A study on

Economic crisis

By Shelby shajahan
 CONTENTS

 DEFINITION OF ECONOMIC CRISIS

CAUSES OF FINANCIAL CRISIS

EFFECTS OF ECONOMIC CRISIS

ECONOMIC CRISIS IN AMERIC

ECONOMIC CRISIS IN INDIA

ECONOMIC CRISIS IN U.A.E

ECONOMIC CRISIS IN FUTURE

 DEFINITION

The term financial crisis is applied broadly to a variety of situations in which some financial
institutions or assets suddenly lose a large part of their value. In the 19 th and early 20th
centuries, many financial crisis were associated with banking crisis (banking panic), and
many recessions coincided with these panics. Other situations are often called financial
crisis include stock market crashes and the bursting of other financial bubbles, currency
crisis, and sovereign default. Financial crises directly result in a loss of paper wealth; they
do not directly result in changes in the real economy unless a recession or depression
follows.

Many economists have offered theories about how financial crisis develop and how they
could be prevented. There is little consensus, however, financial crisis are still a regular
occurrence around the world.

Financial crisis are of several types banking crisis, speculative bubbles and crashes,
international financial crisis, wider economic crisis.

Banking crisis

When a bank suffers a sudden rush of withdrawals by depositors, this is called a bank run.
Since banks lend out most of the cash they receive in deposits, it is difficult for them to
quickly pay back all deposits if these are suddenly demanded, so a run may leave the bank
in bankruptcy, causing many depositors to lose their savings unless they are covered by
deposit insurance. A situation in which bank runs are widespread is called a systemic
banking crisis or just a banking panic. A situation without widespread bank runs, but in
which banks are reluctant to lend, because they worry that they have insufficient funds
available, is often called a credit crunch. In this way, the banks become an accelerator of a
financial crisis.

Speculative bubbles and crashes

Economists say that a financial asset (stock, for example) exhibits a bubble when its price
exceeds the present value of the future income (such as interest or dividends) that would be
received by owning it to maturity If most market participants buy the asset primarily in hopes
of selling it later at a higher price, instead of buying it for the income it will generate, this
could be evidence that a bubble is present. If there is a bubble, there is also a risk of
a crash in asset prices: market participants will go on buying only as long as they expect
others to buy, and when many decide to sell the price will fall. However, it is difficult to tell in
practice whether an asset's price actually equals its fundamental value, so it is hard to
detect bubbles reliably. Some economists insist that bubbles never or almost never occur.
International financial crises
When a country that maintains a fixed exchange rate is suddenly forced to devalue its
currency because of a speculative attack, this is called a currency crisis or balance of
payments crisis. When a country fails to pay back its sovereign debt, this is called
a sovereign default. While devaluation and default could both be voluntary decisions of the
government, they are often perceived to be the involuntary results of a change in investor
sentiment that leads to a sudden stop in capital inflows or a sudden increase in capital flight.
Several currencies that formed part of the European Exchange Rate Mechanism suffered
crises in 1992-93 and were forced to devalue or withdraw from the mechanism. Another
round of currency crises took place in Asia in 1997-98. Many Latin American countries
defaulted on their debt in the early 1980s. The 1998 Russian financial crisis resulted in a
devaluation of the ruble and default on Russian government bonds.
Wider economic crises
Negative GDP growth lasting two or more quarters is called a recession. An especially
prolonged recession may be called a depression, while a long period of slow but not
necessarily negative growth is sometimes called economic stagnation.

Declining consumer spending.

Since these phenomena affect much more than the financial system, they are not usually
considered financial crises per se. But some economists have argued that many recessions
have been caused in large part by financial crises. One important example is the Great
Depression, which was preceded in many countries by bank runs and stock market crashes.
The subprime mortgage crisis and the bursting of other real estate bubbles around the world
have led to recession in the U.S. and a number of other countries in late 2008 and 2009.
Nonetheless, some economists argue that financial crises are caused by recessions instead
of the other way around. Also, even if a financial crisis is the initial shock that sets off a
recession, other factors may be more important in prolonging the recession. In
particular, Milton Friedman and Anna Schwartz argued that the initial economic decline
associated with the crash of 1929 and the bank panics of the 1930s would not have turned
into a prolonged depression if it had not been reinforced by monetary policy mistakes on the
part of the Federal Reserve, and Ben Bernanke has acknowledged that he agrees.

CAUSES
MARKET INSTABILITY
The recent market instability 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,
business, and financial institutions .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.
Another main cause of crisis is the expense become more than income.

HOW DID IT GET SO BAD?

Greed: The American Economy is built on credit is a great tool when used wisely. For
instance, credit can be used to start or expand a business, which can be used wisely. For
instance, credit can be used to start or expand a business, which 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.
Thousands of people took out loans larger than 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 than 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.

HISTORICAL BAKGROUND
The initial liquidity crisis can in hindsight be seen to have resulted from the incipient
subprime mortgage crisis, with the first alarm bells being run by the 2006 HSBC results. The
crisis was widely predicted by a number of economic experts and other observers, but it
proved impossible to convince responsible parties such as the Board of Governors of the
federal reserve of the need for action.
 One of the first victims was Northern Rock, a major British Bank. The highly leveraged
nature of its business led the bank to request security from the Bank of England. News of
this lead to investor panic and a bank run in mid-September 2007 calls by Liberal Democrat
shadow chancellor Vince cable to nationalize the institution were initially ignored, however
in feb-2008, the British was taken into public hands. Northern Rock’s problems proved to be
an early indication of the troubles that would soon befall other banks and financial
institutions.

EFFECTS
By year’s end, the impact of global financial crisis of 2008 was starting to be felt in the
developing world, with slowdowns expected in all emerging economies. There growth
declines could have significant effects on the world’s poorest populations. The World Bank
estimates that a 1% decline in developing country growth rates traps in additional 20 million
people in poverty. Reduced economic growth in both countries could reserve poverty
alleviation efforts and even push more people into poverty, say some experts. The financial
crisis has also likely made the achievement of the united Nation’s Millennium Development
Goals (MDGs) on poverty-to halve the proportion of people in extreme poverty by 2015-
more difficult.
In the developing world as a whole, economists say that soaring food and fuel prices
were already placing strain on the poor prior to the onset of the financial crisis. The UN
world program estimated in September 2008 that there are 850 million chronically hungry
people in the world, a tally that could increase by 130 million this year (PDF). The World
Bank estimates that the number of poor increased by at least 100 million as a result of the
food and fuels crisis. It argues that declines in food and fuel prices in late 2008 have not
solved the problem. According to its November 2008 report, the poorest households were
“forced to switch from more expensive to cheaper and less natural and nutritional foodstuffs,
or cut on total caloric intake altogether, face weight loss and serve malnutrition”.
 CRISIS IN USA

In 2005, the personal savings rate in America hit a post Great Depression low of negative
5%-people were spending more than they were earning. The reduced savings rates were
offset at the time by increasing real estate values and a growing national deficit of more
than $9 trillion, which was temporarily propped up by lending from foreign nations.
The basic problem is extreme financial engineering that has been taken too far as people
thought there was no limit to such engineering, as we know to be case of engineering in the
other fields in the real world. Engineering actually involves human skills and physical
materials to get some products, such as a bridge to connect two sides of the river, construct
a house or an airplane to fly. Financial engineering is devising financial products out of
money to sale and buy by financial houses mainly. The modern banking system was the
first such engineering-devising proportional reserve system in banking history. That is
banking keeps 10-20% of depositors’ money cash and they lend the rest to customers at
interest rates to cover the interest to be paid to depositors and dividend to the
shareholders/owners. This is engineering because as an individual no one would borrow
and then lend to someone even if they are well known. It is engineering because what we
do not do individually we allow banks to do that collectively on our behalf. Hence banks are
considered so essential in a modern economy, including their other services.
CRISIS HURTING INDIA-BUT BANKS SAFE

Prime Minister Manmohan Singh has admitted that the global economics turbulence has
begun to hurt India. Singh met top industry leaders and asked them to remain cautious but
also assured them that the banking systems and deposits were safe and the government
would take more steps to protect economic growth.
The government is closely monitoring the evolving macro economic situation and is fully
alive to its responsibilities to sustain the growth momentum of the economy at a reasonable
rate, “the Prime Minister assured industry leaders.
When the financial crisis erupted in a comprehensive manner on Wall Street, there was
some premature triumphalism among Indian policymakers and media persons. It was
argued that India would be relatively immune to this crisis, because of the “strong
fundamentals” of the economy and the supposedly well-regulated banking system. This
argument was emphasized by the Finance Minister and others even when other developing
countries in Asia clearly experienced significant negative impact, through transmission of
stock market turbulence and domestic credit stringency.
The recent crash in the Sensex is not simply an indicator of the impact of international
contagion. There have been warning signals and signs of fragility in Indian finance for some
time now, and these are likely to be compounded by trends in the real economy. So far the
RBI has claimed that the exposure of Indian banks to assets impaired by the financial crisis
is small. According to reports, the RBI had estimated that as a result of exposure to
collateralized debt obligations and credit default swaps, the combined mark-to-market
losses of Indian banks at the end of July was around $450 million. International banks and
financial institutions in the US and EU are important sources of demand for such services,
and the difficulties they face will result in some curtailment of their demand. Further, the
nationalization of many of these banks is likely to increase the pressure to reduce
outsourcing in order to keep jobs in the developed countries.

CRISIS IN UAE
The world financial crisis has hit Dubai’s economy, slamming the brakes on its surging
development and dimming its gold rush status. Development projects are being delayed
tourism is expected to decline and the government is even exploring how to begin collecting
taxes, once almost unthinkable in this freest of free market enclaves.
At the highest levels, Dubai and Abudhabi worked together to transform Dubai into a
global destination for investment and development. But there was also an undercurrent of
competition, with Abudhabi taking a slower, more conservative, with Abudhabi taking a
slower, more conservative, petro-fueled approach while Dubai moved so fast, at times, it
was compared to a theme park.

CRISIS IN FUTURE
 The surging oil prices are not only indication of a coming economic crisis. The rise
in housing prices-what Alan Greenspan called in June “a forth in some local markets”-is a
sign of speculation and overproduction in another fundamental sector of the U.S economy.

Far from reflecting the demand for housing, the boom in housing prices is the result of
monetary intervention by the U.S Federal Reserve. Low interest rates over the past three
years have had the effect of driving for-profit investment into the housing market in the
expectation of high returns.

GROWING SIGNS OF CRISIS

The early signs of the coming economic crisis are already being felt. Inflation –the scourge
of the working class eroding the purchasing power of wages-is on the rise. Unemployment
rose to an official rate of 5% in September-but that does not include the millions who have
been out of work for more than six months.

“Millions of potential workers who dropped out of the labour force during the recession
four years ago have not returned as expected and thus are not counted in the official
unemployment statistics, “the AFX news agency reported on July.

CHALLENGES FOR THE WORKING CLASS

Economic recession and depression lay the objective basis for a class-wide struggle against
the handful of corporate bankers and generals who rule the country. Illusions of “buying in”
to the capitalist system are stripped away in the most brutal way.

Preparing for the crisis is imperative for all working-class organizations. That means, first
and foremost, building a revolutionary party rooted in the day to day struggles of the working
class and oppressed peoples and tested in leading the political struggles against the
capitalist ruling class.