Introduction
Within the chronicles of the world’s economies, financial crises have remained an unfortunate and moderately increasing trend and so has the economic shock in both the USA and UK that serves as central hubs of global finance. Periodical, systemical or localized, financial crises, and others form multiple economies have led to severe economic collapse, causing upheaval at both political and social levels. As seen globally, these mishaps bring lack of confidence from citizens, disrupt the flow of markets, and completely alter economic perception globally.
This paper seeks to study the financial crises of the two superpower nations in parallel, without disregarding the individual nuances of either nation. Understanding these key differences and commonalities provides a richer perspective on the functioning of world economies, as well as the understanding of learnings from global crises.
- The United States and Its Financial Crises
America has had its fair share of profound financial crises that have impacted the international economy, both directly and indirectly. Here are a few noteworthy examples: The Great Depression (1930s), the Saving and Loan Crisis (1980s), and the Global Financial Crisis (GFC) occurring between 2007 and 2008.
A. The Great Depression (1929-1939)
Without an iota of doubt, the Great Depression was the most catastrophic financial disaster in the United States. Everything started spiraling downwards after the infamous Stock Market Crash of 1929, which resulted in a large number of businesses and banks shutting down. Following this, unchecked unemployment, plummeting consumer confidence, and rampant inflation led the depression to rapidly worsen. The Great Depression was the worst economic disaster of the twentieth century, not limited to the United States, but impacting numerous other nations across the globe.
Causes:
A couple of elements contributed to the great depression, including;
Market speculation: During the 1920s there was a drastic increase in the price of stocks due to speculation, and multiple individuals and companies bought stocks on margin. The moment the stock prices began to tumble, there was a subsequent cycle of panic selling.
Liquidation of banks: The withdrawal caused multiple banks to defaut aided by the heavy investment that was taken in the stock market. Lost deposits and rigidity of funds led to lack of credit, which worsened the economic downturn.
Agricultural surproduction: Farmers had also overshot their harvesting limits and the demand for these crops went down which caused the farm prices to crash.
Decreased international trading: There was a change in the us policy in 1930 called the Smoot-Hawley Tariff that increased tariffs on foreign products. This was met with retaliatory actions from other countries, causing a significant decrease in foreign trade.
Impact:
The loss that the great depression brought to the economy was devastating, which included;
The level of unemployment erupted to approximately 25 percent along with poverty rates drastically increasing.
Defunct banks wiped the savings of around 10 million American citizens.
About 50% of industrial output decreased.
There was a decline in global trade and economic activities in most countries in the world.
New Deal changes policy:
A response by the United States in relation to the Great Depression included a set of initiatives put forth by President Franklin D. Roosevelt, known as the “New Deal”. The following are some core aspects he focused on:
Setting up the SSA and FDIC (Social Security Administration and the Federal Deposit Insurance Corporation). These two were responsible for the protection of deposit account holders as well as providing economic security.
Defining employment and wage relations to control the economy.
Avoiding future market crashes through the creation of SEC (Securities and Exchange Commission) for stock market regulation.
Construction of public works through the WPA as well as private sector investment to stimulate economic activity.
The Great Depression came to an end (more or less in the late 1930s). Economic restructuring that happened later on set the groundwork for American policies for many decades.
B. The Savings and Loan Crisis (1980s-1990s)
The S&L Crisis marked another massive hit to the American economy. Roughly 1000 savings and loans institutions shut down during this period – 1986 to 1995. These institutions were based around mortgage various mortgages and their collapse resulted in a major setback for the American finance system.
Causes:
The S&L Crisis was brought about by multiple reasons:
Deregulation: Starting in the late 1970s and continuing through the 1980s, the financial sector of the economy was deregulated, enabling S&L institutions to make riskier investments, including commercial real estate and junk bonds.
High interest rates: With inflation, the Federal Reserve increased interest rates which resulted in higher borrowing costs, reduced loan demand, and a liquidity crisis in the sector.
Mismanagement: Poor speculative investment and risky lending practices resulted in many S&Ls mismanaging their finances, leading to foreclosure.
Impact:
The S&L crisis resulted in:
The government had to step in to address failing institutions, resulting in the loss of taxpayer money amounting to billions.
Moreover, there was a complete overhaul on the financial system to increase regulation and oversight.
Heightened general skepticism towards the banking industry, which led to an economic decline due to restricted credit.
Response:
Aiming to tackle the crisis, the government set up the Resolution Trust Corporation (RTC) to manage the assets of failed institutions. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) was also passed to intensify regulation on the banking sector to avert future crises.
C. The Global Financial Crisis (2007-2008)
The Global Financial Crisis, GFC for short, is the most recent financial crisis that hit the U.S. This crisis started in 2007 and peaked in 2008. It caused recessions in several economies around the world and greatly weakened the global economy.
Causes:
The GFC stems from a variety of root causes:
Mortgage subprime loan: Due to aggressive lending policies in the U.S, financial institutions made home loans to subprime borrowers with poor credit history. These borrowers were bundled into securities and sold which further increased the risk on a global scale.
Over Investing: Investment and other financial institutions took enormous risks engaging in super speculative actions and borrowing huge amounts of money which they used to hedge their positions.
Deregulation: In the years leading up to the crisis, the financial sector was almost completely deregulated, there was no supervision on speculative and high risk investments and regulations on the derivatives market was insufficient.
Housing bubble: Fueled by the housing market speculation, the availability of credit caused real estate prices to soar. The bubble burst when the prices began to drop, which is why it is referred to as a bubble.
Impact:
The GFC had profound and far-reaching effects:
Global recession: The U.S economy entered a recession as it was hit severely,GDP fell and Unemployment rose above 10% .
Bank failures: Big Financial Institutions such as Bear Stearns,along with Lehman Brothers, ceased operations, while others were bailed out by the government.
Loss of wealth: There was a massive loss as the stock market crashed and trillions of dollars globally went down the drain.
Global trade: During the freeze, there was a massive decline during the crisis along many businesses that found it tough to finance their operations.
Response:
The Us government and the Federal reserved took some outstanding steps to deal with the situation, which included:
Bailout of major financial institutions under the Program TARP.
Conventional Quantitative Easing (QE) after drastically decreasing interest rates economically stimulated the US.
Legislation: Proposed by Obama’s administration in the wake of the 2008 financial crisis, the Dodd-Frank Act (2010) implemented stricter regulations on financial institutions. These included more oversight of the derivatives market, limits on proprietary trading and increased restrictions on trading for one’s own firm’s account.
- The United Kingdom and Its Financial Crises
The UK has also gone through financial crises, although it has been able to cope with these better than some other countries because of its strong financial institutions. Still, the UK was impacted by global trends, and several major financial crises have had an enduring effect on its economy.
A. The Panic of 1825
One of the earliest financial crises in the UK was in 1825, and it is known as the Panic of 1825. This was a banking crisis that came after a speculative boom in investment on the Latin American region’s ventures and government bonds.
Reasons:
The reasons behind the panic of 1825 include:
Too optimistic speculation: British investors went all out financing Latin American governments, especially buying government bonds. The situation worsened when these governments started defaulting on their payment.
Banking system breakdown: Many banks, mainly in London, inexplicably nominalized bad debts and non-funded credits. The Bank of England was backed to jump in the fray and stabilize the system.
Consequences:
The results that most people expected included:
Closure of banks: There was an extreme number of bank failures and the Bank of England had to provide funding to the failing banks.
Loss of Wealth: Numerous individuals lost their finances and trust in the banking systems almost imploded.
Reforms: Policies were established after every speculative step was taken on investments and the banking sector was brought under stricter control.
B. The 1976 IMF Crisis
The United Kingdom encountered a financial crisis in 1976 whilst seeking help from the IMF. They went into deep financial trouble due to the high inflation rate, excessive unemployment, and a deficit in balance of payments.
Causes:
The aftermath of the 1976 crisis was due to:
Pre-existing deficits: The UK possessed a constant lacking balance for years and depended on borrowing to finance the available resources.
Steep financial inflation: The inflation rate was undergoing a massive change due to the sharp increase of oil prices during the oil shock of 1970.
Economic Mismanagement: The government had a failure in intervening with sufficient changes in order to tackle the fiscal issues for the country.
Impact:
Receiving the IMF aid resulted in major consequences:
Stricter policies: Were set by the IMF, providing considerable changes in the funding scheme leading to public unrest and discontent.
Social backlash: After the CBO introduced selective public cuts in spending, the country became flooded with strikes and protests.
Shift in Economic Strategy: The crisis marked an important turning point in the economy which now focused on market-based strategies and privatization.
C. The Global Financial Crisis (GFC) of 2008
The rest of the world was also greatly impacted by the global financial crisis of 2008. The financial sector went into utter panic after the collapse of Lehman Brothers and British banks faced increasing losses due to their heavy reliance on subprime mortgage markets.
Reasons
The factors that caused the GFC in the UK were just about the same as the ones in the US:
Excessive risk exposure: The British banks put a lot of their funds into terribly unsafe financial assets like mortgage-backed securities and other such MBS.
Crash of the housing market: The UK was also undergoing a housing bubble, alongside the US, which when burst led to huge losses for homeowners and financial institutions.
Global Interdependence: The UK, given that it is one of the largest financial powerhouses, London, was one of the world’s financial hubs, the scope of this crisis meant the UK was bound to be affected.
Effects:
This led to:
Rescuing of banks: Many banks like RBS (Royal Bank of Scotland) were nationalized by the UK government to save them from going under completely.
Recession: Unemployment sky rocketed and the economy suffered a deep downturn.
Austerity measures: After the bailout, the UK government started a program of austerity measures to control the fiscal deficit which resulted in public expenditure cuts and an increase in public sector borrowing.
Response:
In an attempt to boost the economy, the Bank of England lowered the interest rates and practiced quantitative easing. To further foster economic growth, the 2012 Financial Services Act was passed.