Introduction
In 2007, the world suffered global financial crisis that was believed to have originated from the United States mortgage industry; the crisis led to world economic retardation since 2008. One sector that was directly affected by the crisis is the financial market industry; financial institutions depend on strength of an economy for sustainable business. When enacting monetary policies in an economy, central banks exercise them via financial institutions. According to MapXL Inc., financial institutions can be classified into four main categories as deposit taking institutions (banks, credit unions, trust companies, building societies, and mortgage companies), insurance bodies (brokers, underwriters), pension funds, and investment banks (MapXL Inc). This paper looks into types of financial institutions and the role they played in the global financial crisis of 2008.
Financial institutions played crucial role in global financial crisis since the institutions take different forms, their role manner in which they affected the crisis varied. The section discusses the role played by each category of financial institution:
Deposit-taking institutions
During the 2008 global financial crisis, deposit-taking institutions (banks, credit unions, trust companies, building societies, and mortgage companies) suffered reduced number of depositors. Disposable income was reduced since people were not having funds to invest/deposit. Before the crisis, the mortgage industry in the United state had embarked on massive financing of people to get homes. The strategies of the institutions made people with low income to access loans and get homes.
Credit unions, trust companies, and building societies had capitalized on the growing demand for homes from financed buyers. The increased demand of homes created an artificial shortage of homes to buy. Individual developers got loans from credit unions, banks, and building societies to build homes for the market. The net effect was more homes than demand; in a capitalist market like the one of United States; the market control the demand and supply. When the supply was increased, the effect was cheaper homes that previous borrowers opted to leave their package as it had deteriorated in value. The abandoned facilities created huge losses to the mortgage companies and no demand for the build homes; this was the start of the crisis (MapXL Inc).
With the world suffering from the crisis, central bank used monetary policies that are exercised via financial institutions. On their part the institutions became more stick on who they should offer a loan facility and the king of security that the person offered. They also controlled the industry that someone was investing. To that customer who had failed to pay their borrowed money, the loans were structured and in most demanding cases “top-up” loans were given to assist them get back to business. Credit unions, trust companies, building societies worked with the government to assist small and medium scale players build their businesses again.
Insurance bodies (brokers, underwriters)
Mortgages are required to be insured; other the mortgages banks are expected to insure the funds they give to their customers. In the wake of global financial crisis, the demand that the insurance bodies got was more than they could handle. Brokers and underwriters had the challenge of making a fair valuation of a property that had deteriorated in value because of the prevailing conditions. For those insured homes that were paid, they were paid at a cost that was lower than the book value that the holding institution had. The effect of the low pay was loss to mortgage companies. On the other hand, the increased demand for payments by defaulted mortgage loans led to insurance companies incurring huge losses. The deterioration, collapse, and loss incurred by the institutions played a crucial role in the crisis.
When the crisis was declared a global matter, the United States government devised policies that could assist insurance bodies (brokers, underwriters) to get into business again. The policies included financing them, becoming the reinsurer and offsetting some of their claims and losses. On their part, the bodies played a crucial role in the recovery process. An economy can only develop when the companies working there have confidence with institutions in the economy. Insurance bodies were given strength that assured investors that their funds can be insured in the country effectively and get their payments in case of damage. The role of insurance bodies can be seen more on its service of creating confidence among investors that the economy is stable enough to accommodate national and international investments.
For those companies who had been affected greatly by the crisis, insurance bodies (brokers, underwriters) accepted to draft their insurance policies in a manner that favored them. This meant that those companies that had accumulated unpaid insurance premiums they were allowed to pay them in new contracts that they were comfortable with.
Pension funds
Pension funds are financial institutions that collect deposits from workers with the assurance that they will pay them their dues with interests attained from ones contribution investments. One sector that pension’s funds had largely ventured before the crisis is building of homes for sale. The demand of homes as was created by access of mortgage facilities from mortgagee industries created even a better market and investment opportunity for the pension funds schemes. The main effect that the institutions felt was the lack of funds and claims from those people who had lost their jobs due to the crisis; they suffered huge losses and claims that they could hardly meet.
With the investment sector, the institutions can be blamed for an increased supply of homes that in turn lead to decrease in their value and eventually losses on mortgage companies. When demand was lower than demand, the prices that the homes were going for reduced that owners/ financed people found no reason to keep expensive facilities when the actual value of the homes were reduced.
With the financial crisis affecting the people negatively, pension funds institutions played a vital role in its recovery. One of the measures that the companies did was to diversify their investments. The diversification relieved the home industry; they also accepted to wave some of the gains they would get from already sold products in the move to be accommodated in the structured loan/mortgage facilities. When the institutions diversified their investments, contributors/member got more confidence with them that they will get their dues at the specified time. The confidence created improved investments in the economy. The institutions developed packages that catered for the low earners and those people who did not have regular income; this assisted to create confidence in the institutions operating in the United States (Kidwell & Whidbee 20-110).
Investment banks
Investment banks are financial institutions that collect member funds and invest in different sectors of the economy; they then give returns to contributors as interests or dividends. They have the mandate of mobilizing, managing, and controlling member’s funds for their mutual benefits. In the wake of financial institutions, the companies had been actively involved in the mortgage industry (they had invested in homes which they sold at a gain). The demand that was created by mortgage financing made the market better as businessmen, who are profit motivated, they were attracted to invest in the home construction industry. Homes build by investment banks formed the largest number of homes that were devalued because of demand-supply factors. The investments banks suffered losses as they could not sell their products at profit as they had promised their members. Member lost confidence with the institutions and investment in the banks reduced drastically. The United States government intervened in the institutions and offered them soft loans to assist them continue operation; on the other hand, the institutions had a role to create and retain confidence to their contributors that there are other areas that there can be invented without such a risk. This saw the diversification of investment to areas like government bonds and bills. With time investors developed/regained confidence in the economy and investment increased. With confident investors supported by strong financial institutions, the United States was able to recover from the financial crisis of 2008 (Anup).
Conclusion
The global financial crisis that started in year 2007 is believed to have been caused by a number of intertwined factors. The financial institutions carry the largest blame as they followed demand and supply for homes without taking precautions. They suffered huge losses that lead to economic retaliation in the world. However the institutions played a crucial role in the recovery process; they accepted to structure previous contracts to the favor their customers and worked on polices that regained their investors confidence to continue investing in the American economy.
Works Cited
Anup, Shah. Global Financial Crisis. Global Issues, 11 Dec. 2010. Web.
Kidwell, Blackwell, and Whidbee Peterson. Financial Institution, Markets, and Money. New York: Wiley, 2010. Print.
MapXL Inc. Financial Institutions. Mapsofworld, 2011. Web. 16 October 2011.