Financial Crises Of s s And st Century A Comparison

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

Introduction

Many definitions and description have been given to the term financial crisis by the world’s financial experts. There is an agreement that the term can be used to describe a situation where certain financial institutions and assets shed a significant portion of their worth. There are various reasons that have been proposed by these same experts as to the causes of financial crisis. They include banking panics and deregulation among other things. However, the causes vary from one crisis to the other and from one period to the other. There are also several effects that are brought about by the financial crisis. They include market crashes and decreased GDP of any country.

For the past a hundred years, there have been several economic crises in the world. Financial crises compose such economic crises. In fact, it looks like each decade has its own set of financial crises, which usually originate in one country and spread to the rest of the world. The 1930’s saw the Great Depression; the 1980’s saw the savings and loans crisis in the US and also the loan default crisis. The 1990’s saw the Asian currency crisis among a plethora of other financial hitches. The first decade of the twenty first century has not been spared either. The 2007/2009 financial crisis is considered in some quarters to be the largest since the Great Depression.

This essay is going to compare the financial crises of the 1980’s with those of the 1990’s. The similarities and differences between the two periods will be given and explanations for the same sought. The essay will conclude with the writer’s opinion on what the financial world should expect in the first decade of the 21st century as far as financial crises are concerned.

Financial Crises of the 1980’s

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

There were several financial crises in the 1980’s around the world. But perhaps the major ones were the debt crisis and the American savings and loans crisis (Carrasco 2008). The latter is referred by many as the 1980’s savings and loans scandal, a befitting term considering the factors that were surrounding it.

A: The Debt Crisis

According to Carrasco (2008), this crisis had its origins in the 1970’s. It is the accumulative effects of what transpired in the 1970’s that brought about the crisis of the 1980’s. There was what Wharton and Allen (2009) refers to as “petrodollar recycling” in the 1970’s. In the 1970’s, there was a considerable rise in the price of oil on the world market. This saw the oil exporting countries of the world, especially those from the Middle East, making considerable profits (Turner 2007). They stashed their extra profits in commercial banks both in America and Europe.

As is to be expected of commercial banks, they could not sit on all that money. They had to come up with ways to make profits from the deposits of the oil tycoons entrusted to them (Turner 2007). That is the reason why they came up with the supposedly brilliant idea of lending profitably to governments and public corporations in the developing world. Given the fact that the money coming from the oil merchants was unlimited, these banks gave out loans under very loose regulations. The creditworthiness of the borrowers- who were usually the developing countries’ governments eager to borrow money for development- was not scrutinized.

In early 1980’s, a global recession saw the value of exports made by the developing world’s to the world market decline (Carrasco 2008). This led to the decline in foreign exchange earned by these countries. They used the foreign currency to settle their loan, and so they faced some challenges here. This was worsened by the strengthening of the dollar relative to other world currencies. Given the fact that the dollar was what these countries were using to settle their loans, this also had the added effect of making their loans more expensive all of a sudden.

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

It was just a matter of time before the countries started to default on their loans. A trend was set by Mexican government in August 1982. It declared to the whole world that it can no longer continue to service the loan (Carrasco 2008). This refrain was picked up by other nations like Brazil and Venezuela. This posed a threat to the lending countries, especially after it was discovered that most of the lending institutions had little capital to offset the effects of the defaults.

B: Savings and Loan Crisis

This crisis started in the 1980’s and extended to the early 1990’s (Wharton & Allen 2009). It was sparked by the collapse of 745 savings and loan corporations in the US (DeLong 2009). One of the major factors that led to this collapse was the tax reform act of 1986 (DeLong 2009). This act led to loss of value of the real estate in America. This loss of value ended the real estate boom which had begun in the early 1980’s through to mid of the decade. Given the fact that majority of the real estate investments were made by money borrowed from the savings and loan associations, it was inevitable that the latter could be spared the loss.

Deregulation was another contributing factor to the scandal. These associations were deregulated such that they had the capabilities of banks. However, these capabilities were not checked by the usual bank regulations (Bradford 2008). They had the option to opt whether they could operate under a state or federal charter. The federal chartered associations were deregulated, and as a result, majority of the state chartered ones converted to federal to cash in on the riding benefits (DeLong 2009). These deregulations mean that they could lend money to the investors on loose standards. This was made worse by the boom of the real estate in the 1980’s. The associations lent money imprudently to undeserving borrowers. With the end of the boom, these associations took the flak, and the tax payer had to come in to bail them out.

Financial Crises of the 1990’s

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

This decade saw five financial crises around the world (DeLong 2009). The first was experienced in 1992 in Western Europe. DeLong refers to it as the Western European Exchange Rate Mechanism (2009). The second occurred in México in 1994-1995. 1997-1998 saw another one in East Asia. In 1998 it was the turn of Russia and finally 1998-1999 in Brazil (DeLong 2009).

One of the major causes of these crises was globalization. The 1990’s saw an increased rate of free trade and free investment around the world (Wharton & Allen 2009). However, this integration of the world market saw the developed countries exploiting the developing ones, leading to the financial crises in them.

Another reason was bad governance. Bad governance leads to adoption of failing policies. For example, the government of México had the ability to reduce inflation if it so wished (Bradford, 2008). But 1994 being an election year, there was change in priorities of the Mexican government. The government blundered in by making weak policies that led to the crisis. The same happened in Thailand when the administration opted to float the bhat in 1997 (DeLong 2009). This saw the collapse of this currency, which affected the whole of the Asian continent, and in extension, the whole of the world.

Financial Crises of the 1980’s and the 1990’s: A Comparison

The crises in both decades were similar to some extent in that some were unpredictable. The financial experts attributed the 1980’s crises to low level of globalization (Turner 2007). They were of the view that if the world economy were to be integrated, local economies could be able to adjust their mechanism to avert a financial crisis. With globalization having picked pace in the 1990’s, the pundits did not predict a financial crisis in this decade. However, they were proved wrong when their predictions were negated by the fact that the same globalization led to a round of another crisis (Turner, 2007). The same applied to the debt crisis of the 1980’s. With the petrodollar rolling in and the third world countries financing their developments, no one predicted a financial crisis. As such, it came as a surprise when the economic recession led to

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

defaults and massive back lash to the lending institutions.

Another similarity is that the crises in both decades can be traced back to bad governance leading to bad financial policies. The deregulation of the savings and loan associations in the US saw many of these organizations lending money unwisely (Bradford 2008). This was further compounded by the tax reforms that followed. The same bad governance can be blamed for some of the crises that occurred in the 1990’s. The Thai administration’s decision to float the bhat was a bad financial policy that led to unfavorable consequences. The Mexican government’s financial policies in 1994, in the eve of the elections, saw rising inflations and an eventual economic meltdown.

However, there were some differences that can be discerned between the two decades’ financial crises. One of them is the circumstances under which the crises occurred. For example, globalization had not taken root in the 1980’s (Wharton & Allen 2009). As such, the local economies were not able to check their financial crises by using the world economy as a buffer. But the conditions were different in the 1990’s. There was widespread globalization. In fact, this same globalization, according to DeLong (2009) could be blamed for the crises.

The financial crises of the 1980’s were caused to a large extent by greed of the bankers following a certain boom. In the credit crisis, the boom was the petrodollar influx and the borrowing tendency of the developing world’s (Carrasco 2008). During the savings and loan scandal, the boom was the real estate and the greed of the bankers to cash in on the boom. However, there were not many booms in the 1990’s. The crises were largely caused by bad governance.

21st Century: Potential Financial Crisis

It seems that every decade has its own financial crises. This is no different to the 21st century.

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

The decade has seen its share of financial crises already. On 2001, there was the crisis that was caused by the burst of the dot com bubble (Turner 2007). Many financial institutions that had invested heavily in the information technology boom suffered heavily when the industry plateaued all of a sudden (Turner 2007). The financial crisis of the year 2007-2009 has been termed by financial pundits as the worst since the great depression (DeLong 2009).

The conditions that exist today are the same that led to financial crises of times before, especially those of the 1980’s. It is like we cannot learn from history. The 2007-2009 credit crunch could have been averted. All the signs were there. There was a boom in the real estate industry, and bankers, with their usual greed, rushed in to cash in. they lent money imprudently. It was no wonder then that the financial market came down on its knees when the real estate bubble burst. Then everyone started comparing it with the 1980’s boom, while the signs were there all along.

Conclusion

There are similarities that can be drawn between all the financial crises that have wrecked the world ever since recorded history. This is especially so for the crises that had occurred since the 1980’s. Most of them had occurred as a result of the greed of bankers as they try to make profits in a boom. This is for example the real estate boom of the 1980’s and the 2005-2006 real estate booms.

In fact, a pattern seems to appear where financial crises come after a boom. The credit crisis of the 1980’s followed a boom in the world’s oil market. The savings and loans scandal came after a boom in the real estate, the same with the 2007-2009 crises. The 2001 crisis followed a boom in the information technology sector. Sometimes, it seems like these crises are inevitable, as if they are normal occurrences and man has no control over them more than he has control over the elements of weather. But on retrospect, most of these crises can be averted with enough planning. This is because they seem to follow a lapse in our planning procedures.

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

References

Bradford, CS 2008, “All the financial crises of the world are related.” Financial Times, 23(2), 2008.

Financial Crises of 1980’s, 1990’s and 21st Century: A Comparison

retrieved from http://www.uiowa.edu/ifdebook/ebook2/contents/part1-V.shtml ; on 16

retrieved from http://www.j-bradford-delong.net/TotW/learned.html ; on 16

Turner, CV, 2007, “Can we avert financial crises?” The Economist, July 27, 2007.

Wharton, MN & Allen, IO, 2009, Financial crises of the world, 2nd ed, New  York: McGraw-Hill.