|
 |
 The Nature and Causes of Financial Crisis in 2008 and its Impact on Iranian Economy (No. 9)
|
March 2009
Department of Economic Research / Energy Economics Research Group
|
|
| |
Abstract
The current economic crisis which has affected seriously the advanced economies and has reached most developing countries originated initially from the US mortgage crisis in 2006 and expanded rapidly to the US banking system and then to the European major credit institutions. The crisis soon developed to a global crisis in major financial markets through spreading to major financial institutions and resulting in rapid fall in shares prices which shocked the stock exchanges worldwide.
The bankruptcy of some well-known banks and financial institutions which followed by the crisis gave rise to panic in financial markets especially in the US and provoked severe tight policies in credit systems leading to economic recessions and the increasing levels of unemployment. Households' pessimisms on economic prospects caused strong downward shifts in consumers spending pushing down sales and profits with the prompt consequence of increasing the levels of unemployment. In the medium to long-terms and as long as the households' pessimism holds, the declining trend in investments ensuing from the falling profits and plummeting shares prices would induce further economic recessions and higher levels of unemployment.
Factors at work in this crisis may be classified in the following three categories: the speculative boom in the US housing market, financial innovations in subprime mortgage industry, and the lack of adequate supervisions and effective regulations in stock exchanges, financial institutions and derivatives trading.
The surge in property prices in the US economy started in 2001 and 2002 and accelerated rapidly. This was conducive to further investments in housing industry and the positive effects on economic recovery, which the US economy badly needed after the burst of the dot.com bubble in 2000. Easy access to loans in the mortgage markets enabled an increasing number of households to become home-owners. This provided the necessary conditions for an upward shift in households demand for commodities and services, which in turn enhanced investments in other sectors of the economy providing an appropriate economic environment for strengthening households' optimism and confidence in the future course of economic activities. The property prices continued to surge even at higher speeds, and the "housing bubble" emerged in the US economy. The US monetary and financial authorities did not, however, pay due attention to the warning of financial and economic experts on the likelihood of bursting the bubble and on the seriousness of its consequences.
The multi-trillion US mortgage market constitutes a major share in the US credit market. Traditionally, the property purchased by a borrower remained with the lending institution as collateral thus ensuring that the lending practice would not lead to any crisis in the credit market. However, the recent financial innovations in mortgage markets allowed the creation of a secondary market for mortgages by issuing securities whose underlying is the purchased property. The Mortgage Backed Securities (MBS) were therefore introduced as a strong financial instrument in financial markets and particularly in derivatives trading. As compared with other securities, MBS soon became more popular due to its higher yields resulting from the continuous surge in the US property market. Many banks and financial institutions in the US, Europe and Asia tended to purchase massive volume of MBS. This was exacerbated by the continuous increase in MBS trading profit due to active participation of speculators in derivatives markets.
Transferring the risk of default to a wide range of traders became possible by the opportunity of trading MBS. This innovation of originating and distributing risk enabled the banks and financial institutions to offer mortgage loans to a very wide range of applicants to the extent that a considerable number of households known as subprime borrowers with very low income or even with no job could have become home owners.
Upon the burst of the US housing bubble and the ensuing decline in property prices, many of the subprime borrowers were unable to pay their mortgages. Profitability of the MBS started to decline rapidly and many of the banks and financial institutions which held sizeable amounts of MBS in their portfolios became either bankrupt or were pushed towards bankruptcy. The credit crisis in the affected banks and financial institutions soon crossed the border and extended to other institutions in Europe and Asia turning into a global financial crisis in an integrated global financial market.
The symptoms of the crisis could have been easily diagnosed since 2005, but the bankruptcy of one of the four biggest US financial institutions in September 2008 may be considered as the turning point in the crisis which resulted in the Wall Street crash in the following days. The 700 billion dollars bailout proposed by the Federal Reserves and approved by the Congress failed to stop or even mitigate the growing pace of the crisis. Similarly, bailouts in Europe and Asia were proved not to be productive in curbing the crisis. It seems, however, that the crisis will, similar to the 1930's great depression continue to accelerate for a few years before the early signals of economic recovery can be identified.
Currently, the capital markets are globally integrated and a crisis in a market can easily and rapidly be transmitted to other markets. Managing the crisis hence necessitates coordinated efforts particularly in monetary policies among the central banks. IMF, being an institution of international character can in principle play a significant role in securing this coordination. However, as mentioned earlier, the lack of adequate regulations in capital markets and particularly in derivatives trading in paper markets as well as the growing exposure of traders to risk leverage are the principle factors at work in the origination and development of the current crisis. IMF intends seriously to constrain the adverse effects of the crisis by imposing further regulatory measures on the operation of international financial institutions. The serious challenge to IMF is how to internationally coordinate policies taken by individual member countries which are based on their national interests.
Developing countries are affected by the current crisis to the extent that they have been exposed to the risks generated in international capital markets. As compared to many other developing countries, the Iranian banking system and financial institutions have not been strongly linked to international capital markets and hence not being exposed to their toxic risks. Iranian economy has therefore received relatively the least adverse effects. However, the global economic recession has already depressed the demand for raw and basic material, and will continue to do so in the near future. This particularly holds for crude oil and petrochemicals which constitute a major share in Iranian exports.
International oil markets will continue to experience the current low prices for crude oil. There are, however, reasons to believe that the upward trend for crude oil prices may be observed in not-too-distant future. The slumping investments in exploration and development in oil fields around the world which has followed the current crisis will sooner or later exhibit its adverse effects on the actual oil supply and particularly on the expected supply of crude oil. This would certainly lead to higher oil prices. Although the decline in the global demand for crude oil has been responsible for the prices to fall so rapidly, the decline in the expected supply of crude oil will ultimately play the determinant role in the pricing mechanism.
Iranian economy will experience serious shortages of foreign exchange resulting from the fall in oil exports revenues. Despite the lower imports bill, this would necessarily imply a considerable budget deficit with its inflationary consequences. Careful revisions of economic policies are therefore needed. This is particularly important in the area of subsidies on energy products. Any policies aimed at removing the current massive and destructive subsidies by direct payments to the most affected consumer groups should basically be revised due to the serious inflationary consequences of such payments.
The current crisis and its impacts on Iranian economy have provided an opportunity to critically consider the strong dependency of the national economy on crude oil prices. This together with a national determination as well as the tenacity of authorities may provide a solid foundation to cut the existing adverse consequences of the structural dependencies of Iranian economy on oil revenues.
To read complete text of this quarterly on the Persian website click here.
|
|
|
|
|
|