FINANCIAL CRISIS

Financial Crisis

Financial Crisis

About Financial Crisis

The term financial crisis is used to describe a broad set of changes in the financial conditions that include crisis of foreign exchange, banking crises and stock market crises. But the term is also used to refer to the crises of the debt or crises that affect the futures market. A financial crisis may involve only a few countries or initiated in one country can spread by contagion and become international and the global economy slump. One of the greatest historians of finance is the American economist Charles Kindleberger, which lists the financial crises since the 17th century in "A History of finance". He argues that the financial cycle involves five phases: growth, enthusiasm and excitement, fear and disorder, consolidation, and reorganization. It calls in particular on the turmoil resulting from the imbalance between production and consumption (Howard, 2010).

Financial Crisis and the Market Cycle

The global financial crisis shook the international financial system around the globe, and its repercussions are still being felt globally. Owing to its severity, it has been labeled as the worst crisis since the Great Depression. It is now, more than ever before, clear that the current financial system is not stable and that the invisible hand is not doing what its proponents claimed (OECD, 2010).

Why was there a financial panic? The blowup is easy to understand. Many firms faced a crisis of their own creation. Subprime mortgages were often held in fragile special purpose vehicles (SPVs) funded by rolling over short-term debt. Legally separate SPVs allow banks to buy certain assets without having to put up capital. The structures were designed to hide risk and to go around existing law (Here again, the regulators dropped the ball.). When the mortgages lost value, the short-term debt holders refused to renew their loans. This led to forced liquidations at depressed prices. Big trading losses brought on the credit crisis (James, 2010).

The current global financial crisis brought Islamic financial industry (IFI) into the limelight as a possible alternative. However, IFI has not been totally immune to the crisis; it has been hit as well, although to a much more moderate extent. This may indicate a possible correlation between IFI and its conventional counterpart, as it lives under the same umbrella and is governed by the same rules of the game (Frederick, 2005).

The movement from a period of increasing prices and strong performance, or bull market, through a weaker performance period of and declining prices, or bear market, and regaining the new strength is termed as market cycle (Benn, 2009).

A market cycle mostly is ahead of the economic cycle as the length of each cycle varies by several months to many years at times. The cycle's top is termed as the “peak” and the bottom as the “trough”. Similarly the stock market trends that operate on different cycles are based on the investing strategies termed as the asset allocation (Robert, 2010).

The crisis of 2008 and its affect on financial market

The mortgage market became a ...