Executive Summary
The primary goal of the paper is to understand the influence of the credit crisis on the financial market liquidity. In this instance, its impact on the inactivity of the debt markets, interest rates, and IPOs were analyzed. The literature review was used as a primary research tool to gather information about these phenomena. The literature review revealed that lack of liquidity occurs due to the investor’s sentiment and lack of the circulation of the liquid financial assets on the debt market. Consequently, the debt markets become and remain inactive due to the lack of demand for securities. In turn, the interest rates also have to be at a high level since it is a primary financial instrument to find the balance between the losses and incomes. Lastly, the activity on the IPO market also remains low.
As for the discussion, it is unclear whether the financial crisis can be prevented and controlled. Furthermore, it is questionable whether it has only a negative impact on the global economy, as it increases competition between the companies. It was revealed that some companies, such as online nonbank creditors could benefit from this situation and increase their value of IPO. Moreover, following the historical flow of events is beneficial for the understanding of the actions on the financial market and understanding the necessity of governmental intervention. In the end, further research is needed since the number of interdependent variables, which are co-dependent and have to be analyzed simultaneously, determines the existence of a credit crisis. Lastly, the findings can be beneficially used by management and financial institutions to find the potential advantages of the situation.
Introduction
The credit crisis is a common financial phenomenon, which has a circular occurrence since the economic stages have tendencies to repeat. It implies that “there is little or no credit available for borrowers” (Hollander, 2011, p. 4). The primary cause of this situation is the economic change, which affects the lender’s decision-making whether there is enough value to take the risk of the investments (Hollander, 2011). Additionally, a similar situation occurs when the lender experiences financial difficulties and has an insignificant amount of money, which is available for a loan. Nonetheless, in this case, the credit crisis has a vehement influence on the economic situation in the world since credit plays a substantial role in the financial activities of the companies and population. It is evident that the credit crisis has a vehement impact on financial market liquidity and causes changes to the activity of the debt markets, interest rates, and IPOs.
A primary goal of the paper is to discover whether the credit crisis has a vehement impact on the financial market liquidity. Moreover, it is necessary to focus on the fact and provide an explanation of why the debt markets become inactive. Additionally, in this assignment, it is necessary to determine how this financial situation affects interest rates. Lastly, high attention is paid to the fluctuations of IPO and describes the primary reasons for the occurrence of this alteration. Finally, it is necessary to discuss the reasons for the occurrence of each phenomenon.
The literature review is used as a primary research tool to collect data, evaluate the significance of the problem, and determine the correlation between the financial crisis and changes in financial market liquidity, activity of debt markets, interest rates, and IPO. The discussion and analysis of this phenomenon are conducted based on the previous studies, which are presented in the literature review. In the end, the conclusions are drawn to summarize the findings.
Literature Review
The primary goal of the literature review is to clarify the matters related to the credit crisis and determine its consequences on the financial market liquidity, activity of the debt markets, interest rates, and IPOs. Speaking of the effect of the credit crunch on the lack of liquidity in the debt markets, it has to be mentioned that their actions are represented by various financial entities such as banks, Krishnamurthy claims in his article How Debt Markets Have Malfunctioned in the Crisis (2010). Nonetheless, the historical flow of events has to be analyzed to determine the potential reasons for the inactivity of the debt markets. Figure 1 presents the key events, which contributed to the development of the crisis in 2007-2008 (Krishnamurhy, 2010). Firstly, it is evident that Bear Stearns’s failure was a starting point since it questioned the ability of the other banks to face the situation. The significant drop of AIG also contributed to the cultivation of the idea that the investment banks will go into bankruptcy rapidly since they are not able to survive the credit crisis (Krishnamurhy, 2010). In the end, the Treasury had to contribute to balancing out the situation since otherwise, the bankruptcy could be considered as a potential outcome. In this case, governmental contribution remained a necessity, as the banks were not able to balance their assets and losses due to the uncertain and unstable situation on the market.
Nonetheless, Figure 1 helped understand the origin of the problem and the flow of economic events, which led to the lack of liquidity of the debt markets. The absence of liquidity can be determined by the decrease of the purchasing initiative from financial instructions and the preference of the investor to the liquidity of their ownership (Krishnamurhy, 2010). In this case, the liquid assets do not participate in the financial circulation actively since the investors prefer to have these resources saved and utilize illiquid financial tools. In the end, following the flow of events contributed to the understanding of the occurrence of the situation on the market and revealed the reasons for the market liquidity and necessity to the inactivity of the debt markets.
Additionally, Madura in his book Financial Markets and Institutions implies that the lacking liquidity occurs due to the inability of the institutions to sell the recently purchased bonds and securities on the secondary market, as the potential investors consider this purchase irrelevant and risky (2012). This aspect leads to the generation of high volumes of illiquid assets and an intense lack of liquidity in the debt market. In turn, the inactivity of the debt markets can be explained by the fact that investors are not willing to contribute to the active bond purchase, as the benefits from these actions remain unclear during the credit crisis (Madura, 2012). Their lack of investment interest can also be explained by high-interest rates. Moreover, insurance companies tend to stop providing credit insurance (Vaidean & Ciumas, 2010). This aspect also leads to the inactivity of the debt markets since the operations become riskier and unsafe. The combination of these factors is the primary determinant of the investor’s activities since it is evident that the investors will be able to contribute to the activity of the debt market only when the uncertainty decreases, and the benefits from the purchases will be clarified.
Interest rates are another aspect, which is affected by the credit crisis. However, firstly, the credit crunch can be defined as the “period during which borrowed funds are difficult to obtain and, even if funds can be found, interest rates are very high” (Wallace, Avis, & Smith, 2008, p. 58). In this case, the primary problem is the fact that the interest rates remain high during the credit crisis, and it involves the high costs of the loan of the financial resources. Additionally, Wallace, Avis, and Smith in their article The Credit Crunch: The Domino Effect claim that credit crunch occurs due to the inability of the banks to provide loans due to the lack of capital equity (2008). In this instance, the increase in the interest rates remains a necessity since the banks have to be able to find the equilibrium between costs and benefits to sustain on the market. The situation is unstable, and this step is essential.
Nonetheless, it remains unclear whether the interest rates determine the credit crisis or vice versa. For example, Stewart in his article IMF Warns of New Financial Crisis if Interest Rates Rise claims that steadily increasing interest rates might be a potential reason for the occurrence of the financial crisis in the emerging markets since these countries tend to invest in cheap purchases to reduce the financial debt (2015, para. 1). Figure 2 portrays the current situation of the emerging markets’ economy. It could be noticed that the corporate debt tends to increase in the progression, as the differences between the early 2000s and 2014 are dramatic (Stewart, 2015). The increase in debt is one of the primary reasons for the rise in interest rates (Stewart, 2015). It is evident that in this case, banks have to generate additional revenue. Consequently, the increase in interests remains essential to stay competitive in the market and avoid bankruptcy. In this instance, the countries have to increase the interest rates to maintain their economy in balance.
It could be said that the increase in the interest rates is one of the reasons for the credit crunch since the reduction of this aspect will lead to a decrease in the consequences of the credit crisis (Wallace, Avis, & Smith, 2008). Moreover, the interdependence between debt and interest rates cannot be unnoticed, as changes in the value in one lead to the alteration of another. In this case, these two phenomena cannot be separated and have to be analyzed simultaneously while determining the reasons for the credit crunch.
The influence of the credit crisis on IPO is another vehement topic, which requires discussion. For example, it is evident that the financial crisis adversely affected the IPO market in 2007, as at some point they posed to “virtual halt” (“Credit crisis”, 2007, para. 1). However, despite being in disturbing condition, some of the companies tend to increase the value of their IPOs during the financial crisis. For instance, in the article Lending Club Files for IPO: Start-up Emerged during Credit Crisis Armental and Chapman claim that Lending Club Corporation was able to increase their IPO since the online bank lenders tend to rise in value due to the inability of the traditional banks to provide the loans (2014). The management of the company considered the financial crisis the best time for expansion since the other banks remain inactive due to the lack of loans available for the public.
Nonetheless, the primary contributing factors of the release of the IPO are capital demand, investor sentiment, and the condition of the stock market (Blum, 2011). The credit crisis does not provide favorable conditions for the growth of the IPO since the investors do not tend to contribute to the development of the company due to the lack of assurance of success. For instance, the article IPO Firm Characteristics Pre- and Post-Financial Crisis by Henry and Gregoriou focuses on the fact that the financial of 2008-2009 dramatically affect the IPO market dynamics due to the regulatory changes in the economy and investor sentiment (Henry & Gregoriou, 2013). Moreover, the number of IPOs also remained low due to unfavorable economic conditions in the world.
Despite struggling to survive the economic recession, the companies still have to go public during the not suitable time, Blum claims (2011). The IPOs will remain low during the credit crisis because the investors stay alert about the current state of the economy and evaluate the investments carefully. It is evident that it is risky to invest in the companies during the stage of recession since the company’s future, and sustainability remain unclear.
Discussion and Analysis
The primary goal of this assignment was to reveal the correlation between the credit crisis and the lack of liquidity of the debt market. In this instance, the analysis of the events, which determined the existence of the credit crunch, contributed to the understanding of the inactivity of the debt markets and the lack of debt market liquidity. It is evident that the investors prefer to utilize illiquid financial tools during the occurrence of the crisis, as the investments of the liquid assets are rather risky, and the outcomes are uncertain. It could be said that in this case, the insufficient action of financial institutions determines the investor’s attitude about the existing economic situation. It affects their actions and decreases the amount of circulation of liquid assets in the debt markets.
Moreover, it has to be mentioned that the market during the crisis remains unpredictable, and its high activity might be a reason for the bankruptcy. In this instance, the primary grounds for the debt market inactivity were revealed. Firstly, the investors are the critical drivers for the trade on the debt market, and they are not interested in the investment of their financial resources in risky deals, as it might affect their economic stability. Secondly, the interest rates maintain a high level and change the investor’s sentiment. Lastly, the financial instructions remain inactive since there is a lack of demand for securities during the financial crisis.
The literature review revealed that interest rates are dramatically affected by the credit crunch since the banks are not able to provide the same number of loans. Consequently, they have to increase their interest rates. This action contributes to finding the financial balance between costs and incomes. Nonetheless, the rise in debt has a strong influence on the growth of the interest rates, as the modification of the interest rates is one of the financial instruments to determine the balance in the economy. Nevertheless, this change hurts the economic situation locally and globally since credit operations are regularly used by organizations and other members of society. This matter limits their opportunities and raises prices. In the end, all of the aspects such as debts and interest rates have to be analyzed simultaneously, as their interdependence cannot be unnoticed.
As for the IPO, it could be said that the value of the IPO is dependent on various factors. In this case, the literature review revealed that some companies were able to increase their IPO during the occurrence of the financial crisis. However, some companies were not able to maintain their leading positions, as it is hard to adapt to the unstable times of economic crisis. Nonetheless, the credit crunch might be beneficial for some companies since they can provide the customers with the necessary services, which are not available from the traditional banks. In this case, they can increase their market shares and emerge while the traditional banks remain inactive. However, in this instance, it is evident that this matter will lead to the disbalance in the economy after the crisis since the traditional banks will lose a share of their client base to the online nonbank lenders, as these types of companies will gain positive brand image and cultivate customer’s loyalty during the crisis.
In the end, it remains questionable whether the financial crisis can be prevented and controlled. Additionally, it is still unclear whether the modification of one aspect might prevent its rapid development, or it is essential to adjust all aspects simultaneously. Furthermore, it remains unclear whether it is an entirely negative phenomenon since some companies might benefit from it. Nonetheless, the complexity of the existing economic phenomena was revealed, and it seems that each element has a dramatic influence on the formation of the credit crisis. In this case, the domino effect takes place, and each contributor has to be evaluated simultaneously due to the high interdependence. It could be said that future research is necessary. It is evident that all of the aspects, which were discussed in this paper, have to be evaluated as a combination of factors simultaneously. The findings can be used by the financial institutions and management, as this research might reveal the potential benefits of the economic crisis.
Conclusion
In conclusion, it was revealed that the economic situation in the country and the world substantially depends on economic stability. Credit crisis causes significant damage to the economy, as this complex phenomenon vehemently affects all the necessary attributes of the national and global economy such as debt markets, interest rates, IPO, and financial markets liquidity. Nonetheless, it is unclear whether its impact is entirely adverse since some companies can benefit from it and increase their market shares.
Moreover, it was determined that the lack of liquidity in the debt markets has a strong correlation with the credit crisis. The credit crunch contributes to the bankruptcy, as the banks are not able to sustain on the market. Additionally, the lack of liquid instruments remains high, since the investors prefer to keep their assets in the liquid form. Furthermore, a vehement correlation between the lack of liquidity and inactivity cannot be unnoticed, as the high activity of the financial institutions leads to bankruptcy and the necessity for governmental intervention to find the balance during the economic crisis.
As for the interest rates, it became evident that they determine the economic condition. Moreover, a substantial correlation between the debt and interest rates was revealed. In this case, the companies seek balance and raise interest rates. Furthermore, it could be said that they use interest rates as a capital-generating tool.
Lastly, it was revealed that the IPO usually loses its points due to the inability to provide loans and lack of financial capital during the credit crisis. However, some companies find this situation as an opportunity for expansion and occupy the free niches. In the end, it is evident that all of the aspects, which were evaluated in this assignment, are strongly interdependent and have to be evaluated simultaneously, as they have a strong influence on the formation of the credit crisis and vice versa. In this instance, it is evident that further research remains a necessity. In the end, the findings can be beneficial for financial institutions and management.
References
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