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Introduction
The capital markets in the world are experiencing the worst crisis since 1929. This crisis originated from the subprime mortgage crisis of the United States of America (Cheung, Fung and Tsai, 2010, p 2). The crisis in the US economy, being the largest in the world, led to a further crisis in other economies of the world; and as the crisis continued to worsen, it led to a decline in the prices of stocks in the global economies.
In addition, the loss of the value of the majority of stocks in the financial markets led to huge losses to the investors. This created a lack of trust in the citizens to the major financial institutions especially after the collapse of the Lehman brothers; and this lack of trust, later on, coupled with the dwindling values of stocks, made the banks and other financial institutions to be faced with huge liquidity problems. As a result, most customers did not trust the financial institutions as they saw there was a real risk of the banks collapsing, leading to the loss of the money they had invested (Cheung, Fung, and Tsai, 2010, p 2).
Capital markets around the world experienced a reduction in the values of their market activity due to reduced investor confidence. This made the government and market regulators intervene in various ways to prevent further disintegration of the economy. The government response was generally varied in different places. It mainly depended on how the economy had been affected and the resources which were available to the government.
The financial crisis showed how the various economies of the world are interdependent and how one happening in one part of the world can affect another part of the world. The countries which were most affected were the countries that had liberalized economies that allowed investors to invest in various means with even some offshore investments.
The capital markets were experiencing among their best growths just before the onset of the financial crisis. In the US the market indices were at their all-time highest values just before the onset of the financial crisis in 2007. During this time the values of different stocks were high and the investors were getting good returns for their stock investments.
However, after the onset of the crisis, the values of the stocks plummeted forcing the capital markets regulators to intervene to prevent further deterioration of the situation.
Spillover effect
This can be explained as the spread of the economic crisis of one country to other countries which depend on the economy of that country. The factors which cause the crisis may be varied. However, depending on the size of the economy, the effects of the crisis are likely to be felt by other countries.
The Asia financial crisis which occurred in the late 90s did affect the world economy to a large extent. However, the economic crisis of Mexico in the 90s affected the economy of Argentina forcing the government to come up with measures to protect its economy (Cheung, Fung and Tsai, 2010, p 3).
.the factors that lead to the economic crisis are usually varied. However, in most cases, one factor plays the major role in initiating the crisis which further spreads to other sectors of the economy and even to other economies.
In the East Asia financial crisis, the devaluation of the Chinese and Japanese currency and the reduction in the price of semiconductors initiated the crisis which affected a large part of East Asia in various ways (What Caused East Asia’s Financial Crisis? 1998 Para 5). The financial crisis in East Asia is also be said to contribute to the financial crisis of Russia which was initially initiated by the fall in the prices of oil due the period. Since Russia relies heavily on oil or related revenue, it was greatly affected the economy of Russia (Schmidt 2009 para1).
As seen above the financial crisis in one part of the world usually contributes to the crisis in other parts of the world. The factors that contribute to the crisis are usually few but lead to the effects being felt in other parts of the economy. This was what happened during the 2007 financial crisis in the US. However, an important observation is a fact that this crisis originated from the world’s largest economy and hence was felt by other world economies which directly or indirectly rely on the economy of the US.
The crisis which was caused by the US subprime mortgage spread into other areas of the economy and eventually affected the capital markets. And since capital markets are closely interrelated the crisis spread to other capital markets throughout the world (Cheung, Fung and Tsai, 2010, p 2).
Impacts of the crisis
The impact of the crisis on the capital market was different for different areas. However, one main similarity in the different countries was the deterioration of the investor confidence leading to a reduction in the values of the stocks. There was also a difference in the response of various governments and market regulators. The response mainly depended on the nature of the effect of the crisis.
The financial crisis also led to the collapse of various systemic companies which were considered to have sound financial positions. Some of the companies which collapsed had a long history and existed for many generations. An example of such a company is the Lehman brothers, which has been in operation in the US for a very long time (Mohan, 2009, p 1).
The collapse of the companies led to large amount of job losses further increasing the unemployment of rates of different companies. The collapse of various companies led to reduced value of stocks and market activity in various capital markets as the investor confidence in the companies continued to dwindle. This created strains in the companies as they were unable to raise additional capital to fund their activities and also protect them from collapse.
The reduced activity of the capital markets made governments and stock market regulators come up with different mechanisms to help increase the market activity and help in restoring the investor confidence in the capital markets.
Response by capital market regulators and governments
Many banks and other financial institutions are usually involved in the capital markets. They invest in the securities and bonds which are offered. Therefore the collapse of the banks usually has a very significant effect on the capital markets. Various governments introduced different forms of legislation to ensure the financial stability of the banks and regulate their practices which have a direct effect on the capital markets (Buiter, 2007, p 12). By regulating the activities of the banks and financial institutions which are involved in the capital markets the governments hope to increase the investor confidence and help the capital markets to recover from the financial crisis.
Since the current capital market turmoil originated from the subprime mortgage businesses and spread further into other countries the governments and market regulators should ensure that they effectively monitor the activities of systemic business enterprises. The government and market regulators should ensure that the companies perform transactions that do not put them at great risk of collapse leading to the loss of the investors’ money.
To effectively achieve this governments and market regulators should come up with different regulations to control the activities of the systemic business enterprises. The governments should regulate the company not for just who they call themselves but for what they perform. No company should be regulated, as the financial turmoil has proved that even companies which are large and are considered financially healthy are prone to collapse leading to panic among the investors and capital market users (Qureshi, 2009).
The capital markets are in turmoil mainly due to reduction of the investor confidence in the markets. Therefore to improve the confidence the governments and market regulators should come up with mechanisms that will ensure the transparency of the businesses which are involved or listed in the capital markets (Portugal. 2008).
The governments and market regulators should encourage banks and other systemic organizations to raise additional capital through the capital markets (Portugal, 2008). This will enable the banks to have additional capital to help protect them from lack of capital which may lead to its collapse. The venture into the capital markets to seek additional capital would also help increase the market activity of the capital markets. This would slowly help in restoring the investor confidence and thereby lead to the recovery of the capital markets.
The governments should also provide liquidity to the banks and other institutions which may have adversely been affected by the financial crisis. This will help keep the companies afloat and reduce their debt burden which is denying it the much-needed liquidity (Portugal 2008). To achieve this, central banks of various countries put liquidity to the financial institutions to protect them. When they were unable to solve the problem the governments resulted in bailouts of various financial institutions and other systemic companies to protect them from collapse which may further fuel the investor confidence and lead to further dwindling of the capital markets (Smaghi, 2009), the companies which were still unable to cope with the crisis were sold and merged with other institutions which were presumably stronger.
This is what happened when Barclays bank bought part of the assets of the Lehman brothers and American bank. Barclays bank was considered to be in a good financial position than the Lehman brothers. By so doing the Barclays bank helped secure thousands of jobs and protected the capital market from panic due to the collapse of the Lehman brothers which was a prominent American bank. Some governments also resulted to injecting liquidity into the economy slowly regularly (ecaway, 2009)
The governments and the capital market regulators should strengthen the underwriting of the financial institutions. Financial institutions need to effectively manage their risks (Portugal 2008).
To improve the activities of the capital markets the governments and market regulators can also decide to buy the available securities. By buying the available securities the governments inject liquidity into the capital markets. By so doing it also increases the demand for the securities since the government is capable of buying securities in large amounts. This also helps other companies to venture into the capital market to obtain additional capital since there is high demand for the securities which leads to increased market activity. Improved market activity leads to the increase in investor confidence thereby leading to the recovery of the capital markets (Andrews, 2009).
Responses by users of the capital markets
The financial crisis has led to the decrease in the value of different stocks due to the financial problems which the companies face during the initial stages. Since the stocks were losing their value, this made the users of the stock market offload their stocks into the markets to avoid further losses. This has made the people who invest in the capital markets look for other means of investing which will have good returns (Cheung, Fung and Tsai, 2010, p 2).
The financial crisis led to the collapse of various financial institutions which the investors considered to be financially sound. The users of the capital markets used to invest in these companies since they were assured of the security of their investment. And since the companies generally had sound financial records the investors would ultimately get good returns for their investments. However the financial crisis showed that all companies were prone to collapse (Mohan, 2009, p 1). This made the users result to panic sale of the stocks of the various stocks.
The investors of the capital markets generally buy the stocks when the prices are low and sell when the prices are high to make good returns on their investments. By looking at the market trends the users of the stock can generally predict the future prices of certain stocks in the capital market. However, the financial crisis led to increased volatility of the capital markets. The value of the stocks keeps changing from time to time (Cheung, Fung and Tsai, 2010, p 2). There is generally no general trend in the value of the stocks hence the users of the capital market are reluctant to invest in the stock market as they are generally not assured of the return of their investment.
The financial crisis also led to reduced activities of the stock market. Various companies were not willing to look for additional capital from the capital markets either through IPOs or issuance of various securities. This is because the investors’ level of trust in the companies was low as there was no guarantee of the companies’ profitability in the future.
Recovery of the market has generally been slow. Most businesses are unwilling to venture back into the capital markets. The users of the capital markets are also unwilling to venture into the capital markets. The slow recovery has resulted in reduced market activity. The value of market activity is still considerably low compared to the activities just before the onset of the crisis.
Conclusion
The financial crisis exposed different companies to various financial strains leading to the reduced activities of the capital markets. However, the governments and regulators need to view the challenge posed by the financial crisis as an opportunity to strengthen the capital markets and prevent future occurrences of such a crisis. Most governments have come up with different legislation which ensures the sound financial activities of various companies.
The current financial crisis has also proved that many companies and businesses are interconnected. Hence the happenings in one place will ultimately affect the operations in another part of the world. This has made governments come up with measures that will prevent the spillover of the crisis in other parts of the world.
Reference List
Andrews, E. L., 2009. Fed Plans to inject another $1 Trillion to Aid the Economy. NY: The New York Times. Web.
Anon.1998. What Caused East Asia’s Financial Crisis? CA: Research Department Federal Reserve Bank of San Francisco. Web.
Buiter, W. H., 2007. Lessons from the 2007 financial crisis. Web.
Cheung, W., Fung, S. and Tsai, S., 2010, Global capital market interdependence and spillover effect of credit risk: evidence from the 2007-2009 global financial crisis London: Routledge. Web.
Ecaway. 2009. The global financial crisis: impact response and way forward. United Nations economic and social council economic commission for Africa / Africa union commission. Web.
Mohan, R., 2009. Global financial crisis-causes, impact, policy responses and lessons. Web.
Qureshi, A., 2009. Global Market Turmoil & the Demise of the Hyper-Specialised Capital Markets Lawyer. Web.
Schmidt, R., 2009. The 1998 Russian Financial Crisis. Part 1: Course of Events stockbreakthroughs. Web.
Smaghi, L. B., 2009. The financial crisis: challenges and responses. European central bank. Web.
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