Do Modern Finance And Government Intervention Crash The Financial Research Paper

Do Modern Finance And Government Intervention Crash The Financial System - Research Paper Example This crisis resulted in severe issues including threat of total failure of large financial institutions, evictions, foreclosures, stock market downturns, housing market meltdowns, job terminations, and prolonged unemployment. Evidently, the 2008 global financial crisis significantly reduced the growth rate of countries worldwide and many western economies including US suffered huge net losses. A large number of business organizations went out of the business and thus many investors lost their money. Investigation reports indicate that it was the US housing bubble that led to the damage of financial institutions worldwide. Even though the US Federal government has pumped a huge volume of money into the market, the US economy has not yet completely recovered from the impacts of the crisis. This research paper will critically analyze the crash of the global financial system by referring to the book ‘Alchemists of loss: How modern finance and government intervention crashed the fin ancial system’ written by Dowd and Hutchinson. The paper will particularly evaluate whether the elements of modern finance and government intervention have played a role in crashing the financial system. An Overview of Modern Finance Emergence of floating currencies was a major event led to the development of modern finance. In 1971, Richard Nixon, the 37th president of the United States, suspended the dollar’s convertibility into gold in order to resolve financial difficulties associated with a huge trade deficit and Vietnam War. This policy brought an end to the Bretton Woods system of fixed exchange rates whereby capital flow from one country to another had been limited by exchange regulations. Since investing abroad was an expensive task under the Bretton Woods system, pension funds had kept their money home. According to Caldentey and Vernengo (2010), the policy amendment made the currencies floatable and entirely changed the way financial markets operate; and this change also created the need of currency hedging and resulted in the introduction of futures in financial markets. The floating exchange rates played a crucial role in the development of liberalized markets, which eliminated credit controls and promoted the entry of new lenders. Another effect of the new exchange rate system was the abolition of capital controls and this process led to a sharp appreciation of the dollar and pound. Institutions like insurance companies and pensions funds could freely move money without cross border limitations. In 1975, America introduced a financial reform to eliminate the distinction between brokers and jobbers and thereby to slash commissions. This reform gradually led a long term decline of broking revenues and widely restructured the industry. The increased need for capital forced investment banks either to make money on the stock market or to combine with commercial banks. The broadening of banking businesses resulted in more complex banking transactions and firms started to engage in more risky business ventures. In order to mitigate the growing level of business uncertainty, new forms of exchange rate risk reduction mechanisms such as options and swaps were introduced. In the w ords of Ryder, â€Å"futures, options, and swaps all have the same characteristic: a small position can lead to a much larger exposure† (cited in The Economist). In order to take advantages of the changes in global business environment resulting from globalization, creditors began to lend huge amounts of money to entrepreneurs and other