Corporate Financial Management: Causes, Effects, and Reforms

This paper discusses the root causes and effects of the global financial crisis, with a focus on the collapse of financial markets and the possible reformation of the financial system. It also provides an overview of the impact of the crisis on different economies and suggests recommendations to avoid a similar catastrophe in the future.

Running head: CORPORATE FINANCIAL MANAGEMENT
Corporate Financial Management
Name of the Student
Name of the University
Authors Note
Course ID

1CORPORATE FINANCIAL MANAGEMENT
Table of Contents
Introduction:...............................................................................................................................2
Examples of Financial Crisis:....................................................................................................2
Collapse of Financial Markets:..................................................................................................2
Possible causes of Financial Crisis:...........................................................................................4
Can Global Financial Crisis happen again?...............................................................................5
Effect of GFC in different economies:.......................................................................................6
Actual or recommended reformation:........................................................................................8
Conclusion:................................................................................................................................9
References:...............................................................................................................................10

2CORPORATE FINANCIAL MANAGEMENT
Introduction:
The strengthening of international economic crisis, followed by the insolvency of
Lehman Brothers in 2008 made both the monetary and economic environment very difficult
all through the world. The occurrence of global financial crisis could be considered as an era
of change for both the monetary regulation systems and central banks. Economies all around
the world during 2008-09 suffered the most difficult financial tremor ever since the Great
Depression in 1930 (Balakrishnan, Watts and Zuo 2016). The international financial crisis is
considered as the deepest financial downturn ever since the Second World War. Although the
national financial crisis happens fairly and periodically but the international financial crisis is
very rare and only accounts the third instance ever since the Long Depression of 1893-79.
Parallel to the present Great Recession was the “Great Trade Downfall” where the
trading environment across the world declined sharply commencing from the third quarter of
2008 till the second quarter of 2009. The decline was considered largest over the last forty
years (Rey 2015). This paper explains the root cause of financial crisis and its impact on the
economies. More specifically, it would provide an overview of financial crisis in some of the
economies around the world and suggested recommendations to further avoid the catastrophe
from happening again.
Examples of Financial Crisis:
Collapse of Financial Markets:
The credit crisis is regarded as the direct resultant of mortgage market failure in US.
In 2001 the difficulties has commenced when the decision of Federal Reserve Bank was
implemented to reduce the rate of interest to 1%, so that it can overcome the negative impact
of September 11 on the economic growth (Jackson 2018). The decision of reducing the
interest rate by Federal Reserve Bank resulted in inflow of money from the emerging nations

3CORPORATE FINANCIAL MANAGEMENT
such as China and Middle East leading to huge availability of credit in the US. The investors
that were represented by the Investment Banks looked for strong return on their investment
which were greater than the 1% of the Federal Reserve Bank. The investors capitalized on the
opportunity that was presented by the rising mortgage market in country.
With the availability of higher credits several Americans were stimulated to purchase
their own house by borrowing from the Mortgage Lenders. With high amount of borrowings
the demands for new houses among the Americans grew further (Fligstein and Roehrkasse
2016). As a result of this there was a boom in the Real Estate Market from 2002-06 and the
price of the house tripled during this period. The mortgage companies packaged these
borrowings and sold the same to the investment banks that later characterised these
borrowings based on their risks and sold the loans to financial derivatives under variety of
names and returned back to the investors across the world. The risk was shifted from the
mortgage lenders to the investment banks and finally to the financial investors. The scheme
appeared risky however the home owners paid their monthly instalment and everything
appeared normal.
In order to keep the process smooth, the mortgage lenders began running out of the
customers that are credit worthy and started attracting applicants that were risky with history
of poor credit. The money lenders used schemes such as no down payment, no proof of
earnings and no kind of credit check to lure the uncertain applicants (D'souza 2016). The
venture of sub-prime loans resulted the mortgage market to for the explosion. The
justification for the subprime loan was that even though the risky applicants turns into
defaulters their home would be sold to somebody else and that too at a greater price.
However this was not the case as the rate of defaulters in the sub-prime loans were several in
number than expected and the investment bank were having several houses but did found any
buyers.

4CORPORATE FINANCIAL MANAGEMENT
The higher supply over the demand resulted in the bursting of bubble that was created
and the prices of the houses began falling sharply. The fall in price resulted the prime loan
owners to default because it was useless to make payments for the loans on low-cost houses
(Ciro 2016). The mortgage lenders on the other hand were unable to locate any new buyers
and they were unable to sell their loans to the investors. The entire financial system was
frozen in the nutshell. The collapse of the financial system led to several bankruptcies and
closure of the financial firms in US and across the world.
Lehman Brother Failure and Balance of Payments:
The failure of the Lehman Brother did not resulted in any kind of impact on the
domestic financial segment in respect of the inadequate exposure of the Indian Banks. After
the failure of the Lehman Brother, there was an unexpected alteration in the external
environment. There was the huge amount of sell-off in domestic equity markets by the
portfolio investors that reflected in deleveraging (Leiss, Nax and Sornette 2015).
Subsequently, there was a huge amount of capital outflows by the portfolio depositors in
September 2008 with connected pressure in the overseas exchange market. While the inflow
of foreign direct investment represented resilience but the access to the commercial lending
and trade loans became to a certain degree challenging. The net amount of capital inflow in
2008-09 was considerably lower and there was a reduction in reserves. There was a large loss
of reserve in 2008-09, with valuation loss amounting to US $38 billion out of US $58 billion.
Possible causes of Financial Crisis:
According to Dijkstra, Garcilazo and McCann (2015) it is difficult to determine the
main root cause of financial crisis. Nevertheless, the economist and analyst have indicated a
combination of several factors which has contributed to the burst of loan market in US and
subsequently around the world. The most notable cause of financial crisis was the inequity in

5CORPORATE FINANCIAL MANAGEMENT
the world trade. During the year 2001, China gained the most advantage by joining the World
Trade Organization. China utilized the advantage of new system of international trade and
flooded the international markets with the cheaper exports. China kept its exchange rate of
Yuan very low and its exports were very competitive in the international market (De Bruin
2015). This enabled China to amass higher amount of trade surplus whereas the rest of the
world especially US increased its trade shortfall. The shortfall in the US trade balance three-
folded from 69 USD in 1999 to as high as 256 USD in 2007. There was a sharp fall in the
production of both industrial and consumer goods in US and the economy of America shifted
to service economy.
The excessive amount of deregulation of financial market is regarded as another
reason for the international crisis. Ever since 1980, US was the leader in world of financial
market liberalization. To attain this, the financial market largely deregulated with the
relaxation of FED monitoring and supervision. In the last two decades the theory of market
liberalization swept the world following the push from the GATS treaty (Mensi et al. 2016).
This enabled US to enlarge its role as the dominant player in offering financial service.
Several financial products and derivatives were bought forward as the consequence of rising
international trade and liberalization. This resulted in the involvement of several investment
and financial banks in the securities and loans market as the example of deregulation and
liberalization. The expansion ultimately resulted in bursting of bubble and froze the entire
securities and loan market.
Can Global Financial Crisis happen again?
The emerging story is that the central all through the world have presented a rapid
sequence of reducing the lending cost and also recorded the $10 trillion of the negative
yielding sovereign debt. Reduced borrowing costs encourages high supply of money as the
temporary measure of purchase and enabling the countries to recuperate from the financial

6CORPORATE FINANCIAL MANAGEMENT
crisis (Gendron and Smith-Lacroix 2015). The political structure in several nations are yet to
apply the structural financial reformations needed by the sustainable financial growth and
have only injected funds from central banks to borrow the added cash to cover the deficit
rather than restructuring it evocatively.
Private sector companies have retreated from the capital venture that might be
encouraging for financial progress. The actual impact of financial growth is that there is wide
range of leverage however the international debt has been increasing negatively to stand -240
of the GDP by the year 2020. The non-corporate level debt has outclassed the growth of GDP
and has currently shadowed the debt to GDP ratio that has been witnessed in the last three
recession (Choudhry, Hassan and Shabi 2015). As a result, this becomes imminent that the
international financial crisis might happen again and the lead time among the rise in corporate
debt in relation to the GDP and earlier depression has varied.
Effect of GFC in different economies:
The recent financial crisis was very much notable as it impacted much of the world
and due to this reason it has been rightly said as global financial crisis. It is notable that
majority of the developing countries escape from being the part of recession due to actually
having a negative growth (Claessens and Van Horen 2015). However, the developing
countries GDP declined massively from the pre-crisis level to six percent points
approximately which was similar to that of the developed nations.

7CORPORATE FINANCIAL MANAGEMENT
Figure 1: Decline in World Trade Import and Exports
(Source: Claessens and Van Horen 2015)
Figure 2: Decline in Nominal Merchandise Exports by Major Regions
Source: (Moore and Mirzaei 2016)
The current account in US swung in opposite direction while the GDP of US declined
to 4%. In Germany the unemployment rate declined to 7.2% while in the US the rate of
unemployment stood 10.2%. In Spain the rate of unemployment ranged between 11.9% and
19.3%. The economies around the world suffered heavy decline throughout 2008 and 2009

8CORPORATE FINANCIAL MANAGEMENT
that also created effect on the GDP and macro-economic policies (Demirguc-Kunt and Peria
2016). Trade was heavily effected in the emerging European economies and fell to half what
it was a year before. In Russia, the exports in 2009 were half and its import stood three-fifths.
Figure 3: Russian Import and Export in 2008 and 2009
(Source: Demirguc-Kunt and Peria 2016)
The effect of economic crisis in the home country of Australia was less. However, the
main effect of economic crisis was on the household as there was sharp fall in price leading a
decline of 10% in Australian household market. The Australian dollar also experienced a
decline as it depreciated by 30 per cent from 2008-09 (Dijkstra, Garcilazo and McCann
2015). The bankruptcy of Lehman Brothers weakened the Australian foreign exchange
market forcing Reserve Bank of Australia to interfere in the overseas exchange to improve
the liquidity position.
Actual or recommended reformation:
In light of the international financial crisis government and central banks across the
world resorted to the monetary policies so that it can contain the financial crisis. The
government and the central banks took the measures of reducing the interest rates to reduce

9CORPORATE FINANCIAL MANAGEMENT
the borrowing costs for the private business for speedy commercial activities (Moore and
Mirzaei 2016). Few recommendations can be made that may help in correcting the mistakes
of financial crisis.
Reforming the WTO and international trade would not allow China to be a dominant
player in the world trade. This would help in elimination of unfair trade practices and would
promote higher economic growth. Another recommendation can be made towards improving
the public spending on infrastructure and construction activities which may result in
economic growth. The government and central banks should implement market regulation
and supervision in the short run to direct better credit lines for the companies and improved
monitoring of tax reports of financial companies. Furthermore, IMF must play an active role
in regulating and auditing the international financial system. China has made proposal of
creating a new global currency to replace the USD. This proposal must be accepted to
eliminate the world’s reliance on USD as it is main cause of crisis.
Conclusion:
Finally, the present GFC has showcased that market can fail and such failures results
in higher costs. The monetary system is susceptible to overindulgences due to the higher
leverage of banks and other financial institutions. The perception that markets would take
care of the weakness has again proved wrong. To be précis, improper supervision of agencies
over the financial market and expanding financial derivatives beyond the acceptable level
creates imbalances and give rise to exceptional economic crisis.

10CORPORATE FINANCIAL MANAGEMENT
References:
Balakrishnan, K., Watts, R. and Zuo, L., 2016. The effect of accounting conservatism on
corporate investment during the global financial crisis. Journal of Business Finance &
Accounting, 43(5-6), pp.513-542.
Choudhry, T., Hassan, S.S. and Shabi, S., 2015. Relationship between gold and stock markets
during the global financial crisis: Evidence from nonlinear causality tests. International
Review of Financial Analysis, 41, pp.247-256.
Ciro, T., 2016. The global financial crisis: Triggers, responses and aftermath. Routledge.
Claessens, S. and Van Horen, N., 2015. The impact of the global financial crisis on banking
globalization. IMF Economic Review, 63(4), pp.868-918.
De Bruin, B., 2015. Ethics and the global financial crisis. Cambridge University Press.
Demirguc-Kunt, A. and Peria, M., 2016. MS, & Tressel, T.(2015). The impact of the global
financial crisis on firms’ capital structure. Policy Research Working Paper Series WPS7522.
Washington DC: The World Bank.
Dijkstra, L., Garcilazo, E. and McCann, P., 2015. The effects of the global financial crisis on
European regions and cities. Journal of Economic Geography, 15(5), pp.935-949.
Dijkstra, L., Garcilazo, E. and McCann, P., 2015. The effects of the global financial crisis on
European regions and cities. Journal of Economic Geography, 15(5), pp.935-949.
D'souza, J., 2016. Once the bubble bursts: An overview on the comparison of the Asian
economic crisis and the global financial crisis. Journal of Public Administration and Policy
Research, 8(3), pp.25-32.

11CORPORATE FINANCIAL MANAGEMENT
Fligstein, N. and Roehrkasse, A.F., 2016. The Causes of Fraud in the Financial Crisis of 2007
to 2009: Evidence from the Mortgage-Backed Securities Industry. American Sociological
Review, 81(4), pp.617-643.
Gendron, Y. and Smith-Lacroix, J.H., 2015. The global financial crisis: Essay on the
possibility of substantive change in the discipline of finance. Critical Perspectives on
Accounting, 30, pp.83-101.
Jackson, K., 2018. Asian contagion: the causes and consequences of a financial crisis.
Routledge.
Leiss, M., Nax, H.H. and Sornette, D., 2015. Super-exponential growth expectations and the
global financial crisis. Journal of Economic Dynamics and Control, 55, pp.1-13.
Mensi, W., Hammoudeh, S., Nguyen, D.K. and Kang, S.H., 2016. Global financial crisis and
spillover effects among the US and BRICS stock markets. International Review of
Economics & Finance, 42, pp.257-276.
Moore, T. and Mirzaei, A., 2016. The impact of the global financial crisis on industry
growth. The Manchester School, 84(2), pp.159-180.
Rey, H., 2015. Dilemma not trilemma: the global financial cycle and monetary policy
independence (No. w21162). National Bureau of Economic Research.