital from countries they had invested in even in those countries where risk was minimal this caused values of stocks and domestic currencies to plunge. This also led to reduced exports and commodity prices. Thus, the effects of the banking crisis caused widespread downfall in the economy (Nanto, 2009).
The Historical Phenomena It Replayed and Policy Processes
History rarely repeats itself but when it does it is with a reason as it happened during the economic crisis. The problem of the first boom of the 1920s began in the US and so did the just ending financial crisis of the 2007- 2008. There was excess leverage in the system, which made speculators hope for better future economic periods leading to unwise economic decisions. The excess leverage which was in the form of buying stocks while the 2007-2008 financial crisis can be attributed to too much leveraging in the retail mortgage products and absolute return strategies but no matter what it is leveraging.
Home price deflations in the national level have never declined to such extents except during the great depression and thus the replay in history. The massive monetary and fiscal policies are another sign of history repeating itself. While in the 1930s the stimulus came in the form of the Smoot- Hawley Tariff Act which increased taxes on goods imported to the US. With the recent financial crisis, the intervention has been through fiscal stimulus packages where the government is buying out mortgage debts which also are a form of a fiscal policy (Johnson, 2009).
The Major Implication of These Policies
The past problems have often helped us anticipate how the future is likely to be, unfortunately as economists argues, some historical trends send conflicting signals on how the economy is likely to behave in future thus the need for less reliance on what has been applied in the past.
While some of the recent government actions taking place in the United States and around the world are helping in saving the economic situations in the short run, there is need to admit that we are making mistakes, the economies should allow the markets to rule themselves. As Keynes preached of a capitalist system with minimal government intervention, this means that though we should not prohibit the central banks and the federal banks from lending out the money, may be we should realize by wanting things to go on a prescribed way, we prevent a new market order from reigning.
For the decision makers to benefit from the current banking policies, efforts need to be done to ensure everything is practiced in line with the regulations and finally while the present policy interventions might work on mitigating the effects of the crisis long term considerations need to be put in work be it regulative or restrictive to ensure the economic cycle remains at least at a constant level.
Amandeo, K. (n.d). Savings and Loans Crisis. Web.
Calomiris, C.W. (2008). Banking Crises: American Enterprise Institute for Public Policy Research. Web.
Johnson, S. C. D. (2009). History Does Not Repeat Itself, But It Sure Does Rhyme: State Street Global Advisors. Web.
Nanto, D.K. (2009). The Global Financial Crisis: Analysis and Policy Implications. Web.