Financial Crisis (Coursework Sample)

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Financial Crisis
The term financial crisis is a general term that applies to a variety of situations where the financial value of an asset suddenly decreases leading to great loses in the nominal value of the asset. Most of the financial crises occurring internationally have links to panics in the banking system and many other recessions that coincide with the bank panic. There are other sovereign defaults in that lead to international financial crises. Other situations, which have been common in the facilitation of financial crisis,are stock market crash, the busting of financial bubbles, and the current prolonged instances of currency crises (Sharma, 2003). The direct cause of financial crises, which is common in all other causal factors is the paper wealth and does not necessarily result to changes in the real economy. Economist have offered numerous theories that explain the development if the financial crisis and their prevention mechanisms. There are many proposals on how to end instance of financial crisis although there is no consensus hence its continued occurrence. In my essay am going to discuss the causes of financial crisis in the international scope and their consequences.
Types of crisis and their causes
In order to understand fully different causes of financial crisis we can discuss briefly the different types of financial crisis. Banking crisis is a type of financial crises, which occurs when banks suddenly suffer a rush of withdrawals by the various depositors. Banks refer to this event as the bank run and are common as banks lend most of the cash they receive in form of deposits. The bank may be in a position to pat all the deposits as at a moment due to lending. At the event where the bank is not in position to settle all the pending financial debts its insolvent leading to a widespread systemic banking crisis hence the bank panic. Another common cause of financial crises is the speculative bubble crash (Lee, 2008). This type of crisis comes from over pricing of some class of assets consumed by a specific group of person in the society. The effect of this is that the potential buyer purchases the item in speculation of selling it at later higher price without calculating the price it is to generate in future. A crush usually occurs when the merchant finds market for the products and fails to get. The buyer may find it hard to resettle the initial price of the product leading to a bubble crash in the economy. This is the trickiest form of crises because it has no speculation.
International financial crises
Occurs when a country maintains a fixed exchange rate and suddenly has to revalue because of speculative attack of the same product by economists. This results to the common currency crisis or a balance in the payment crisis. This form of crisis may result into a country being unable to repay sovereign debt at the national level (Sharma, 2003). The devaluation default could both be from government or voluntary investor sentiments that may lead to a sudden stop in the capital flight. Another cause, which is last in my list, is the world economic crisis. A recession in the GDP has severe prolonged unnecessary negative growth in the economy resulting to the common economic stagnation. Financial crisis has been the major cause for economic crisis with the great depression being the major contributor of the risk crashes. Another cause of the same was the subprime mortgage crisis, which busted in the real estate bubble leading to economic crisis in the United States.
Causes of financial crisis and their consequences
For a success in any type of investment, each investor should predict on the activity of her competitor. This makes one able to gauge on the other’s reflexivity hence being able to compare the financialmarkets hence a beautiful contest game. In such a situation, each investor can predict the activity of each participant and calculate the available opaque and market disclosure. The habit of business to mimic others is strategic complementary and is a major cause of financial crisis. The main argument on these lines is that when people have the same idea there is usually a self-fulfilling prophecy, which commonly occurs in the incentives.
Leverage
Leverage, which refers to borrowing of financial investment, is the most common cause of financial crises. When an individual or company borrows to invest, he sees the potential of making more profits from the investment a case, which is only true in an instance of success of the business. In case of failure of the business, it creates bankruptcy where the business fails to honor its promises to other firms (Lee, 2008). The failure to honor promise by a business may lead t financial troubles in the other institutions leading to crisis depending on the level of advantage.
Liability mismatch
Another cause of financial crisis is the asset liability mismatch, which is a situation in which the risks associated with debts and assets do not undergo proper alignment. The mismatch between short term and long term is the main cause for bank run. A mismatch may occur in a situation where emerging market governments fail to sell bonds dominated to their own currency hence forced to sell the same in form of dollars, which generates a mismatch in currency denomination of the liabilities and the assets (Kahler, 2008).
Uncertainty and herd behavior
Individual economic psychology and herd behavior are main cause of financial crisis as they result to common mistakes made in investment. Economic reasoning has close relation to the current technical and financial innovations and explains how investors grossly overestimate the asset values. This leads to irrational exuberance in the investment environment and definitely causes financial deregulation (Sharma, 2003). An investor can get many liabilities after overvaluing a product. In instance of selling, the asset to settle outstanding debts the item may fail to realize the estimated amount. This event may cause failure to settle the debts an event, which may result to financial crisis in the correspondent institutions. The herd behavior causes prices of products to spiral up above the actual value of assets making a crash inevitable. Since the gains have no assurance, there is a rush of sale and reinforcement of decrease in prices.
Regulatory failures
Another cause for financial crisis is the failure of government in attempts to eliminate and mitigate regulations of financial sector. Transparency deficiency in governing bodies especially for big financial institutions results to financial statements, which disobey standardized accounting procedures. This situation leads to loss of a lot of money due to fraud instance drag the performances of the institutions hence international financial crisis. Other cause of international financial crisis include contagion which is the idea where financial crisis spread to other institutions due to outstanding occasion is an institution like bank run. Another cause is the recessionary effect where the crisis affects other impact outside the financial sector.
Roles of international monetary fund
The international monetary fund is an institution that tries to stabilize exchange rates and assist the reconstruction of the globes international system after the Second World War. World nations contribute money to the fund to assist other nations especially developing nations with payment imbalances. These nations can borrow money from the international monetary fund for a given period which is usually on long-term basis. One of its duties is to improve the economies of its member nations. It has one hundred and eighty eight member countries currently. Its headquarters are in the United States of America in Washington DC.
The international monetary fund is an institution that gives emergency money to countries that have financial difficulties caused by poor policies or by external factors. These external factors may include; drop in prices of important goods and services, when a neighboring nation is experiencing financial difficulties. Many African and Asian nations benefit from the fund because they are mostly experiencing financial problems. There are high rates of poverty and political instability; these reasons make it hard for the developing nations to have stable economies. Before the international monetary fund lends money to these countries, they do a survey about very important aspects of the country they include; checking the gross domestic product, per capita income and political stability. Countries that experience political instability rarely get the funds that they require this is because the money does not serve the right purpose, which is to develop not to enrich individuals. The problem with many countries that require monetary assistance have a lot of corruption cases and bad leadership and this hinder the international monetary fund from assisting them when they are in dire need of the money.
It tries to promote trade between world nations and securing the economy of the world in general, this occurs through analyzing and advising member countries on the policies that they make. The purpose of advising is to avoid inconsistencies between member nations on the policies they make and common policy mistakes (Tirole, 2002). It influences member state...