UNIVERSITI MALAYSIA SABAH

LABUAN INTERNATIONAL CAMPUS

GB30403 : CURRENT ISSUES IN INTERNATIONAL AND OFFSHORE BANKING

Current Global Financial Crisis and its Implication on International Financial

Institutions: The Case of US Region

Prepared for:

Mr. Shamsulbahri Bin Mohd Nasir

Prepared by:

GROUP NAME: ROGER FEDERER

NAME MATRIC NUMBER

Sitti Khatijah Binti Yatto BG09110011

Jusrianti Binti Mannu BG09110026

Emmah Binti Ohsou BG09110029

Nur Shelisa Binti Sabrin BG09110140

Intan Waliyya Sari Binti Saidina Ali BG09110239

Nurul Jannah Binti Yusap BG09110341

Nur Azureen Binti Anuar BG09110488

Submission Date: 18 April 2011

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Contents

Abstract .............................................................................................................................................. 2

INTRODUCTION.................................................................................................................................. 3

MOTIVATION AND SIGNIFICATION....................................................................................................... 4

SCOPE OF RESEARCH ....................................................................................................................... 4

LITERATURE REVIEW ......................................................................................................................... 5

FACTORS CAUSES GLOBAL FINANCIAL CRISIS IN UNITED STATES ..................................................... 8

DISCUSSION AND FINDINGS ............................................................................................................... 9

RECOMMENDATIONS ....................................................................................................................... 18

CONCLUSION ................................................................................................................................... 20

RFERENCES .................................................................................................................................... 21

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Abstract

This research aims to identify the global crisis in United States and the performance of the

International Financial Institution (IFIs) before and after the current financial crisis and its implication to

the IFI which is originated in the United States. Most researchers have found that the crisis began with

the world stock market fallen and also resulted from subprime mortgage crisis in US on 2007. During

the crisis it affected the activities of economy, relative price changes, fiscal retrenchment and change in

assets. Some resolution to improve the IFI such as regulating system risk, separating proprietary trade,

information transparency, creating a robust and resilient financial system, capital flow management and

much more has been apply to lower the effect from the crisis. Therefore, it is suggested that the

government or others speculators used this research as guideline for policy maker, reference to

reducing the financial crisis, reference to identify high risk economy experiencing inflation and sources

for speculator. This research evaluates the performance of IFI before the crisis as well as after the

crisis.

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INTRODUCTION

International Financial Institution (IFIs) is the generic name given to all financial institution operating on

an international level. IFIs can be mean to the two Bretton Woods institutions, the International

Monetary Fund and the World Bank, or any multilateral organization with financial operation is an IFI,

for example, the regional multilateral banks, regional authorities, some agencies of the United Nation

Organization that disburse funding and etc. ( Ravi, 2002). The United States is one of the members of

six international financial institutions which is the International Monetary Fund (IMF).

United States enjoys a special position in the IMF and the World Bank. This institution created

with their structure, location, and mandate which is determine by the United States. The United States

had just over a third of the voting power in each institution (Woods, 2003). But it was not lasting longer,

IMF face a global financial crises in 2007. There were many financial crises but the current crisis which

is began in mid 2007 in United States. But there were bubbles dependant growth model in a

surprisingly large number of countries-all now bursting (Roach, 2009). Falling U.S housing prices led to

major problems at U.S subprime lending outfits in turn, thus prompted problems at major U.S financial

institutions and a broad credit squeeze, which affected the global economy. The credit excesses that

created this disaster were global. Here is some example of current financial crisis, on 8 April, the IMF

illustrates the magnitude of the present crisis, mark-to market losses on mortgage-backed securities,

collaterized debt obligations, and related assets through March 2008 approximate $945 billion. In

absolute terms this represents the largest financial loss in history, exceeding asset losses resulting

from Japan‟s banking crisis in the 1990s ($780 billion) and far surpassing losses emanating from the

Asian crisis of 1997-1998 ($420 billion) and the U.S savings and loan crisis of 1986-1995($380 billion) (

Barlett, 2008).

The globalization move very fast and its negative impact are even faster. In this context the

„rapid global integration and deep and complex interconnection between financial institutions, the crisis

quickly moved assets, markets and economies. The rest history or, more precisely, history in the

making‟ (Blanchard, 2008). U.S is such a huge part of the global economy, as it shrinks; the entire

global economy will go into recession. In Europe, Canada, Japan and the other advanced economies, it

will be severe (Roubini, 2009).

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The objectives of this research are:

1. To identify the performance of international financial institution.

2. To determine the causes of the global financial crisis in United States.

3. To identify the implications of global financial crisis in United States to the international financial

institution.

MOTIVATION AND SIGNIFICATION

Our research can be used to reduce the effects of financial crisis either before, during or after the

financial crisis. Our research can be used as guidelines for policy makers, reference to reducing the

financial crisis, sources for the speculators to make an investment and as the reference to identify high-

risk economy experiencing inflation.

SCOPE OF RESEARCH

Our research is about the implication current global financial crisis to the international financial

institution. We are focus on the United Stated financial institution and several countries that have been

affected from the United Stated crisis.

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LITERATURE REVIEW

The global financial crisis, brewing for a while, really started to show in the middle of 2007 and into

2008. Around the world stock markets have fallen, large financial institutions have collapsed or been

bought out and governments in even the wealthiest nations have had to come up with rescue packages

to bail out their financial systems. The “global financial crisis” also called as global financial, global

financial turmoil mainly resulted from subprime mortgage crisis of 2007 (Gupta, 2010). Owing to its

severity it has been labeled as the worst crisis since the Great Depression (Smolo and Mirakhor, 2010).

Subprime lending crisis, which began in the US has become a financial contagion and has led

to restriction on the availability of credit in world financial markets. Hundreds of thousands of borrowers

have been forced to default and several major subprime lenders have filed for bankruptcy (Gupta,

2010). On July 11, 2008, the largest mortgage lender in the US collapsed which is Indy Mac Bank‟s

assets were seized by federal regulators after the mortgage lender succumbed.

One of the factors that effects to global financial crisis is the miss-pricing of risk. According to

Goodhart (2008) the international financial institutions (IFIs) give very low interest rates from 2001 until

2005. This under-pricing of risk had resulted from the long period of extraordinarily low nominal and

very low real interest rates that had continued from the ending tech bubble in 2001, until central banks

generally began to raise interest rates again in 2005. The fear of defilation and the savings glut led to a

period of expansionary monetary policies, with nominal policy interest rates at very low levels and with

accelerating monetary growth in several countries (Goodhart, 2008). Another factor is the new financial

structure. The last 10 years have seen enormous strides in the development and extension of new

forms of securitization and the growing use of derivatives of all kinds. This has been combined with a

revised banking strategy, that began in the USA, but has spread recently to Europe and abroad which

is this goes by the general title of „Originate and Distribute‟ (Goodhart, 2008). From Gupta (2010) he

had two reasons that are bets tied to residential real estate and role of proprietary trading. On a reason

bets tied to residential real estate there a large number of banks and other major intermediaries

managed to increase risks by exploiting loopholes in regulatory capital requirements to take highly

leveraged (Gupta, 2010). This is one-way bet on the economy. Besides bet among bank are popular

residential real estate, commercial real estate and consumer credit also one of the popular bets. When

things went wrong, many companies were so large that there were no easy bankruptcy procedures nor

any way of ensuring they continue to perform their financial plumbing while in bankruptcy (Gupta,

2010). The second reason is role of proprietary trading. Proprietary trading is used in banking to

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describe when the firm‟s traders actively trade stocks, bonds, currencies, commodities, their derivatives

or other financial instruments with their own money as opposed to its customers‟ money, so as to make

a profit for itself. Some of the trenches remained in the “warehouse” of banks (Gupta, 2010). They will

pay premium due to the aggregate nature of their risk, their liquidity and the low cost of short-term debt.

Soon, banks will convert the warehouse into a “principal or prop-trading activity, allocating capital to

build-up of more exposure (Gupta, 2010).

From this factor, it‟s give impact to financial systems. First effect is economic activities will

slowdown, relative price changes, fiscal retrenchment and change in assets (Baldacci, Mello and

Inchauste, 2002). In particular, any small panic-trading signal can become a precipitated factor for

investors, leading to an overall loss of confidence and an increase in the perceived risk of holding a

range of investments in different equities (Chung, 2004). Different with Gupta (2010), the implications of

the crisis is the global slump in economic growth triggered by the financial crisis also has adverse

consequence for government revenues through the operation of automatic stabilizers. If economic

activity recovers relatively soon, the impact of lower revenues should not raise major concerns. But

should the slowdown turn into a prolonged recession, the impact for sustainability of public finances

would be far more severe. According to Hilb (2010), from the global financial crisis there is a lesson to

IFIs it is keep it controlled. The global financial crisis had shown that many boards exhibit weakness in

terms of controlling, ethical compliance and risk management. The crisis has illustrated that for publicly

traded companies, the greatest area for improvement is not within ethical compliance. This implies that

not everything that is abided by law corresponds to legitimate action (Hilb, 2010).

After the global financial crisis happen there will be new challenges. According to Gupta (2010),

first is sectored balance sheet data. The availability of data on the assets and liabilities of non-bank FIs,

non financial corporations and the household sectors needs to be improved. The crisis highlighted the

need to capture activity in segments of the financial sector where the reporting of data is not well

established and in which sizable risks may have developed. A solid accounting framework (along the

lines of the public sector accounting principles, which are compatible with the IMF‟s Government

Finance Statistics Manual (GFSM), 2001) is a core building block. Second challenge is leverage and

liquidity (Gupta, 2010). The high levels of leverage (assets to capital) that built up in the economic

system and the de linking of financial cross-border from real activity for industrial countries are another

feature of the recent crisis (Gupta, 2010).

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Gupta (2010) had recommend some resolution to improve the resolution of a failing IFI that has

cross-border, there are regulating system risk, separating proprietary trade, information transparency,

creating a robust and resilient financial system, capital flow management and much more.

The global financial crisis has been one of the excessive leverage, a problem to which the

global imbalances have been a major contributor. Lessons we have learned may collide with the reality

of messy national and global politics, but one thing we have learned painfully is that in this

interconnected global financial world, we will ultimately sink or swim together.

PERFORMANCE OF INTERNATIONAL FINANCIAL INSTITUTION

There are a few strategies in the IMF‟s medium-term. First is surveillance, which is the IMF is

enhancing the effectiveness of surveillance through greater focus, candor and even-handedness. The

medium-term strategy is proceeding on two parallel tracks: implementation of surveillance and

development of its legal basis. Second strategy is emerging market economies. The IMF is

strengthening its advice on financial sector and capital market issues and considering the adequacy of

instruments to support members, as well as the possibility of a new contingent financing instrument for

crisis prevention. Third strategy is capacity building. The IMF is improving alignment with members‟

needs and its own strategic priorities, taking advantage of complementarities with other providers. Last

strategy is governance, which is work in the area of governance is currently focused on reform of

quotas and voice; other priority issues include the management selection process and the role of the

IMF Executive Board.

Countries are now setting clear goals and targets linked to public actions, improving their

budgeting and monitoring systems and opening the public space to a more inclusive discussion of

national priorities and policies.

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FACTORS CAUSES GLOBAL FINANCIAL CRISIS IN UNITED STATES

The recent market instability in United Stated was caused by many factors, chief among them a

dramatic change in the ability to create new lines of credit, which dried up the flow of money and

slowed new economic growth and the buying and selling of assets. This hurt individuals, businesses,

and financial institutions hard, and many financial institutions were left holding mortgage backed assets

that had dropped precipitously in value and weren‟t bringing in the amount of money needed to pay for

the loans. This dried up their reserve cash and restricted their credit and ability to make new loans.

There were other factors as well, including the cheap credit which made it too easy for people to buy

houses or make other investments based on pure speculation. Cheap credit created more money in the

system and people wanted to spend that money. Unfortunately, people wanted to buy the same thing,

which increased demand and caused inflation. Private equity firms leveraged billions of dollars of debt

to purchase companies and created hundreds of billions of dollars in wealth by simply shuffling paper,

but not creating anything of value. In more recent months speculation on oil prices and higher

unemployment further increased inflation.

Besides that, greed also factors occur financial crisis in United Stated. The American economy

is built on credit. Credit is a great tool when used wisely. For instance, credit can be used to start or

expand a business, which can create jobs. It can also be used to purchase large ticket items such as

houses or cars. Again, more jobs are created and people‟s needs are satisfied. But in the last decade,

credit went unchecked in our country, and it got out of control. Mortgage brokers, acting only as middle

men, determined who got loans, then passed on the responsibility for those loans on to others in the

form of mortgage backed assets. Exotic and risky mortgages became commonplace and the brokers

who approved these loans absolved themselves of responsibility by packaging these bad mortgages

with other mortgages and reselling them as investments. Thousands of people took out loans larger

than they could afford in the hopes that they could either flip the house for profit or refinance later at a

lower rate and with more equity in their home which they would then leverage to purchase another

“investment” house. A lot of people got rich quickly and people wanted more. Before long, all you

needed to buy a house was a pulse and your word that you could afford the mortgage. Brokers had no

reason not to sell you a home. They made a cut on the sale, then packaged the mortgage with a group

of other mortgages and erased all personal responsibility of the loan. But many of these mortgage

backed assets were ticking time bombs. And they just went off.

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The housing slump set off a chain reaction in U.S economy. Individuals and investors could no

longer flip their homes for a quick profit, adjustable rates mortgages adjusted skyward and mortgages

no longer became affordable for many homeowners, and thousands of mortgages defaulted, leaving

investors and financial institutions holding the bag. This caused massive losses in mortgage backed

securities and many banks and investment firms began bleeding money. This also caused a glut of

homes on the market which depressed housing prices and slowed the growth of new home building,

putting thousands of home builders and laborers out of business. Depressed housing prices caused

further complications as it made many homes worth much less than the mortgage value and some

owners chose to simply walk away instead of pay their mortgage.

DISCUSSION AND FINDINGS

The causes of the financial crisis are various. No one “cause” can be singled out as the main culprit.

Rather, the crisis was the result of a continuum of interrelated causes and contributing circumstances

that evolved and interacted in complex ways over time.

The crisis generally is considered to have begun in 2007, reached a critical point in 2008, and

continues in 2009. Different factors played a role at different stages of the crisis. Some may be

considered root causes while others only aggravating circumstances. At times, the crisis seemed to ebb

and flow and had various cascading effects, engulfing otherwise healthy institutions and revealing

weaknesses in the systems that were not perceived as such earlier. Different phases of the crisis

challenged institutions and their regulators in different ways.

Some experts have blamed the financial crisis on “subprime lending.” Yet, absent low interest

rates and government policies that subsidized the housing market, the supply and demand for

subprime lending and exotic mortgages might have remained on a scale inconsequential to the larger

financial system. Absent securitization as a means of selling mortgages to banks and investors,

mortgage originators might have applied more prudent credit underwriting standards and not made so

many loans dependent on questionable sources of repayment. Absent the ability to sell mortgage-

backed securities to investors, securitizes might not have purchased the loans or would have been

more cautious in doing so. Absent credit default swaps and triple-A ratings by credit ratings agencies,

investors might not have purchased the mortgage-backed securities and the “toxic assets” might not

have spread so widely through the financial system. This causal chain of events is oversimplified and

incomplete, but illustrates the difficulty of isolating any one cause as the main perpetrator. Other factors

contributed to the financial collapse, including excessive leveraging by financial institutions and

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American consumers, a global credit imbalance, the size and interconnectivity of financial institutions,

regulatory gaps and lapses in supervisory oversight, flawed risk management and corporate

governance within individual financial institutions, and overly strict application of mark-to-market

accounting rules that distorted bank balance sheets in a pro cyclical way. Underlying all of this were

government economic and social policies and political pressures that contributed to the build-up of

causal forces.

Several causes have been highlighted by various analysts. While no consensus has yet emerged as to

the exact causal factors, the following reasons have been mentioned in the following sections.

a) An interest-based and debt-driven financial system

The current financial system is predominantly interest-based and debt-driven. Both Keynes and

Minsky argued that a system dominated by interest-based debt contracts is inherently unstable.

Minsky (2008) pointed out that an arrangement “in which borrowing is necessary to repay debt is

speculative finance”. Further, he called the banks “merchants of debt”. Interest and debt are the two

fundamental causes of banking instability and, as such, fundamental causes of the current financial

crisis.

b) Subprime mortgages and securitization

The initial trigger of the crisis was the dramatic fall of housing prices and defaults on subprime

mortgages (Allen and Carletti, 2008). Through the process of securitization, the financial institutions

devised new products, packaged them and sold them in the market. In the early 1990s, there were

no subprime mortgages. But one result of the adoption of the now infamous “originate and

distribute” model was that subprime mortgage originations rose to $625 billion in 2005 from zero in

1993, with an average annual growth rate of 26 percent during that period. Gramlich, 2007 called

this market the “Wild West”.

While subprime mortgages were on the rise, securitization lengthened the distance between

borrowers and lenders. Underwriting standards deteriorated dramatically as the major players in the

“originate and distribute” model were also those in the “shadow banking system” (Yellen, 2009).

Thus, the securitization process did not make new instruments safer, as was suggested by the

rating agencies, because they were basically credit-debt instruments closely correlated with

movement in prices of underlying assets such as houses.

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Sources : US Census Bureau, Harvard University-State of the Nation‟s Housing Report 2009

c) Monetary policy and low interest rates

It is believed that “abnormally low interest rates” over a prolonged period prior to the crisis

combined with excessive and easy monetary policy paved the way for the emergence of the crisis

(Kashyap et al., 2008). Low interest rates made mortgage payments cheaper, which in turn

increased demand for homes, leading to higher house prices. In addition, existing home owners,

lured by the lower interest rate, started to refinance their existing mortgages to cash out as much as

and as fast as possible.

d) Credit growth and predatory techniques by lenders

According to the Bank for International Settlements (BIS), the fundamental cause for the current

global financial crisis lies in “excessive and imprudent credit growth over a long period” (BIS, 2008,

p. 143). As a direct result of the exceptional boom in credit growth over the years, financial

institutions searching for higher and higher profits adopted predatory lending, increasingly non-

transparent instruments and off-balance-sheet operations to avoid capital and liquidity regulation

(Aziz, 2008). Although default cases were on the rise in 2006, banks did not slow down on lending.

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e) The complexity and mispricing of the risks of new products

The decade prior to the crisis was marked by financial engineering and innovation of new products.

Although financial innovation can contribute to the growth of the economy and benefit the society, it

could also cause enormous damage as it creates new instruments whose risks are less

understood, assessed and regulated (Ahmed, 2009). Owing to the increased complexity of financial

products and markets, regulators, supervisors and market participants in general failed to

effectively evaluate the inherent risks (Ahmed, 2009). Some would say that the crisis was not due

to the complexity of the new products as much it was due to mispricing of the risks of these

products. Be that it as it may, the crisis exposed the inadequacy of the risk management practices

of many financial institutions.

f) Liquidity, leveraging and the fear of contagion

The current crisis also revealed the importance of liquidity risk management and leveraging.

Liquidity risk management is important due to its role in maintaining institutional and systemic

resilience in the face of shocks and, conversely, due to the system-wide contagion caused by

liquidity shock to a single institution. Once the US financial crisis began, the panic spread

worldwide. The resulting uncertainty and lack of liquidity made banks more averse to risk, as they

were afraid of contagion (Hassan and Kayed, 2009). Furthermore, with the complexity and opacity

of credit instruments, the interbank market froze, forcing financial institutions into deleveraging.

g) Regulatory and supervisory failures

Lack of both supervision and regulation of the financial sector played an important role in the crisis.

This led to the growth of unregulated exposures, which further led to excessive risk-taking and

weak liquidity risk management (Aziz, 2008). It is now evident from the crisis that the regulatory and

supervisory frameworks of leading economies were incomplete and inefficient (Jordan and Jain,

2009, October).

h) Transparency and disclosure

The complexity of the new products and the lack of transparent information sent wrong signals to

market players, leading to underestimation of the risks involved. This led to overleveraging and

excessive borrowing. Once market confidence was shaken, panic in the market became inevitable

since no one had a clear idea of the depth of the problems.

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i) The role of rating agencies

Rating agencies were assumed to play the role of guardians of the market. They were thought to be

market-filters, making sure that full and accurate information are available to the market. However,

credit rating agencies were consulted, for a fee, on design and structuring of new products by those

who participated in the packaging and distribution of complex credit-derivative instruments. This

created competition between rating agencies that led to a deterioration of credit standards

(Mirakhor and Krichene, 2009).

j) The effect of financial globalization

Although the current financial crisis started in the USA, the negative effects were felt all over the

world. Financial integration and the internationalization process that had begun in earnest in the

second half of the 1980s picked up accelerated momentum in the 1990s, creating strong

international linkages. These linkages, unfortunately, were mostly reliant on investment through

financial intermediaries, banks and “shadow banks” – in credit-derivatives, particularly subprime

instruments. Once the housing credit market collapsed in the USA, panic spread rapidly and leads

to paralyzing the international financial market.

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Impacts to the Financial Institutions

The International Monetary Fund estimated that large U.S. and European banks lost more than

$1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are

expected to top $2.8 trillion from 2007-2010. U.S. banks losses were forecast to hit $1 trillion and

European bank losses will reach $1.6 trillion. The International Monetary Fund (IMF) estimated that

U.S. banks were about 60% through their losses, but British and euro zone banks only 40%.

One of the first victims was Northern Rock, a medium-sized British bank. The highly leveraged

nature of its business led the bank to request security from the Bank of England. This in turn led to

investor panic and a bank run in mid-September 2007. Calls by Liberal Democrat Treasury Spokesman

Vince Cable to nationalize the institution were initially ignored; in February 2008, however, the British

government failed to find a private sector buyer relented, and the bank was taken into public hands.

Northern Rock's problems proved to be an early indication of the troubles that would soon be fall other

banks and financial institutions.

Initially the companies affected were those directly involved in home construction and mortgage

lending such as Northern Rock and Countrywide Financial, as they could no longer obtain financing

through the credit markets. Over 100 mortgage lenders went bankrupt during 2007 and 2008. Concerns

that investment bank Bear Stearns would collapse in March 2008 resulted in its fire-sale to JP Morgan

Chase. The financial institution crisis hit its peak in September and October 2008. Several major

institutions failed, were acquired under pressure, or were subject to government takeover. These

included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia,

Citigroup, and AIG.

Beginning with bankruptcy of Lehman Brothers on September 14, 2008, the financial crisis

entered an acute phase marked by failures of prominent American and European banks and efforts by

the American and European governments to rescue troubled financial institutions, in the United States

by passage of the Emergency Economic Stabilization Act of 2008 and in European countries by

infusion of capital into major banks. Afterwards, Iceland almost claimed to go bankrupt as the country's

three largest banks, and in effect financial system, collapsed. Many financial institutions in Europe also

faced the liquidity problem that they needed to raise their capital adequacy ratio. As the crisis

developed, stock markets fell worldwide, and global financial regulators attempted to coordinate efforts

to contain the crisis. The US government composed a $700 billion plan to purchase nonperforming

collaterals and assets. However, the plan failed to pass because some members of the US Congress

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rejected the idea of using taxpayers' money to bail out Wall Street investment bankers. After the stock

market plunged, Congress amended the $700 billion bailout plan and passed the legislation. The

market sentiment continued to deteriorate, however, and the global financial system almost collapsed.

While the market turned extremely pessimistic, the British government launched a 500 billion pound

bailout plan aimed at injecting capital into the financial system. The British government nationalized

most of the financial institutions in trouble. Many European governments followed suit, as well as the

US government. Stock markets appeared to have stabilized as October ended. In addition, the falling

prices due to reduced demand for oil, coupled with projections of a global recession, brought the 2000s

energy crisis to temporary resolution. In the Eastern European economies of Poland, Hungary,

Romania, and Ukraine the economic crisis was characterized by difficulties with loans made in hard

currencies such as the Swiss franc. As local currencies in those countries lost value, making payment

on such loans became progressively more difficult.

As the financial panic developed during September and October 2008, there was a "flight-to-

quality" as investors sought safety in U.S. Treasury bonds, gold, and currencies such as the US dollar

(still widely perceived as the world‟s reserve currency) and the Yen (mainly through unwinding of carry

trades). This currency crisis threatened to disrupt international trade and produced strong pressure on

all world currencies. The International Monetary Fund had limited resources relative to the needs of the

many nations with currency under pressure or near collapse. A further shift towards assets that are

perceived as tangible, sustainable, like gold or land (as opposed to “paper assets”) was anticipated.

However, as events progressed during early 2009, it was U.S. Treasury bonds which were the main

refuge chosen. This inflow of money into the United States translated into an outflow from other

countries restricting their ability to raise money for local rescue efforts.

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Implication to the United States economy

Began in August 2008, financial institutions in the United States (U.S.) began to show failure due to the

global financial crisis the worst since the Great depression. As a result, the US had to bear the excess

payment of expenses using the foreign loans, with carrying out the average current account deficit of

6%, as a proportion of gross national product (GDP), in 2003 to 2007. Following from these US

financial institutions have a larger experienced significant liquidity in consumer credit and mortgages.

Credit boom occurred in the US due to added further fuel and recycle of Asia surplus through the

purchase of US Treasury. This situation contributes to the imbalance in the economy enemies led to

the current account deficit in the United States.

In addition to the cost of household borrowing in the US started to decline since January 2001

to June 2004 as a result of the recession in 2001. Starting in the summer of 2006, once the interest

rates began to rise, the house prices in the US began to show the fall in value and thus lead to higher

subprime defaults. As a result refinancing became increasingly difficult and the number of foreclosed

homes also began to rise. Since this many financial institutions began to affected, especially institutions

with large exposures to subprime-related structured products such as Washington Mutual. This

situation has been a worsening liquidity problems as a result of that started freeze occurred in the

interbank market transactions globally. In September and October 2008 crisis sub-prime mortgage

relatively benign began to spread to other financial institutions and also affect real economic situation.

This case is due to global metastasis through trade and capital flows channel and then began to lead to

economic failure around the world.

Between 2008 and early 2009 securities suffered huge losses due to loss of investor

confidence on global stock markets and a decline in credit availability. GDP in the major industrial

countries and the IMF projects started showing shrinkage or reduction. Due to a decline in consumption

and business investment has led to a decline in US wealth. Between June 2007 and November 2008,

America lost an average of more than a quarter of the estimated collective value of their net. Housing

bubble has resulted in an increase of US home mortgage debt relative to GDP increased in 2008. This

is because cash back is for users of home equity extraction doubled in 2005. Crisis in US home owners

have taken a substantial equity in their homes.

Meanwhile, effect global financial crisis to insurance companies is, when the sovereign local

currency rating constrains the financial strength ratings on U.S. insurers because their businesses and

assets are concentrated in the U.S., including a large proportion of U.S. backed holdings. However, if

any changes to the U.S. sovereign credit rating would have a less direct and slower impact on global

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insurance companies with well-diversified assets outside the U.S. In U.S clearinghouses and the central

securities depository CSD, the sovereign rating also constrain the rating on U.S. clearinghouses and

CSD ratings because their clearing business is concentrated in the domestic market and is correlated

with the U.S. economy (Bank Ratings Framework, 2011).

In U.S. government-supported entities (GSEs), it have a close tie to sovereign ratings because

they are often partially or totally controlled by a government, and they also help to implement policies or

deliver key services to the population and ratings on Temporary Liquidity Guarantee Programs (TLGP)

debt have a close tie to the U.S. sovereign credit rating, this is because the Federal Deposit Insurance

Corp. (FDIC) guarantees this debt. The effect in U.S banks and broker/dealers, the impact is a change

to the U.S. sovereign rating could have on banks and broker/dealers ratings likely could depend on the

confidence sensitivity of their funding profile and could affected by their various indirect and direct

exposures to U.S. Treasuries. A part from that, any rating action on these companies likely could reflect

the severity of any movement in short-term rates since these companies rely on the liquidity of the

short-term funding markets (Bank Ratings Framework, 2011).

Effect on U.S. traditional and alternative asset managers, the expectation on short-term funding

disruption could have minimal ratings implications for traditional and alternative asset managers. While,

these asset managers are more closely tied to the performance of the equity and fixed-income markets.

Lastly, in U.S finance companies, the impact is the decreased viability of the wholesale funding market

could hurt U.S finance companies as economic and market factors reduce profitability, and leading to

the liquidity concerns (Bank Ratings Framework, 2011)

China has enjoyed one of the world‟s fastest growing economies and China also has been a

major contributor to world economic growth (Morrison, 2009). The current global financial crisis has

threatens to significantly slow the China economy. Several of the Chinese industries majoring in export

sector have been hit hard by crisis and millions of workers have reportedly been laid off. The global

financial crisis has give effect to United States and China relationship. As we know, U.S and China are

two of the dominant economies in the world. These two economies are become increasingly integrated

with each other through the flows of goods, financial capital and people. The effect of global crisis has

make the relationship between both of them become international attention. In addition, U.S and China

are together epitomizing the sources and dangers of global macroeconomic imbalance. The crisis is

likely to strengthen the hold between two economies (Prasad, 2009).

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RECOMMENDATIONS

a) Regulating systemic risk

From an economic point-of-view, the best solution to contain the excessive systemic risk created

by too-big-to-fail institutions is to charge them upfront for the implicit taxpayer guarantees they

enjoy. They should pay a fee both for their expected losses in the event of failure and for expected

losses when failure occurs in the context of a systemic crisis which could be broadly defined as the

financial system as a whole becoming undercapitalized. Indeed, such a structure of the fee can be

shown to be optimal in a setting where there is a negative externality on the real sector whenever

there is a systemic crisis. The key point is that, when faced with these fees, the IFI will on the

margin choose to hold more initial capital which be less levered, take less risky positions and

organically choose to become less systemic.

b) Separating proprietary trade

Separating commercial banking from proprietary trading is a way of containing the moral hazard

arising from government guarantees not just from actions of financial firms that receive the

guarantees, but through competitive pressures, also through actions of other firms in the financial

sector. The point is that when risks are not perfectly seen and new ones are created innovations

by banks to get around any restricting regulation a blunt isolation of the government guarantees

provides an additional firewall against systemic risk.

c) Information transparency

Data dissemination standards can enhance the availability of timely and comprehensive statistics,

and so contribute to the design of sound macroeconomic policies. The IMF has taken several steps

to help enhance information transparency and openness including the establishment and

strengthening of data dissemination standards to help member country policymakers prevent future

crises and diminish the effect of those that occur. The standards for data dissemination consist of

two tiers, the special data dissemination standard (SDDS) and the general data dissemination

system (GDDS). The SDDS was established in 1996 to guide emerging market economies that

have, or might seek, access to international capital markets, while the GDDS was established in

1997 to help countries provide more reliable data. Both are voluntary, but once a country subscribes

to the SDDS, observance of the standard becomes mandatory. Countries must also agree to post

information about their data dissemination practices on the IMF‟s external website on. Dissemination

19

standards bulletin board (DSBB), and establish an Internet site containing the actual data, called a

National Summary Data Page, to which the DSBB is linked. The IMF notes that approximately 81

percent of its membership participates in the new data initiatives.

d) Creating a robust and resilient financial system

The presence of a sound financial system which is comprising banks, security houses, securities

exchanges, pension funds, insurers, and alternative investment vehicles that is essential to support

sustainable economic growth and development, and the role of the central bank and national

supervisors/regulators is critical in promoting financial stability to achieve stable, sustainable growth

of the world economy it is necessary to facilitate information exchange among major financial

centres and strengthen international cooperation on financial market supervision and surveillance.

e) Capital flow management.

Economies with relatively open capital accounts face the challenge of managing potentially volatile

and pro cyclical capital flows. Large and rapid inflows of mobile capital can suddenly stop or even

reverse themselves and, thus, threaten domestic macroeconomic and financial-sector stability.

The authorities may use a combination of several policy options to contain or mitigate the impact of

large, disruptive capital inflows. They may, for example: accumulate foreign exchange reserves

through sterilized interventions, as a short-term measure to cushion the impact of future reversals

of capital flows; introduce greater exchange rate flexibility, leading to currency appreciation and

stemming speculative inflows; encourage capital outflows, to lessen the upward pressure on the

currency and the need for costly sterilized interventions. There is no silver bullet solution, and

policymakers need to find the best combination for their countries given the specific country

conditions.

f) Internationalization of currencies

Emerging economy governments are often cautious in internationalizing their currencies as traders

can use offshore markets for speculative activities. Policymakers should apply an integrated set of

rules and regulations to prevent an overly active offshore market for domestic currencies, with the

support of international organizations where appropriate choice of an exchange rate regime.

20

CONCLUSION

According to Somolo and Mirakhor (2010) the crisis in US in the mid 2007 are the worst since the Great

Depression. This supported with Gupta (2010) in his research show how US has become a financial

contagion and has led to restriction on the availability of credit in world financial markets. Many factor

such as subprime lending crisis, miss-pricing risk, under-pricing risk, become a reason for the global

financial crisis in US. The crisis gives impacts to the activities economy will slow down, relative price

changes, fiscal retrenchment and change in assets (Baldacci, Mello and Inchauste, 2002). But this is

different with Gupta (2010), the implications of the crisis is the global slump in economic growth

triggered by the financial crisis also has adverse consequence for government revenues through the

operation of automatic stabilizers. In overall, the crisis gives effects to every sector.

Many ways have been suggested to settle the problem of financial crisis. According to Chapra

(2008), he suggested three critical steps in an effective system of checks and balance that will help

avoid making mistakes similar to those which led to the current crisis. The three critical steps are (1)

establishing moral constraints on greed to maximize profit, wealth and consumption, (2) strengthening

market discipline that will exercise a restraint on leverage, excessive lending and derivatives and (3)

reforming the system‟s structure combine with prudential regulation and supervision to prevent crises,

achieve sustainable development and protect social interest. This solution almost same with Gupta

(2010), Gupta recommend some resolution to improve the resolution of a failing IFI that has cross-

border, there are regulating system risk, separating proprietary trade, information transparency,

creating a robust and resilient financial system, capital flow management and much more. The IFI

played an important in countercyclical financing and in financing emerging develop needs. In 2008, the

IMF has taken the lead with its strong encouragement of additional fiscal stimulus in countries with

healthy balance of payment and public debts profile. This is one example how the IFI stabilized the

markets after the crisis. Besides, in The Global Monitoring Report (2009), the IMF moved quickly to

establish a new Flexible Credit Line (FCL) to provide large and up-front financing to emerging

economies with very strong fundamental and policies.

21

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