Document Sample
                                       Michael O. Ndugbu, Ph. D
                                    Head, Dept of Banking & Finance
                                     Imo State University, Owerri.

1.       Background
A financial system is a complex collection of institutions established with the intention of bringing people
who want to borrow and those who want to lend together to ensure and enhance the transfer of funds.
Financial crisis over time gives rise to economic meltdown. In 2007 and 2008, the worst crisis in decades
ripped through the global financial system and the root cause has been attributed to the collapse of sub-
prime mortgage loans market which was the primary effect of the overheated U.S housing market. The
sub-prime lending is a sort of lending to borrowers who, under normal circumstances, would not qualify
to access loans due to poor credit worthiness and poor credit records (Attah- Quayson: 2008). As a result
of this, these sub-prime borrowers pay higher interest on these credits. Given that the venture was quite
lucrative, all big Banks in the U.S financial system involved themselves in the market.
When financial engineers in the U.S noted the level of risk associated with the business, they, smartly,
repackaged these loans in the form of securities and sold them in order to rid the risky assets off their
books. In essence, this market became essential aspect of the complex international financial system. This
was the main reason why the collapse of this market easily became contagious to the international
financial system. The chill quickly spread beyond U.S borders - it rolled markets with little or no
exposure to sub-prime losses mid gutted companies whose business seemed far removed from finance. In
the words of Fratianni and Marchionne (2009), many industrialized countries entered recession. Emerging
economies such as China, India, and Brazil saw their stock markets drop precipitously and their heady
economic growth rate went down.
         Global Financial crisis and economic meltdown thus refers to a situation or condition when the
world’s financial and economic status quo can no longer be maintained, because the financial and
economic crises are at their bad point. This paper traces the causes, spread and effects of the current
global economic and financial crisis.

2.      Financial Vs Economic Crises

         The term financial crisis is applied broadly to a variety of situations in which some financial
institutions or assets suddenly loose a part of their value. In the 19 th and early 20th Century, many
financial crises were associated with banking panics, and many recessions coincided with these panics.
Other situations that are often called financial crisis include stock market crashes and the bursting of other
financial bubbles, currency crisis and sovereign defaults they all relate to finance sub-sector.

         On the other hand, economic crisis involves a situation of setback or slow growth in overall
economic activity combined with rising unemployment. The present global crisis has been taking place in
an economic environment characterized by various imbalances as sparked by the outbreak of the financial
crisis of 2007 - 2009.

        In comparison, there could hardly be any economic crisis without financial crisis because finance
is the hub and lubricant of every economy and so its crisis must certainly translate to the rest of the
economy. On the contrast, finance is specific while economy is broader, that is to say that whereas
financial crisis is the trouble of finance sub-sector, economic crisis is the trouble of the entire economic
sector of the given nation.

3.      Causes of Financial Crisis

        The underlying causes leading to the global financial crisis had been reported in business journals
for many months before September, 2008, with commentary about the financial stability of leading
United States of American and European investment banks, insurance firms and Mortgage institutions
consequent to the sub-prime mortgage crisis. Beginning with failures caused by misapplication of risk
control for bad debts, collateralization of debt insurance and fraud, large financial institution in the U.S.
and Europe faced a credit crisis and a slowdown in economic activity. The impact rapidly developed and
spread into a global shock resulting in a number of European bank failures and declines in various stock
indexes, and large reductions in the market value of equities and commodities. The credit crisis was
exacerbated by section 128 of the U.S Emergency Economic Stabilization Act of 2008 which allowed the
Federal Reserve to pay interest on excess reserve requirement balances held on deposit from banks,
removing the incentive for banks to extend credit instead of placing cash on deposit with the Federal
Reserve Bank.

         Recent studies have shown that there could be remote and immediate causes(s) of financial crisis.
Given the U.S financial crisis, Soludo (2009) emphasized on the following as the possible causes of the
crisis. According to him, they include:

i.      Leverages, swaps and the collapse of the sub-prime market;

ii.     Poor coordination and late intervention by governments and Central Bank;

iii.    Easy monetary policy in the aftermath of the September 11, 2001 to avoid recession;

iv.     False assumptions of ever-increasing housing prices, which led to sub-prime lending;

v.      Continued fall in house prices and borrowers inability to refinance, thus leading to defaults;

vi.     Crash of structured products and market, which made consumer loans, market distress, and led to
        counter-party risk;

vii.    Banks stopping ending but recalling some of their loans, which resulted to stock, market burst;

viii.   Pressure on banks to raise capital.

Generally, other indicators of financial crisis include; Financial innovations, loose regulatory regimes and
several unregulated financial markets and products, investors seeking higher returns through riskier
investments, exposure of investment bank through leveraging, rising liquidity stock market burst, huge
write-down and downgraded ratings.

       These are possible causes of the U.S financial crisis and possible indicators of financial crisis
anytime, anywhere.

       In a similar breath, Moyers (2007) and Lahart (2007) posited that the immediate cause of the
global financial crisis was the bursting of the United States housing bubble, which peaked in
approximately 2005 – 2006. They maintained, that “high default rates on “Sub-prime” and adjustable rate
mortgages (ARM) began to increase quickly thereafter. An increase in loan incentives such as easy initial
terms and a long-term trend of raising housing prices encouraged borrowers to assume difficult mortgages
in the belief that they would be able to quickly refinance at more favourable terms.”

        Refinancing means borrowing money in order to pay a debt. As interest rates began to rise, the
housing prices started to drop moderately in 2006 – 2007 in many parts of the United States of America.
Refinancing then became more difficult. As a result, defaults and foreclosure activities increased
astronomically because the easy initial terms have expired while some prices failed to appreciate as
anticipated and ARM interest rates rose even higher.

        The factors responsible for the above are many including:

        (i)     Share in GDP of the US financial sector since 1860.

        (ii)    Systemic crisis (iii)    Growth in the housing bubble

       (iv)     Easy credit conditions (v)       U.S. Current Account Deficit (vi)         Sub-prime
Lending         (vii)   Predatory Lending (viii) Deregulation of the financial Sector

        (ix)      Increase in Debt Burden        (x)      Incorrect Pricing of risk

        (xi)    Boom and collapse of the shadow banking system; and          (xii) Commodity bubble

4.      Effects and Consequences of Global Financial Crisis on:

4.1      Individuals: Starting with our own country, Nigeria, the effects are felt in various ways.
Though Soludo (2009) tried to prove the vulnerability of Nigeria in this problem, indices all over indicate
that the Nigerian individual citizen might have had and may still be having the effects of this meltdown
on himself. According to Alawode (2009), a Significant facet of the crisis manifested in the massive
downsizing of staff in various industries – banking, oil and gas, manufacturing, even the small and
medium enterprises sub-sector was not left out. There have been trimming of salaries and benefits of
workers in some other sectors, which resulted in less disposable income for individuals and their families.

        This crisis produced a chain reaction, as less disposable income resulted to lower demand for
goods and services, thus reducing the productive capacities of industries. Consequently, the first measure
employers decided taking to lessen the impact on their business was the reduction of staff or their
benefits. Joblessness is a significant effect of the crisis on individuals. According to Attah-Quayson
(2008), four mining companies in Ghana have laid off hundreds of workers because of the credit crunch,
which has meant significant downward revision of projects for the mining companies.

         The crisis has destroyed savings. It is hard to forego consumption if the rates on savings accounts
are below the rate of inflation (Greenspan, 2007). Another effect on individuals is the high cost of living.
This is highly connected with joblessness given that most jobless families now find it difficult to meet up
their family expectations in the primary areas of feeding and clothing.
       What about suicide? Most displaced men resorted to suicide when they see that the future has not much in
       stock for them, all these, and even more, are the effects of the crisis on individuals.

       4.2     Public/Government Institutions:

                          The crisis is having a great impact on Government and public institutions even here in

               Soludo (2009) outlines the effects on Government as follows:

               (i)        Collapse is commodity price especially oil;    (ii)    Revenue contraction;

               (iii)      Declining capital inflows in the economy;

               (iv)       De-accumulation of foreign reserves and pressure on exchange rate;

       (v)     Limited foreign trade finances for banks- as credit lines may dry up for some banks; and
(vi)   Capital market downturn, divestment by foreign investors with attendant tightness and possible second
       round effects on the balance sheet of banks by increasing provisioning for bad debts and decrease in

               Furthermore, effect on industrialized nations and other emerging economies that have been
       supporting African Governments have been significantly implicated in the recent decade.

       Also, we should not lose sight of unemployment created and its attendant results on Government in the
       area of insecurity and crime - even hostage taking in the case of Nigeria.

                Given the decline in the rate of export by international companies, most firms, and corporate
       bodies are finding it difficult to break even and this has significantly reflected on their bottom line even
       on their taxable income. It is, therefore, obvious that the effect on Government and public corporations is
       highly intolerable.

       4.3     Private Organizations:

                Most companies are winding up whereas the few survivors are merging. This is the case with
       domestic airline operators in Nigeria as revealed by Chanchangi (2009). According to this source, there is
       need for Government support because things are changing adversely in the sector. Almost all these
       airlines have stopped international operations and, if not for individual operators’ difference, merging
       would have become the next option “given the prevailing economic situation and the revenue that comes
       to us”. South African, Anglo Gold Ashanti, the world’s third largest producer of gold, has reviewed its
       plans to review capital expenditure by $400 million by quitting some of its projects and this is likely to
       further worsen the situation.
         In the same vein, Lonmius Plc, the world’s third largest platinum producer, advices workers of
possible lay-offs due to significant decrease in demand as well as prices for its metal which value has
fallen internationally due to poor patronage to some of their major customers (auto producers), who
equally reported slow sales owing to the crisis, (Attah-Quayson: 2008).

4.4.        Other Effect of the Global Crisis in the African Region

Economic Growth:            It was initially believed that the crisis would have minimal impact on African
countries because of:

       i.      Their low integration into the global economy;

       ii.     African countries tend to have very small inter-bank market; and

       iii.    Several countries have restrictions on new financial products as well as market entry, which
               should shield them from direct effects of the global financial crisis.

    Recent developments show that the negative contagion effects of the crisis are already present in
African region. As the African countries are heterogeneous, the crisis had effects on some countries more
than some others. For example, the fall in economic growth expected in 2009 was more severe in Angola,
Botswana, South Africa, Equatorial Guinea and the Sudan which were expected to lose more than 4%
points in growth. In Egypt, Kenya, Cape Verde, Nigeria, Ethiopia, Tunisia, Nairobi, Mozambique, Sierra
Leone, Lesotho, Ghana and the Democratic Republic of Congo, growth declined by between 2 and 3%
points in 2009.

            Stock Markets

        The direct effects of the crisis on Africa are mostly through the financial sector. The crisis has
increased the stock market volatility in Africa. Wealth losses have been observed in the major stock
exchanges. The stock market indices declined in Nigeria and Egypt by about 67% between March 2008
and March 2009. Significant losses have also been observed in Kenya Zambia, Botswana, and Mauritius.

The stock market turmoil has begun to have significant negative effects on the financial sector and on
aggregate demand. For instance, it has negatively affected bank balance sheets. If the trend continues,
non-performing loans in the banking sector would increase with dangerous consequences for the financial
stability of the region. In Ghana, the ratio of non-performing loans to gross loans increased from 7.9% to
8.7% between 2006 and the third quarter of 2008. In Lesotho, it increased from 2% to 3.5% in the same
period (IMF 2009).


         Bank failures have been rare in the region because most African banks do not have any
significant exposure to the sub-prime mortgage market and asset-backed securities (ABS). But they are
vulnerable to contagion effect originating from the high rate of foreign ownership of banks in the region
to the effect that those foreign banks reduce their support of local banks or sell their assets in them.
Serious consequences have been observed in particularly high susceptible regions of Botswana, Central
African Republic, Cape Verde, Chad, Cote d’Ivoire, Equatorial, Zambia and Lesotho.

        In Nigeria, a flood of banks, including Afri Bank Nig. Plc, FinBank Plc, Intercontinental Bank
Plc, Oceanic Bank International Plc and Union Bank of Nigeria Plc, were at the brink of failure until
Intervention of the CBN that bailed them out with over N400B in August 2009 (Thursday Newspaper,
Vol. 14, No. 5230, pages I and 8).

The global financial crisis has no doubt affected banking operations in Nigeria. In the immediate
aftermath of the crisis when hedge funds and portfolio investors were liquidating their investments and
moving their monies out of the country, banks must have earned good commissions and fees from such

         But not long after that the crash in share values at the Stock Exchange became manifest resulting
in massive and sudden loss in the values of shares which the banks were holding as collateral for the
margin lending which they had booked. Then there was the stampede to recall such loans which urgency
was heightened by the demand made about the same time that banks should observe uniform year ends to
facilitate comparability and promote greater transparency.

The Nigeria banks have lent out large chunk of money for the purchase of shares which transaction was
entered into not because of any particular credit worthiness on the part of the borrower but the expectation
was that in the event of a default the shares would be warehoused and eventually disposed off to recover
such indebtedness. But the crash in the value of the shares made such calculations wrongheaded and led
to substantial exposure on the part of the bank to this category of borrowers. According to Chizea (2009)
such kind of exposures are estimated to be of the order of N800 billion. It also reported that the banks are
massively exposed to the downstream sectors of the petroleum product market.

         Some banks also in a bid to swallow the bait dangled by the Central Bank of Nigeria that if they
increased their shareholders’ funds to a minimum of one million dollars would be allowed to participate
in the management of the country’s foreign reserve in partnership with reputable international financial
institutions went into close collaboration with some of the banks. Moreover, to that extent might have
increased the level of their exposure to these financial institutions and are therefore likely to be more
vulnerable to the crisis, which have been the lots of such international banks. if is of course any body’s
guess that credit lines have almost disappeared and where they are still available, would be at relatively
higher charges.

        Foreign Exchange Sector

       African countries have been under enormous pressure in their foreign exchange market since the
emergence of the global financial crisis. In Nigeria, the exchange rates stood as follows on 19 th August,
2009: $1 N I 50; £1 = N244; 1 Euro = N2 10.
5.       Conclusion: The current global crisis started as a financial crisis owing to the deficiencies that
emanated from the sub-prime mortgages in the United States. This has gradually translated itself to a
global economic crisis as it pierced and permeated other great economies of the- world owing to the
independence of countries in trade and commerce. Gradually, a decrease in asset value (stock and real
estate) led to a loss of consumer confidence and precipitous decline in consumption; these translated into
sharp decline in economic activities with its attendant effect in unemployment, reduced consumption,
weakened financial system, loss of confidence in financial market, declined economic growth and even
threat to (global) economic recession.

          Rescue interventions should inform the Central Banks to put in place a monetary policy that will
 enhance their regulatory role on other financial institutions and their products as well as make
 Government to function as a shock absorber to its citizenry by subsidizing the general effect of the crisis
 on its citizens such that unemployment and low per capital income will not be translated from such crisis

6.      Recommendations:

         Having explored the effects and consequences of global economic/ financial crises, it is pertinent
to proffer suggestions that will assist individuals and corperate organizations to cope with crises situations
explained in the course of this study. As noted in the previous sections of this study, the crisis produced a
chain reaction as less disposable income resulted in lower demand for goods and services, thus reducing
the productive capacities of industries. Consequently, the first measure employers decided taking to
lessen the impact on their businesses was the reduction of staff or their benefits. This study recommends
the following for individuals.

i)       Cost Cutting: Bismark in Alawode (2009) advised people to cut costs to free up cash to buy
potential assets at very cheap rates. Examples of such assets include real estate, shares and anything that
can generate money now or later. To achieve this, individuals are advised to consult experts on such
issues that are relevant to their business. This would enable them to know areas in their lives or business
where they are incurring unnecessary cost, and make amends where possible. It may involve refurbishing
certain items rather than buying new ones such as furniture, clothes, cars etc.

ii)      Diversifying Skills: At this period, it is very important for individuals to realize that their ability
to get their needs met should not be tied solely to their certificates or educational qualifications. Those
who have skill(s), which may or may not be similar to their discipline, have an added advantage during
times of economic downturn. Murdock in Alawode (2009) observed that Money is the reward for solving
others problems. What this implies is that even the financial meltdown presents some challenges that need
solutions which some would be ready to pay for in cash or kind. Teachers of vocational skills at all levels
especially the well educated class should enjoy more patronage in the present crisis. One can always get
one’s needs met as long as the person is able to meet people’s needs. The more needs a person meets, the
bigger the rewards he gets even in an economic downturn.

iii)     Explore Solutions: Rather than focus on the problem the financial meltdown poses, individuals
         should focus on the solutions they can proffer to others on the meltdown. While demand is going
         down in certain areas, the economic downturn is opening up opportunities in other areas too.

iv)      Low Priced Services: During an economic downturn, individuals and organizations want goods
         and services at lower costs. Individuals and small business organizations offering quality goods
         and services at lower costs are preferred to expensive ones. Fayo Williams is the Founder and
         Chief Executive of Rely Supply, a Pharmaceutical Company who is also a good orator. “It is an
         innate ability of practicing public speaking”, she noted. She wrote to certain organizations such as
         Business Schools, submitting applications to speak, which in her words, was another way of
         earning more income. She rendered such quality services at a relatively lower price.

v).      Free Services: Due to the meltdown, people and organizations appreciate free services and
discount more. Rocky Tapscott, a wealth creation expert advises those freelancing to do some free
services for clients. For example, when you render free services, you develop your skills and build a
relationship for future work down the road. This has helped some to obtain and sustain contracts with
some organizations.


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Mac-leva, F. (2009) “Taraba Government suspends Education Commissioner”, Daily Trust

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Greenspan, A (2001) “

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This Day Publications Ltd.

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