FINANCIAL CRISIS

Financial Crisis



Financial Crisis

Introduction

Financial Crisis and the Market Cycle

The global financial crisis shook the international financial system around the globe, and its repercussions are still being felt globally. Owing to its severity, it has been labeled as the worst crisis since the Great Depression. It is now, more than ever before, clear that the current financial system is not stable and that the invisible hand is not doing what its proponents claimed.

Why was there a financial panic? The blowup is easy to understand. Many firms faced a crisis of their own creation. Subprime mortgages were often held in fragile special purpose vehicles (SPVs) funded by rolling over short-term debt. Legally separate SPVs allow banks to buy certain assets without having to put up capital. The structures were designed to hide risk and to go around existing law (Here again, the regulators dropped the ball.). When the mortgages lost value, the short-term debt holders refused to renew their loans. This led to forced liquidations at depressed prices. Big trading losses brought on the credit crisis (Sakbani, 1985).

The prolonged period of “the great moderation”, together with runaway credit growth, paved the way for the current crisis. Easy money, uncontrolled growth of credit and debt, lax regulation and supervision, innovation of complex and opaque financial products, mismanagement of risks involved, lack of disclosure and transparency, predatory lending and high leverage - among other factors - are thought to be the main culprits behind the crisis.

The current global financial crisis brought Islamic financial industry (IFI) into the limelight as a possible alternative. However, IFI has not been totally immune to the crisis; it has been hit as well, although to a much more moderate extent. This may indicate a possible correlation between IFI and its conventional counterpart, as it lives under the same umbrella and is governed by the same rules of the game.

The movement from a period of increasing prices and strong performance, or bull market, through a weaker performance period of and declining prices, or bear market, and regaining the new strength is termed as market cycle.

A market cycle mostly is ahead of the economic cycle as the length of each cycle varies by several months to many years at times. The cycle's top is termed as the “peak” and the bottom as the “trough”. Similarly the stock market trends that operate on different cycles are based on the investing strategies termed as the asset allocation.

The Great Depression

During the 1930s, citizens of the USA found themselves in dire financial and societal straits. The major thematic sections of this encyclopedia, The Economic Depression, The Political Depression, The Social Depression, The Artistic Depression, and The Ethnic Depression, each focus on a particular aspect of the social order during those bleak days and the solutions, which were created to overcome them. (Akyuz, 1999).

The 2008 global financial crisis has highlighted the limitations of our current financial theory and models. It was the most severe crisis since the Great Depression of the 1930s, yet few ...