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The Main Causes of the Economic Crisis of 2007-2008
The economic crisis of 2007-2008 was termed as the Global Financial Crisis or the Great Recession due to being the most significant one since the Great Depression (Askari & Mirakhor 2015). Given the importance of the event, it seems necessary to investigate its causes.
The causes of the crisis are still debatable (Askari & Mirakhor 2015), but it is customary to assume that the crisis began with the subprime mortgage issues in the US (Cabral 2013). A subprime mortgage is offered to a person who does not have a very good credit history; the mortgages also were longer and had rather low-interest rates, which increased the number of their users (Foster & Magdoff 2009, p. 96). It is also argued that a rapid increase in debt can result in financial crises since it fosters the development of speculation, which tends to lead to a rapid decrease in the price of the assets involved in a bubble (Askari & Mirakhor 2015, p. 18). In the case of the 2007-2008 crisis, subprime mortgages resulted in the household bubble in the US, forming a first complex cause of the event.
Apart from the mortgages, debt played a part in the so-called shadow banking, which employed a variety of instruments (like collateralized debt, bond, and loan obligations) to increase credit and which was quickly turning toxic due to the lack of supervision (Askari & Mirakhor 2015, p. 7). The response of banks to the growing debt consisted of freezing credit, which occurs when banks hesitate to lend since they are unsure if they can be paid back (Askari & Mirakhor 2015, p. 19). As a result, resources in the market proceeded to decrease, and even shadow banking could not improve the situation (Askari & Mirakhor 2015, p. 7).
The explicit signals of the crisis included the collapse of multiple financial institutions. In the US, these institutions included Lehman Brothers, Citigroup, and Bear Stearns; in the UK, HBOS and RBS collapsed; also, other European companies like Hypo Real Estate and UBS signalled the issue (Erkens, Hung & Matos 2012, p. 389; Fratzscher 2012, p. 347). Lu and Whidbee (2013) demonstrate that these collapsing financial institutions tended to be large, which made them more vulnerable due to greater involvement in real estate mortgages and other low-performing or non-performing loans. Also, the authors found that these institutions were more likely to rely on financial instruments and have low liquidity.
Thus, the primary reasons for the financial crisis appear to be interconnected, and their complex relations are likely to have led to the severity of the resulting crisis (Askari & Mirakhor 2015). The interrelation of the issues ensured that the crisis left the US (its country of origin) and caused many harmful consequences in both developed and developing economies all over the world (Fratzscher 2012).
Forecasting Crises
Before the crisis of 2007-2008, the perspectives of economic development appeared to be very positive (Cabral 2013), which might have been misleading. However, certain issues (for example, the analysis of certain instabilities in the market) did indicate that a crisis was brewing (Fratzscher 2012). Moreover, some of the specialists, including institutional investors and analysts, were found to have predicted the events (Adebambo, Brockman & Yan 2015). Adebambo, Brockman, and Yan (2015) point out that these groups of stakeholders have a certain advantage in forecasting due to the amount of information that they are provided with as well as their ability to use particular tools. In this paper, the analysis of the mentioned tools is going to be carried out to check if the modern economy is appropriately equipped to forecast new crises.
Before proceeding, it is important to point out that while a crisis is, admittedly, an event, not every event is a crisis. A crisis is a specific event, one that occurs unexpectedly and poses a clear threat to business and the interests of its stakeholders (Coombs 2014). Coombs (2014) also points out that while a crisis is unpredictable, it can be foreseen, and most organisations try to foresee a variety of events, including crises. In this context, forecasting can be regarded as the practice of predicting future events “based on past trends” (Cook et al. 2014, p. 1), and forecasting tools are going to be divided into those employing quantitative, qualitative, and mixed-approach methods.
Quantitative Methods
An example of quantitative forecasting is modelling, which involves “using mathematical concepts to describe a system, study the effects of different components, and make predictions about system behavior” (Cook et al. 2014, p. 1). For instance, a causal forecasting model can be used for the event and crises forecasting; it is a statistical model that aims to predict a variable (termed “dependent”) with the help of one or several “independent” variables (Salpasaranis, Stylianakis & Kotsopoulos 2014). The apparent advantage of the quantitative method consists of their reliability and validity, which is characteristic of quantitative tools that are employed properly (Cook et al. 2014). Quantitative tools presuppose standardisation and control over extraneous variables and researcher bias, which makes them more likely to produce reliable forecasting (Cunningham 2016). However, in the cases of improper implementation (mistakes, lack of planning, insufficient control over extraneous variables, deliberate misconduct, and so on), these advantages are eliminated. Apart from that, quantitative methods maybe not suitable for certain aspects of the business that are not quantifiable and can only be analysed through qualitative methods (Cunningham 2016, p. 99).
Qualitative Methods
A common qualitative method is brainstorming: it involves an active discussion of an event (scenario, model, trend, and so on) carried out by a team of professionals to produce insights (Cook et al. 2014). Another similar tool is the group consensus method, which can be regarded as a form of brainstorming that needs to result in a certain decision (Cunningham 2016, p. 99). Hence, the pluses of the qualitative method include its ability to pool experience, attract multiple opinions and perspectives, thus gaining a more comprehensive overview of the situation, which affects the predictive ability of the methods in a positive way. Unfortunately, the lack of standardisation and controlling methods also means that qualitative methods are more likely to be inaccurate, especially if they are affected by bias or incompetence. Thus, qualitative forecasting is often regarded as a supplementary method, the need for which is explained by the fact that some of the aspects of organisational life are not quantifiable (Cunningham 2016, p. 99).
Mixed Approach
Apart from qualitative and quantitative methods, analysis can employ mixed ones that contain a variety of specific tools that unite both approaches to improve the quality of the forecasting. A most commonly used mixed-approach method is scenario analysis, which involves creating a vision of the development of an event (for example, crisis) and the employment of one or several qualitative and quantitative tools to analyse it (Kennedy & Avila 2013). Naturally, scenario analysis can be purely qualitative or quantitative, but the tool has the potential of being a mixed-approach one (Amer, Daim & Jetter 2013). Mixed approaches are typically used to employ the advantages of qualitative and quantitative methods while also avoiding their disadvantages, some of which are complementary. Therefore, the mixed approach can be regarded as a particularly strong method of forecasting, even though in some cases (scenarios analysis included), it can be more difficult to carry out due to its comprehensive nature (Kennedy & Avila 2013).
Conclusion
Different approaches to forecasting offer their advantages and are likely to have disadvantages. Therefore, the combination of opportunities and limitations of diverse tools should be considered when choosing the instrument that is appropriate for a particular situation (Amer, Daim & Jetter 2013). In any case, forecasting is a useful device that informs planning and decision-making, which makes it a crucial component of crisis management that can be used to manage new crises (Cook et al. 2014).
Strategy for Organisational Survival in Crises (from the Perspective of Strategic Crisis Management Theory)
Wooten and James (2008) define crises as “low-probability and high-consequence events and are generally characterised by ambiguity” (p. 4). Similar definitions that mention low probability and the significance of consequences are provided by Coombs (2014) and Howell and Miller (2006). Thus, the main characteristics of a crisis clearly indicate that it requires careful management and cooperation in making rapid decisions for organisational survival. Modern studies in the field can provide several frameworks, tools, and theories which can inform crisis management strategy and action.
Frameworks for Survival
Of the existing frameworks that describe the process of the crisis and the company’s strategy in surviving it, the five-phase framework appears to be especially comprehensive. According to Wooten and James (2008), the first stage is signal detection, which is followed by preparation and prevention. If the crisis is not prevented, damage control and containment are required. Then, the recovery of normal business activities takes place. Finally, the learning phase of this crisis management model requires analysing the event and gaining lessons from it.
The final phase of the framework is its distinct advantage because it offers sustainable development. Learning from crises is most important (Kolb 2010), and it can be regarded as one of the ways to turn the crisis into an opportunity to evolve and improve (Jessop 2015; Howell & Miller 2006). Moreover, the framework offers different scenarios (avoided crisis and the crisis that does occur), which also appears to be a plus that indicates the tool’s flexibility.
The framework by Herrero and Pratt (1996) includes only three stages, which already makes it less detailed. The first stage presupposes the identification of the problem, which is not equivalent to the signal detection of Wooten and James (2008). Signal detection can be considered as a part of the identification of the problem, but the lack of emphasis on this part of crisis management appears to be a disadvantage of the three-element framework since crisis prediction is an important part of crisis management (Cook et al. 2014).
The second stage is the choice of the action that would be appropriate in the situation; it is followed by the implementation of the action. No opportunity for prevention is included in this framework, which is an essential element of crisis management (Coombs 2014). Similarly, no lessons learned are included; also, the framework does not choose to specify the direction of the actions in crisis management (for example, business revival or crisis prevention). Therefore, the framework by Herrero and Pratt (1996) is relatively simplistic. Simplistic frameworks are easy to use; also, the framework by Herrero and Pratt (1996) focuses on decision-making, which can also be regarded as an advantage given the central role of decision-making in crisis management (Coombs 2014). The decision-making element is not explicitly included in the five-phase framework, which can be regarded as its relative disadvantage. However, when compared to the five-phase framework, the three-stage one appears to be noticeably less advantageous.
Tools for Survival
Apart from the frameworks, a couple of tools are also worth mentioning in the context of crisis management theory. Contingency planning and business continuity planning are relatively close terms, both of which define the activities (measures) that will help in the process of business recovery. Also, both deal with potential threats (Scholz 2013, p. 121). However, the former refers to specific issues that the company might need to deal with and that are especially harmful to its business, while the latter introduces a plan for the general resilience of a company and its ability to prevent and mitigate potential threats in functionally significant areas (Suciu, Aldea-Partanen & Piciorus 2012, p. 377). It is also apparent that both these tools need to be updated after particular crises to correspond to the lessons learned (Oliveira & Gimeno 2014, p. 134).
Theories for Survival
Two theories can be regarded as tools for developing the communication that is required for crisis management (Suciu, Aldea-Partanen & Piciorus 2012). As defined by Infante, Rancer, and Womack (2003), the structural-functional systems theory is directly dealing with communication establishment (Howell & Miller 2006). In this theory, the information networks that can be used by an organisation to ensure communication, as well as command levels, are considered. Also, the innovation diffusion theory, which was introduced by Rogers (2003), can be helpful. The author defined innovation diffusion as “the process by which an innovation is communicated through certain channels over time among the members of a social system” (p. 5). Rogers (2003) tracks this process, attempting to identify its antecedents, drivers, and specifics, and it is established that innovation is often a response to the solution of a problem. In the context of crisis management, the problem is apparently a crisis, and the theory can be used to discuss the way crisis can be turned into an opportunity for a variety of business fields (Wu & Chiu 2015) as well as a tool for communication establishment (Suciu, Aldea-Partanen & Piciorus 2012, p. 377).
Conclusion
The modern theory of crisis management offers practitioners a wide variety of tools, theories, and frameworks that can help to survive a crisis by planning, making decisions, establishing communication, and ensuring appropriate functioning of other important elements of crisis management. It is noteworthy that not all the tools are equally compelling, but since every of them has its advantages and disadvantages, the choice of the appropriate one depends on a particular situation.
Crisis Leadership Lessons
The crisis of 2007-2008 was admittedly a most traumatic event for the economy of the world, which has led to multiple negative consequences and side effects (Askari & Mirakhor 2015). However, it can also be regarded as an important experience which can help economists, businesspeople and other specialists and researchers to learn certain lessons, for example, in the field of leadership (Kolb 2010). Wooten and James (2008) point out the fact that prior to the crisis, few efforts were made to define “crisis leadership competencies” (p. 2), even though leadership is apparently crucial for crisis management. At the same time, as suggested by Rawlinson (2009), the events of the crisis managed to discredit leadership and the previously existing leadership practices. As a result, extracting lessons from the crisis appears to be crucial for the development of leadership practices in the future.
The crisis drew the attention of specialists to a variety of themes. In particular, the topic of uncertainty was reintroduced due to the event (Nelson & Katzenstein 2014). Risk contributed to the development of crisis (first with market players taking too many risks and then with banks freezing credits in reluctance to take risks) (Askari & Mirakhor 2015), but apart from the risks, the notion of uncertainty is of importance for the market. Where risks can be predicted, and their probability can be measured, uncertainty is unpredictable (Nelson & Katzenstein 2014). Rawlinson (2009) refers to this phenomenon as “the unknowable” and highlights the importance of the role of the “captains” in managing uncertainty (p. 8). Thus, the author suggests that by attracting attention to this topic, the crisis is also likely to teach the leaders the lesson of caution and the importance of forecasting and planning. By recognising the fact that uncertainty is an essential element of business, leaders can make the first step towards more successful crisis management.
Apart from this change in focus, a certain shift in celebrated leadership styles can be traced back to the crisis. Rawlinson (2009) demonstrates that by the time of the crisis, individualistic and autocratic leadership was already discredited, resulting in the advancement of the concept of leadership that is shared with the team and that is more democratic. The crisis, however, showed that the democratic approach might not have been entirely successful either. Rawlinson (2009) believes that autocratic methods are unlikely to strive after the crisis (the author also advocates for diversity and dissent, which appears to contradict individualistic styles). However, he suggests that since the crisis, companies are more likely to pay greater attention to their leadership styles, team organisation, and team and leader competencies. Thus, the crisis shows that rather than following a particular model, a company should carefully consider the leadership styles and organisation and customise them to gain more benefits from them.
A significant lesson learned from the crisis is connected to the fact that greater attention to human resources also resulted in the development of the trend for fostering diversity and dissent not only as a fact of organisational life but also as a potentially positive feature of a team (Rawlinson, 2009). Indeed, dissent has been shown to foster innovation because it introduces a variety of diverse opinions and worldviews (Nijstad, Berger-Selman & Dreu 2012). It is apparent that dissent needs appropriate management to prevent it from being disruptive, and it is apparently the responsibility of leaders to ensure an inclusive, innovation-fostering environment for the employees (Mitchell et al. 2015). As a result, this leadership lesson is particularly promising for post-crisis leaders.
Finally, the crisis also led to the development of ethical, moral leadership (Rawlinson, 2009). Moral issues are common in business and require the attention of leaders, thus spurring them to find a code of ethics to guide them. Apart from that, ethical and moral leadership has proven to be reassuring and inspirational for employees and other stakeholders (Mayer et al. 2012; Yidong & Xinxin 2012). Also, modern studies suggest that ethical leadership tends to have other positive effects, including those that are not related to ethics; for example, the learning behaviour of employees tends to be improved through the style (Walumbwa, Hartnell & Misati 2016). Thus, ethical leadership is not only a tool (or a set of tools) for the successful resolution of ethical dilemmas and fulfilment of the business’ social responsibilities; it can also be developed into a competitive advantage, which makes it an essential lesson learned by post-crisis leaders.
To sum up, the crisis has resulted in noticeable changes, which is natural for an event that was so powerful and impactful. The fact that positive outcomes can result from negative events implies that people can learn from their mistakes and develop their business and economy to make them more resilient in the face of potential future crises.
Portfolio Conclusion
The present portfolio is a collection of papers that are devoted to crisis management, where the crisis of 2007-2008 was used as an illustration of the crisis, the causes and consequences of which were studied. Apart from that, the portfolio investigated modern crisis management theory in search of forecasting tools and survival strategies. The portfolio demonstrates that the analysis of the previous events can help one to gain insights not only in the said events but also into other phenomena of the same or similar kind. The analyses are required to learn from the crisis of 2007-2008 and other crises the lessons which can help to build resilience in the face of future crises.
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