FINANCIAL CRISIS

Analyse the impact of the financial crisis on the UK financial market by comparing main financial variables before, during and after the financial crisis

Analyse the impact of the financial crisis on the UK financial market by comparing main financial variables before, during and after the financial crisis.

Introduction

Financial crises have intervened the operation of financial markets over years. Most noticeably the great depression in 1929-30, the 1970s inflation crises and the banking crises in the 1990s created havoc in the financial markets causing severe disruption. The current financial crisis which emerged in 2007, although the roots were sown much earlier, has been one of the toughest and probably the biggest that financial markets have ever encountered. Referred to as the credit crunch, the impact of the crisis has not only been on the banking sector but on the real economy as a whole potentially leading to long and deep recession.

Literature Review

The 2007-2008 Financial crisis, similar to the Great Depression and Japan's lost decade, started with the bursting of an asset bubble. An important difference, however, has been the introduction of many complex financial instruments since the late 1990's. The result was that many financial firms did not understand the risks of the positions held on their books. As the value of these assets dropped in value, many financial firms were in danger of collapsing. The U.S. government, in trying to avoid systemic failure of the financial system, hastily designed plans to bail out the industry.

In so doing, the government has committed trillions of dollars. Another outcome of the financial crisis is the slowdown of the economy. This has caused price levels to fall as demand slows. Following the advice of John Maynard Keynes, the government is planning to spend billions more to help prop up the economy. The U.S. government is throwing all its financial might at reviving the economy. One group of economists warn that this will lead to a uncontrollable inflation, while another group argues that deflation will bring the United States into Great Depression 2.

Background of the Financial Crisis

In December of 2008, the Federal Open Market Committee decided to lower the Fed Funds target rate to a range between 0-0.25%, a historical low. In the statements released after the meeting of December 16th, the FOMC stated that, “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time” (Federalreserve.gov, 2008). The Fed's decision to use all of the available tools to lift the economy was in response to the lasting effects of the financial crisis of 2007-2008.

According to the International Monetary Fund, “The financial shock that erupted in August 2007, as the US sub-prime mortgage market was derailed by the reversal of the housing boom, has spread quickly and unpredictably to inflict extensive damage on markets and institutions at the ...