finance
US and Europe: Spread Collapse of Japanese
The
of the US Subprime Asset Price Bubble
Mortgage CrisIs(2008) (1990s)
CreditCrunch
Speculative Attack on
Mexican Economic Crisis:
currencies in the Europe-
Speculative Attack and
an Exchange Rate Mecha-
Default on Mexican
nism (1992-1993)
Debt (1994-1995)
What caused the Greatest Economic Crisis in History?
A year after the biggest financial crisis the world has ever faced, Dubai’s recent
debt default is a reminder that the aftershocks still haven’t passed. Talha Ghannam
investigates cause behind the greatest economic crash in history.
Unlike previous crises, the premise upon which the econ- as many banks lost billions of dollars invested into Sub-Prime
omy stands has been shaken with every institution and mortgages. As a result, banks began lending much less as it
country affected either directly or indirectly. The cause; a became impossible to tell which assets still held value and which
financial system built upon risk, interest and greed, driving peo- did not. This is known as a credit crunch.
ple to make the decisions on investments driven by self gain in This failure in the economic system demonstrates a rather
the short run. scary reality into how so much of our finance is dealt with in
Over the last few decades, the world financial system has this way Many of the banks have outgrown their own coun-
developed a series of complex financial tools; derivatives, CDIs try in size and money. In a recent report by Citi Research,
(Credit Default Swaps) and short selling to name a few. The aim: Kaupthing Bank was evaluated at 500% the value of its country,
to minimise investment risk, allow for easier trading and bring Iceland, with UBS coming second at around 380% of the Swiss
US Savings and Loans
greater profits to investors. However, these have also had an economy. When institutions grow so large, they outgrow any
Crisis (1989-1991)
Asian Financial Crisis:
adverse side effect, building a market of “speculation”, relying regulation that countries could have upon them, as was shown Devaluations and Bank-
on the prices of shares rather than the quality of the companies by the bankruptcy of Iceland last year. If a bank is too big to fail,
ing Crisis across Asia
(1997-1998)
that run them. it’s too big to exist.
This has led to many “bubbles” over the last century as peo- The bank-client model should also be mentioned as in the
ple became blinded by rising prices and failed to see the falling last 10 years it’s moved away from looking at “how we can help
demand for the good. This occurred most famously in the Great our client tomorrow” to “how much commission we can make
Depression of the 1930s, but has repeated many times since then from them today”. This short term thinking has led to excessive
such as the Asian Financial crisis in 1998 and the “dot-com” bub- risks and rogue traders which have cost the economy billions, Argentine Economic
ble in 2000. These are described as “boom and bust” periods in with the most famous case, Jérôme Kerviel, amassing an esti-
Crisis: Breakdown of
Banking System
Russian Financial Crisis:
the economy, something politicians and financier have long mated loss of $7.2bn singlehandedly. (1999-2002)
Devaluation of the Ruble
and Default on Russian
tried to eliminate. However, it is not simply the failure of the banks that led to
Debt (1998)
The root cause behind these crises lie in three things; exces- the crisis. The blame must also lie with the short term thinking
sive risk, interest and greed. This begins with a product which of housing manufacturers for their over supply in the market,
Latin America in Debt
Crisis - Beginning in
has maintains high demand over several years, bringing a sus- particularly in the US. Also, the consumerist attitude in the Mexico (1980s)
tained price increase and creating a confidence that it would general public has led to a credit spending culture by both gov-
continue to do so in the future. In the current crisis the product ernment and consumers. The public were generally too greedy
was housing, rising more than tenfold in price in the UK and in taking these loans and borrowed excessively to fuel lavish
many more in other areas of the world over the last few decades, lifestyles, becoming all too willing to indulge in credit they did
creating a perception that it would never fall. This led onto not own.
years of lax lending as the assumption was that the value of the As global leaders meet to plan how the world will go forward
house would secure the lender’s costs should the buyer default. from here, I fear they will yet again ignore the underlying prob-
People borrowed and invested into more property, as well as lem behind the entire crisis; the system itself. So much of the
fueling consumer spending. The USA caused particular diffi- trading done is devoid of many moral principles which should
culties as banks lent billions to those with poor credit ratings underlie any transaction and add fuel to another future crisis if
– Sub-Prime borrowers - believing that the growing housing they are not resolved. From basic principles such as interest to
market would guarantee the debt if the borrower defaulted. more complicated financial tools like short selling and deriva-
Between 2004 and 2006, interest rates rose from 1% to 5.25% tives, it is easy to see why such a system is flawed.
in the US as the Federal Reserve tried to curb rising inflation As Islamic finance grows, we see the emergence of a more
rates. By 2007, a dramatic rise in mortgage delinquencies and principled way of transaction. Estimated at $1trillion, the
foreclosures in the United States sparked the beginning of a industry has potential to grow to prominence with key estab-
downward spiral that would lead to the greatest financial crisis lishments such as General Electric favouring the Islamic Sukook
the world is yet to see. This created a worldwide knock on effect bond over the normal commercial bond worth $500m. In
76 emel magazine |
www.emel.com
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