How 2007 2008 Global Financial Crisis Could Be Mitigated in The Future Paper How can the risk of occurrence of crisis such as 2007-2008 global financial cr

How 2007 2008 Global Financial Crisis Could Be Mitigated in The Future Paper How can the risk of occurrence of crisis such as 2007-2008 global financial crisis be mitigated in the future? What actions do you think a multinational firm can take to limit the impact of future crisis in the global financial system on the ability of the enterprise to raise capital to pay its short term bills and fund long term investments? See attachment for background info5 pages, APA Declining Cross-Border Capital Flows— Retreat or Reset?
For decades cross-border capital flows—including lend-
ing, foreign direct investment flows, and purchases of
equities and bonds—advanced relentlessly, reflecting the
increasing integration of national capital markets into one
single massive global system. Cross-border capital flows
surged from $0.5 trillion in 1980 to a peak of $11.8 tril-
lion in 2007; and then they collapsed. By 2012 cross-
border capital flows had retreated to $4.6 trillion, 60 per-
cent below their former peak. The global capital market,
it seemed, was in retreat.
To understand why, we have to go back to 2008,
when a major crisis swept through the global capital
market that very nearly froze the financial pipes that lu-
bricate the wheels of the global economy. Financial in-
stitutions and corporations around the world routinely
lend and borrow trillions of dollars between themselves.
Most banks and corporations issue unsecured notes
known as commercial paper with a fixed maturity of be-
tween 1 and 270 days. This is a way for those firms to
get access to cash to meet short-term obligations, such
as meeting payroll and paying suppliers. Because the
notes are unsecured, and not backed by any specific as-
sets, only banks and corporations with excellent credit
ratings are able to sell their commercial paper at a rea-
sonable price. This price is set with reference to the
London Interbank Offered Rate (LIBOR). The LIBOR
is the rate at which banks lend to each other. In normal
times, the LIBOR rate is very close to the rate charged
by national central banks, such as the U.S. Federal Re-
serve for the dollar.
Early in 2008 banks in several countries had started
to run into trouble as it became clear that the value of
the mortgage-backed securities that they held was col-
lapsing. This was due to a fall in housing prices, and
rising default rates on mortgages, most notably in the
United States and Great Britain, where lenders had
written increasingly risky mortgages over the preceding
few years. These mortgages were bundled into securi-
ties and then sold to other financial institutions. Also,
many institutions held complex derivatives, the value
of which was tied to the underlying value of mortgage-
backed securities. Now these institutions were facing
large write-offs on their portfolios of mortgage-backed
securities and the associated derivatives. One of these
institutions, Lehman Brothers, had taken aggressive po-
sitions in the market for mortgage-backed securities. In
September 2008 the firm collapsed into bankruptcy af-
ter the U.S. government decided not to step in and save
the company.
The bankruptcy of Lehman sent shock waves through
the global financial markets. In effect, the U.S. govern-
ment had stated it was prepared to let large financial in-
stitutions fail. Immediately, banks reduced their
short-term loans. They did this for two reasons. First,
they felt a need to hoard cash because they no longer
knew the value of the mortgage-backed securities they
held on their own balance sheets. Second, they were
afraid to lend to other banks because those banks might
fail and they might not get their money back.
As a result, LIBOR rates quickly spiked. The dollar
rate, for example, had been 0.2 percent above the rate
on three-month U.S. Treasury bills in 2007, which is
a normal spread. However, the spread increased to
3.3 percent by late 2008, raising the cost of short-term
borrowing some 16-fold. Many corporations found that
they could not raise capital at a reasonable price.
Money market funds, which in normal times are large
buyers of commercial paper, fled to ultra-safe assets,
such as U.S. Treasury bills. This pushed the yield on
three-month Treasury bills down to historic lows, and
also led to a sharp rise in the value of the U.S. dollar. In
essence, the financial plumbing of the global economy
was freezing up. If nothing was done about it, many
firms would be unable to borrow to service their short
term financing needs. They would rapidly become in-
solvent and a wave of bankruptcies could sweep around
the globe, plunging the world into a serious recession,
or even a depression.
At this point several national governments stepped
into the breach. The U.S. Federal Reserve entered the
commercial paper market, setting up a fund to purchase
commercial paper at rates close to the rates for U.S.
Treasury bills. Central banks in Japan, Great Britain, and
the European Union took similar action. Once partici-
pants in the global capital markets saw that national gov-
ernments were willing to enter the commercial paper
market, they too started to ease their lending restrictions,
and LIBOR rates started to fall again. The U.S. govern-
ment established the Troubled Asset Relief Program
(TARP), allowing the U.S. Treasury to purchase or in-
sure up to $700 billion in “troubled assets.” Under TARP
the government began to inject capital into troubled
banks by purchasing assets from them that were difficult
to value, such as mortgage-backed securities. This sig-
naled there would be no more bankruptcies such as
Lehman’s. This too helped unfreeze the market for com-
mercial paper. A major crisis had been averted, but only
just. Although the $700 billion price tag for TARP
stunned people, most of the money lent to banks under
TARP was quickly paid back with interest, and by late
2012 estimates suggest that the total cost to the taxpayer
would be close to $24 billion.
Five years after the crisis hit, the global capital mar-
ket had still not fully recovered from its 2007 peak.
Does this signal a retreat from the globalization of capi-
tal, or merely a reset? Most observers believe the latter
is the case. Since 2008 the world economy has grown
slowly, and economic troubles persist in many regions,
particularly Europe, where several national govern-
ments are burdened with high levels of sovereign debt
that limits their ability to deal with persistently slow
growth and high unemployment. Notwithstanding this,
the world economy continues to become more inte-
grated, propelled by stronger growth in some develop-
ing nations, and as this process unfolds, global capital
markets will inevitably start to expand again to support
cross-border trade in goods and services, as well as
cross-border investments.

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