The financial markets worldwide reflect the consequences of the reduction of loan proceeds in the conditions of deepening economic recession. Despite the assumed large-scale measures, the global financial system continues to experience strong stress. Besides, the worsening economic conditions lead to new considerable write-offs of the value of financial organizations’ assets which react by reducing the balances selling the assets and unprolongation of the loans with upcoming terms.
These measures aggravate downward pressure on the assets’ value and limit access to loans. The restoration of the normal functioning of the financial sector as well as trust toward it is a necessary condition of economic lifting. In that sense, the influence of mortgage loans, insurance, and banking cannot be overestimated.
One of the possible approaches to restructuring the banking regulations is the reconsideration of deposit insurance. The uncertainty that occurs at times of adverse economic shocks, “can lead to runs on banks both good and bad, and the failure of one bank can hasten the failure of others.” (Mishkin & Eakins, 2006, p. 514).
At the time of crisis, the stability of the financial market can be influenced by the level of trust of citizens in their banking system. The government already takes responsibility for such stability considering the role of FDIC during the financial crises through the twentieth century. The Paulson plan in raising the deposit insurance from $100K to $250 was the first step, where the recommended next step would be raising the citizens’ security and confidence level realizing full insurance guaranty of deposits.
Another approach can be implemented by restructuring pension funds and insurances. Firms often fail when they face a cost disadvantage, and in a time of recession, taking an example of firms with defined benefits plans, if they continue to fail, the obligations of PBGC would surpass its resources assuming that the economy remains weak (Mishkin & Eakins, 2006, p. 586). The approach currently seen in the government paying the obligations of the companies, seem to deepen the financial crisis, where according to Zvi Bodie, a professor of finance at the Boston University School of Management and longtime observer of the government’s pension insurance system, ““If one of these companies solves its pension problem by shunting it off to the federal government, then for competitive reasons the others have to do the same thing,”
The proposed recommendation would be to switch to private insurance and individual retirement plans. It can be seen that defined benefit plans are being exploited shifting the burden from the employer to PBGC and accordingly to the government.
In regards to the health and social insurances in general, the switch from government-provided social insurance to private while the government will maintain the regulatory position reducing costs and the risks of abuse.
Another approach to consider restructuring is concerned with financial derivatives. A key role in globalizing the mortgage crisis was played by the tools of the US mortgage crisis of 2007 were played by transferring credit risks, i.e. credit swaps. Considering the global nature of the world financial market, as well as the fact that buyers of high-risk mortgages stuck hedged the credit risk using credit derivatives, it is possible to draw a conclusion that the overwhelming majority of financial players anyhow have appeared dependent on the American mortgage loans.
Moreover, the hedge’s total sum under mortgage credits has many times exceeded the size of these loans, and till now cannot be accurately estimated because of the nature of the credit derivative market. In the conditions of the rapid development of credit derivatives, the banks operating in this segment, face never existed before risks, not being able to reconsider the system of risk-management in time, from the point of view of its conformity to new financial tools. Besides, the banks working with credit derivatives, in most cases face the non-transparency of pricing of assets, the absence of representative prices, and low liquidity of the given market.
The important problem is the absence of a uniform technique of estimating credit derivatives for the banking systems, which are the main participants of this market. The recommendation would be considering the implementation of new rules in regards to regulating credit derivatives making the whole process transparent to the banks, who directly participate in the process. The risk element in swap operations proved to be underestimated, where the regulations might not solve the problem right away, but at least in the long term, it will be certain that the same cause will not be repeated.
The regulatory activities should also be addressed toward future consideration among which the restoration of confidence can be pointed as one of the main key factors. The injecting liquidity approach implemented by the government might have a positive impact on the economy, and at the same time, these interventions were not able to address the concerns about counterparty risk. The restructuring of the banks’ liquidity frameworks should consider the following outlines:
- Considering a broader range of market rates, as well as a better understanding of the way banks can underpin their functioning through transactions.
- Varying between short- and medium-term open market operations
- Term lending, despite being useful in facilitating the balance sheet adjustments, did not provoke commercial and interbank lending. Thus, the usage of such procedures should be limited to short-term reliefs during crises.
Assessing the recommendations of the financial crisis preventive actions, it should be kept in mind that they are directed toward solving the issues that caused the financial crisis, rather than dealing with its consequences. In that sense, the actions of the government should be distinguished as long-term recommendations might not be suitable for regulating the existent consequences of a recession in a market.
It can be seen that the role of FDIC outlined in this paper is important dealing in both short and long-term preventions, where the emphasis on macro-economics in addressing the potential risks of the crisis continuation, cannot be underestimated. The role of the government is also distinctive in the crises, wherein areas the government interventions are necessary, while at other it would be more beneficial to assign this burden to the private sector taking a regularity role.
References
- Mishkin, F. S., & Eakins, S. G. (2006). Financial markets & institutions (4th ed.): Addison-Wesley.
- How not to solve a crisis (2009).
- Mishkin, F. S., & Eakins, S. G. (2006). Financial markets & institutions (4th ed.): Addison-Wesley.
- Pensions’ Death Spiral? (2009). Web.
- Saving the economy by “reforming health care”: what does this mean? (2009).
- Antolin, P., & Stewar, F. (2009). Private pensions and policy responses to the crisis Web.
- Conerly, W. B. (2005). The Defined Benefit Pension Crisis.
- Monetary and Capital Markets Department (2009). Lessons of the Financial Crisis for Future Regulation of Financial Institutions and Markets and for Liquidity Management Web.
- Varchaver, N., & Benner, K. (2008). Derivatives Web.