Global Financial Markets since the Financial Crisis, Stock Markets around the World Have Been In Turmoil

Introduction

Economists consider the recent global financial crisis as the worst since the occurrence of the Great Depression during the 1930s. The financial crisis led to the crumpling of significant financial institutions, fall in the global stock markets and the rescue of banks by governments. The underlying causes of the financial crisis is a debatable issues, although it has been established to began in the United States due to liquidity and valuation problems in the banking system of the US during 2008 (Andrew, 2010). The US housing bubble of that reached its peak during 2007 resulted to a decline in the values of assets in real estate, which imposed significant effects on the global financial institutions. The events culminating to the global financial crisis were because of issues regarding bank solvency, decreases in the available credit and a spoiled investor confidence. These factors imposed significant effects on the global stock markets that resulted in securities suffering huge losses during 2008. McKinsey Global Institute (2009) reported that the recent global financial crisis stopped the three-decade long expansion of the global financial markets. During the years 1980-2007, the global financial assets including bank deposits, equities, and public and private debt, quadrupled with regard to the global Gross Domestic Product (Batten & Szilagyi, 2011). There was also an upsurge of global capital flows because of the liberalization of the financial markets and innovative financial products and services. Mc Kinsey Global Institute (2009) claimed that the outcome of the expansion of the global financial markets was financial globalization. However, the 2008 financial crisis marked an abrupt end to this trend, resulting in a decline of the global financial assets by $ 16 trillion during 2007 to $178 trillion during 2008. The crisis may have ended but the aftershocks are still evident, since financial markets are still operating below their peaks. This paper discusses the importance of the roles that the stock markets perform as primary and secondary markets.

The stock plays an integral purpose in the financial system. It is usually viewed one of the best opportunities for investment despite its volatile nature to market shocks and social events. Modern economists are of the opinion that the role of the stock market has played an important role in the opening up of new opportunities in the financial market and ensuring the growth of the global economy. Companies in the stock market provide new securities, which are usually referred to as the primary market (Dilip & Ariff, 2004). In the primary market, companies benefit from the proceeds of sale of stocks. After the securities have been bought, the securities are sold in the secondary market. The companies do not participate in the sale of stocks in the secondary market. This implies that stock exchanges are the core element of the secondary market. By offering the investors with a chance to engage in the trade of financial instruments, stock exchanges play an important role in enhancing the performance of the primary markets. Such an arrangement facilitates the process of raising finances needed for business expansion by the corporations. Despite the fact that corporations are not direct beneficiaries of the secondary stock market, the managers are supposed to monitor their stock price in the secondary markets (Mayo, 2007).

The first significant role of stock exchange in the secondary market is that it guarantees a constant and ready market for securities by facilitating their sale and purchase. Stock exchange also provides an opportunity to evaluate the securities, which in turn enables the investors to have an accurate knowledge on the worth of their investments. Stock exchange is also an opportunity for capital formation since it encourages saving, investments and cultivates risk taking. Therefore, the stock market is a financial instrument needed for capital formation. The stock market guarantees safety and security when dealing with securities. This is because the managing body is charged with controlling the members and eliminating any fraudulent activities observed in the stock market. Healthy speculation and bank lending are also significant roles of the stock market. It is apparent that the stock market is extremely vulnerable to market shocks, and is likely to be affected by the global events such as the recent financial crisis, which imposes significant impacts on the role of the stock markets on both primary and secondary markets (Global Economics Crisis Resource Center, 2009).

In the primary stock market, the issuance of securities is based on an exchange basis, whereby the underwriters such as the investment banks play an important role in the primary market. The underwriters determine the initial price range of the stock shares and engage in the supervision of the sale of the shares. The primary market plays a vital role in capital formation in the global economy. The secondary market is where the investors acquire the stocks from other investors. The secondary market is extremely vulnerable to market shocks and significant events that are likely to affect the economy of a country. The success of banking institutions significantly depends on the existence of secondary stock markets. This is because commercial banks engage in investments in short-term financial assets, whereby cash is converted quickly using a conversion cost that is negligible. Stocks are in important constituent of secondary financial markets (Global Economics Crisis Resource Center, 2009).

The financial crisis of 2008 imposed significant ramifications on the role of global stock markets in the financial systems, especially after governments embarked on bailing out banks in the United States and Europe. The United States stock market reached its peak during 2007, as marked by Dow Jones Industrial Average going beyond 14,000 points. The onset of the financial crisis resulted in a pronounced decline when the Dow Jones Industrial Average index reached a trough of approximately 6600. Despite the fact that it has recovered after the financial crisis, as noted by indices above 12,000 points for most of 2011, it is still operating at a value below its peak value. The case was similar to global stock markets such as United Kingdom and France. The impacts of the financial crisis on the global stock market were worsened by the fact that investors feared that any official action could not be adequate to mitigate its impacts on the stock market. The United States government used $ 700 billion to bail out banking institutions. This strategy was adopted by numerous European countries as a strategy to boost the confidence of the investors. The underlying fact is that people were scared of the effects of the financial crisis, and embarked on selling. The constant failure of the stock markets even after the crisis can be attributed to the troubles faced by the banking institutions and the inefficient regulatory response initiated by authorities (Paolo & Oldani, 2011). The fall of the stock markets amidst government bailouts in Europe and United States only serves to increase the panic among the investors, which in turn fails to reassure their confidence. For instance, stocks in Asia fell while European markets witnessed losses of about 8 percent. The case was similar for the oil-rich Gulf nations, which at one time were not affected by the financial crisis facing the West. The stock markets of the oil-rich gulf countries witnessed a collapse in investor confidence. Russia was not an exception since trade in the stock market was suspended for two days. As a response strategy, central banks across the world including China, Sweden, United States, Switzerland and European Central Bank embarked on cutting the interest rates. The decision by to reduce the interest rates by 50 percent by the Bank of England resulted in some positive news for homeowners (Paolo & Oldani, 2011).

The global stock markets are currently in turmoil since declines in the stock market values and financial crisis are increasingly becoming a common occurrence. This raises concerns as why the financial markets are extremely unpredictable. In fact, it can be argued that the financial markets are a significant threat to the world economy. Mc Kinsey Institute (2010) asserts that it cannot be an instance of coincidence that the increase in the number and scope of disruptions in the global economy are associated with the expansion of the global financial markets. The financial crisis witnessed in Asia during 1990s was immediately followed by the internet bubble. With the downfall of the Lehman Brothers, the global financial system found itself in the verge of collapsing (Hirst, 2007). Presently, the euro is at risk, and investors fear that their currency is certainly collapsing. The rapid growth of the financial industry was accompanied with the growth of the global stock markets, and their respective incalculable risks. The global leading stock markets have not fully recovered from the fall imposed by the recent financial crisis. Key players in the global economy ate increasing faced with the challenges associated with scarce business and consumer credit availability, high amounts of fiscal deficits, sovereign debt risk and global financial reform movement. An analysis of the post-financial crisis times reveals that various economies are no longer confined by geographical limits. With the shifts in the United States economy in a bid to respond to the global financial crisis by changing, the US government has embarked on inventory restocking, fiscal stimulus and moderate expansion. The outcome of this is that the global financial markets are increasingly becoming selective. This implies that business sectors in various industry sectors will be constrained (Paolo & Oldani, 2011).

The global stock turmoil is further aggravated by the fact that investors are of the view that the United States and Europe and failing significantly to resolve the global economic problems. The basic argument is that global stock markets are in turmoil because investors are seeking safer havens through other investment options such as treasury bonds. The recent unsuccessful initiative by the European Central Bank in order to reassure the markets ended up scaring the investors. The European Central Bank aimed at buying the bonds of other countries as a show of support. Investors perceived that there is a chance they the bank’s approach could be plagued by the debt burdens of those countries. Investors on the US are laying emphasis on the fragile economic performance of the country and high levels of unemployment, resulting in an increase in the selling of stocks (Paolo & Oldani, 2011). Market analysts are of the opinion that the global stock market is likely to witness a further fall because investors are constantly reassessing the bleak economic prospects. Weak economic data is likely to taint the optimism of investors in the global stock market. Analysts are of the opinion that the credit markets have recovered from the impacts of the recent financial crisis. Presently, the crisis of confidence is a significant contributor towards the plunging of the global stock markets. Other perceived safe havens for investing include depositing hard cash in commercial banking institutions and foreign money markets. This further accelerates the turmoil facing the global stock market in the post-financial crisis period. Stock markets from almost every corner of the globe are not operating at peak. For instance, in the US, the stock market has fell below the critical support levels, resulting in increased selling because traders rush to ensure that they are not exposed to the plunging stock prices. In Europe, there are warning signs as the weaker European banking institutions are constantly struggling to finance themselves, the central bank has adopted an initiative to aid the weaker financial institutions through an expansion of its lending to the banks in the euro zone. The trend is the same for Asian stock markets that have not stabilized since the financial crisis and are operating below their peak levels (Hirst, 2007).

There is a positive correlation between decreases in wealth, decreases in consumption and the level of business investment, which when coupled with government expenditure, represent the engine of the financial markets and the larger economy. During the months of June-November 2007, Americans suffered 25 percent loss on the value of their collective net worth. By the dawn of November, the United States stock market index S & P 500 had declined by 45 percent from its peak in 2007. The asset values reduces, which was significant in the case of housing prices that fells by 20 percent from their peak in 2006, with the future markets indicating a looming drop of about 30-35 percent. There are numerous short-term impacts of the recent financial crisis on the global stock markets (Paolo & Oldani, 2011). The first significant impact on the stock market is that it reduced the stock prices. Investors are likely to commence selling their stocks in preference of other investment instruments that are not affected by the volatility of the financial market such as treasury bonds. The increase in sell results in a further decrease in the stock prices. This imposed significant effects on the profitability of businesses after the financial crisis compelling such firms to reduce production and lay off its staff; this in turn serves to accelerate the financial crisis. The second short-term ramification of the financial crisis on the global stock markets is that it resulted in decreased dividends; this is an outcome of the fall in stock prices. A decrease in dividends does not serve to motivate the investors. This further results in a failing stock market since the stockowners are likely to embark on selling of their stocks if they lack confidence in the profitability of the company. The outcome of this is a reduced stock market values and a further depression on the global stock market as a whole. The third ramification of the recent financial crisis on the global financial market is that it resulted in an increased market volatility of the financial markets (Nanto, 2010). The vulnerability of the stock market depends significantly on the investor outlook, a concept that is referred as investor sentiment. During the recent financial crisis, the investor sentiment was mostly pessimistic, resulting in a higher volatility of the global stock market. The outcome is that investors begin to consider investment options that are less risky. The volatility of the global stock market increased due to the failure of United States and Europe to respond effectively to the global financial crisis. This is turn results in a decrease in the investment in the stock market, which in turn results in a decline in the value of the global stock market (Paolo & Oldani, 2011).

The growth of the global financial assets since 1980 has depicted an upward trend, during 2007, the value of global financial assets peaked $ 194 trillion, which is equivalent to 343% of GDP. The financial crisis of 2008 interrupted this growth trend, resulting to a decline in the global financial assets by $178 trillion during 2008. Mc Kinsey Institute (2009) points out that this 8 % decline was the largest since 1990. The decline rate was extremely worse for some nations. The fact is that the damage was widespread, with every country depicting a decline in the financial assets. Only a few economies like the United Kingdom, reported a proportionate increasing during 2008. However, the United Kingdom is considered as a by-product of the financial crisis. For instance, the initiative by the UK government to bail out banks resulted to an increase in the private debt issuance that was more to offset the decrease in equities. The fall in the global financial assets in depicted in the following figure 1 (McKinsey Global Institute, 2009). It is vital to note that assets increase mainly because of an increase in global financial institution debt, which in turn reflects an increase in securitization activities.

Another implication of the recent financial crisis on the financial markets is that it resulted in a sharp decline in equities and securities, which was responsible for almost every fall in the financial assets. The value of the global financial equities reduced by approximately 50 percent ($ 28 trillion) during 2008, the damage was distributed in various countries resulting in the extreme crash after the Great Depression. Despite the fact that financial markets have restored some ground, they are still operating below their peak levels (Hirst, 2007). Additionally, it is estimated that the value of global residential estate values declined by approximately $ 3.4 trillion during 2008, which further increased by $ 2 trillion during 1^st quarter of 2009. Losses in real estate values and equities erased an approximated $ 28.8 trillion of investor wealth as of mid 2009. Recovering from such losses need longer periods of saving, this implies that the global financial markets have to save a total of $ 1.6 trillion for 18 uninterrupted years in order to amass the losses (Hirst, 2007).

In contrary to the decreasing values of equities and real estate, there was a remarkable increase in the value of private debt including asset-backed securities, corporate and financial institutions bonds. Private debt increased by approximately $ 51 trillion by the close of 2008. The inference is that the private debt remained flat in the wake of an increase in government debts. The growth in government debt is larger than the growth before the onset of the financial crisis. There is a probability that government debt will increase further because many nations are embarking on increasing borrowing as a method to pay for planned fiscal stimulus expenditure. With the decrease in the values of financial assets and increases in debt, the leverage in the worldwide economy has increased instead of reducing. This is the case for households, banking institutions, governments and the corporate sector. The global debt-to-equity ratio almost doubled from 124 % during 2007 to 244 percent during the close of 2008.  This indicates the degree of vulnerability of the global financial markets to more shocks (Hirst, 2007).

During 2008, there was an increase in the amount of global bank deposits by $ 5 trillion, which represents 9 % growth. The growth in bank deposits was notable for the case of developed economies; this was a move to ensure safety by depositors and the aggressive efforts deployed by the banking institutions to attract deposits. The bank deposits in mature economies increased by $ 2.8 trillion during 2008 to reach $ 45.3 trillion. The figures relating to an increase in the global bank deposits indicated a departure from the current trends whereby deposits in mature economies increase with Gross Domestic Product. In the short-term, an increase in the bank deposits is likely to continue if the investors continue to be risk aversive and banking institutions competing aggressively for deposits. In the case of emerging markets, there was a rapid increase in deposits by a remarkable $ 2.1 trillion. Despite this, they are just a mere 25 % of the deposits in mature markets (Paolo & Oldani, 2011).

A steep decline in the cross-border financial flows is one of the significant implications of the recent financial crisis. This is resulted in declines in foreign direct investments, cross-border lending and deposits, and purchasing and selling of foreign equities. During 2008, Mc Kinsey Global Institute (2009) reports that there was 82 % decline in the global financial flows from $ 10.5 trillion during 2007 to $ 1.9 trillion. In relation to GDP, the 2008 volume of global financial flows was the lowest ever since 1991. This resulted in turmoil in the global banking system that led to liquidity crises and hurting borrowers who relied on foreign loans. Presently, it is not clear how the global financial flows will recover from these crises (Batten & Szilagyi, 2011). Global financial flows did not only fell, but also reversed because investors, corporations, banking and other financial institutions engaged in selling foreign assets and took their money back to their home countries. In the previous financial crises, cross-border lending was responsible for the overall decline. Worldwide cross-border lending reduced from $ 4.9 trillion during 2007 to -$ 1.3 trillion during 2008. This is an indicator that lenders withdrew more than they made. Approximately 40 % decline can be attributed to the decrease in interbank lending, especially after the downfall of Lehman Brothers during September 2008. However, the most significant factor that resulted in decline of cross-border financial flows was due to the withdrawal of foreign lending to non-bank borrowers in the emerging financial markets. Financial flows of foreign deposits also witnessed a reversal because investors withdrew approximately $ 400 billion in the form of deposits from the foreign financial institutions during 2008. The fall in global financial flows was accompanied by declines in global purchases of foreign equities and debt securities. As a result, global flows into equities were negative, declining from $ 800 billion to – $200 billion during 2007 to 2008. This is because investors disposed their foreign equities and returned their funds to their home countries. In addition, there was a global decline in the purchasing of foreign securities, with the United States being the exception since the government debt increased forcing investors to seek the US Treasuries (Mohamed & Fredj, 2010). Historically, FDI has reported the lowest levels of volatility than any other form of financial flows. The financial crisis did not impose significant impacts on FDI, although it resulted in a decrease in global FDI from its 2007 peak level during 2008. Across the globe, the United Kingdom and Western Europe reported the huge declines in cross-border financial flows. For instance, the total financial flows to the UK were negative during 2008, indicating that foreign investors withdrew more funds from the UK than the amount that they had invested. The decrease in financial flows to the Western Europe indicated a reverse of the lending flows between the UK and the larger euro zone. In addition, it served to point out that there was a decrease in financial flows between countries in the euro zone, and a decline in financial flows between the United States and European countries. The following figure 2 indicates the fall in the global financial flows (Andrew, 2010).

One of the significant ramifications of the decline in the global financial flows is that it resulted in higher credits and increased the volatility of numerous currencies. This is because it has made significant contributions towards the increase in the cost of capital and imposed significant constraints on fund raising by corporations. There have been substantial increases in credit spreads since the onset of the United States subprime mortgage crisis that commenced during early 2007. Prior to the onset of the recent financial crisis, credit spread have been reported to be lower than their historic average, accelerating global credit boom and increasing speculations by observers that the investors were estimating the risk. By mid 2008, after the US subprime mortgage crisis has imposed significant effects on the larger financial market, the credit spread had increased thrice for the risk borrowers, and increased further after the downfall of Lehman Brothers (Paolo & Oldani, 2011). Despite the fact that credit spreads have eased, they are still relatively higher than the years before the crisis, there is the likelihood that they will remain higher in the looming future. The disruptions in the global financial flows resulted in a short-term exchange rate volatility. For example, during the initial weeks of the crisis, the value of the Korean won depreciated by at least 20% against the Japanese Yen, which in turn increased the competitiveness of Korean industries than Japanese manufacturers. On a similar account, the Mexican peso weakened against the US dollar by about 19 percent. In Russia, there was an increase in their foreign reserves, which was attributed to strong trade surpluses.

The recent financial crisis has raised significant concerns regarding the future of financial markets and globalization of financial instruments. During the past decade, cross-border investments and capital flows have increased, which led to the globalization of the financial system. However, this trend weakened during 2008 because of the significant decline in the value of global investments. For instance, cross-border investments between US and Japan, and US and UK declined sharply. The recent disturbances in financial flows raise concerns regarding the continuation of financial globalization. For example, the decline in cross-border lending has forced many national governments to reevaluate the decision to allow foreign banks to dominate the domestic economy. This was the case in Eastern Europe and Latin America, whereby the financial crisis compelled the local subsidiaries of foreign financial institutions to withdraw their credit because of the issues involving the inadequacy of capital for domestic banks. This phenomenon indicates the home bias in terms of investments by banking institutions and foreign investors, who aim at giving more focus on domestic investments than foreign investments. Nevertheless, the withdrawals were also accelerated by political pressures imposed on banking institutions to increase domestic lending in order have support from the government. Presently, policy makers are considering the benefits associated with foreign banks in the sense that they tend to increase competition and offer more efficient and effective financial mediation irrespective of the costs associated with abrupt declines in financing. The impacts of the financial crisis on the global financial flows make it hard to determine the future trends and recovery of cross-border capital flows (Dilip & Ariff, 2004). However, there is evidence that some forms of financial flows such as interbank lending and investment in emerging financial markets are showing recovery. Lending forms the largest component of cross-border financial flows; however, it is not certain whether banking institutions will embark on adjusting their balance sheets and reclaim their appetite for global expansion. In addition, it is unclear whether the policies initiated by national governments will impose significant pressure on the banks to increase their priority on domestic lending. The bottom line from the above observation is that the recent financial crisis stalled the third-year steady expansion of the global financial markets.

References List

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