Global economic crisis

Abstract

Capitalism, an economic system whereby land, labor, production, pricing and distribution are all determined by the market, has a history of moving from extended periods of rapid growth to relatively shorter periods of contraction.

The ongoing Global Financial Crisis 2008-09 actually has its roots in the closing years of the 20 th century when U.S. housing prices, after an uninterrupted, multi-year escalation, began declining. By mid-2008, there was an almost striking increase in mortgage delinquencies. This increase in delinquencies was followed by an alarming loss in value of securities backed with housing mortgages. And, this alarming loss in value meant an equally alarming decline in the capital of America’s largest banks and trillion-dollar government-backed mortgage lenders (like Freddie Mac and Fannie Mae; the government-backed mortgage lenders hold some $5 trillion in mortgage-backed securities).

The $10 trillion mortgage market went into a state of severe turmoil. Outside of the U.S., the Bank of China and France’s BNP Paribas were the first international institutions to declare substantial losses from subprime-related securities. Just underneath the U.S. subprime debacle was the European subprime catastrophe. Ireland, Portugal, Spain and Italy were the worst hit. The U.S. Federal Reserve, the European Central Bank, the Bank of Japan, the Reserve Bank of Australia and the Bank of Canada all began injecting huge chunks of liquidity into the banking system. France, Germany and the United Kingdom announced more than €163 billion ($222 billion) of new bank liquidity and €700 billion (nearly $1 trillion) in interbank loan guarantees.

Operational and Compliance Risks

Operational risks associated with the global economic crisis are divided into financial and trading operational risks, while compliance risks are divided into debt compliance and reporting compliance and fraud.

Operational Risks

Because the global economic crisis was triggered by skyrocketing sub-prime mortgage foreclosures and subsequent bank lending limitations, financial risks are the primary focus of this subsection followed by a brief discussion of trading operational risks.

Financial Risks:

Financial risks are divided into the following risk categories: capital costs, currency translation, liquidity, commodities, capital availability, and credit ratings. Following is a summary of the major events that have transpired under each financial risk category.

Capital Costs:

Because commercial banks are fearful of lending to high-risk entities, U.S. junk bonds are now trading at more than 14 percentage points above comparable U.S. Treasury bonds relative to a spread of less than 6 percentage points in September 2008. Companies such as Texas-based El Paso Corp., one of the largest U.S. natural gas producers, were recently charged a 15.25 percent interest rate to borrow US $500 million for five years. As a result, delaying near-term growth plans may be an appropriate strategy for companies with junk bond status given exorbitant capital costs.