Global Financial Crisis Part 2

"The fall of index in stocks led to slow economic development". The statement posted on the previous blog is quite ambiguous. I prepare to admit that fall of stock index ISN'T the ONLY contributing factor to downturn in economic development, BUT, to say that stock market does not influence the economic development, is untrue.

In September, as I was burning the midnight oil as usual, I happened to switch on the TV to check the latest political development in Malaysia. However, the channel was switched to CNBC. It was the day where Lehman's Brother announced its bankruptcy. It was then, I found out that the fall of Freddie May, Fannie May, Lehman's Brother, Meryll Lynch etc sparked a liquidity crisis, aggravated by the "the boom then the burst" of housing bubble and a deepening European recession. Since the banks are tattered in the web of loans, the banks around the world are dragging down on another. The confluence of the events meant one thing, $6.5 trillions had disappeared within days from the investment world.

How on earth $6.5 trillion disappeared? Lets start with ordinary people. Mr A invest his money in an investment firm. Investment banks basically like Lehman's Brother had bad debts. The debts amounted $100 billion as the people are unable to pay their loan due to the housing bubble. However instead of disclosing the bad debts, the said investment bank continue lending money to ordinary people to avoid liquidity crisis. Let's not forget about Mr. A. Mr A is unable to receive the profits he gained from his investment through the said investment bank. This is what happen to the investors. Later the investment bank declared bankruptcy. It was then, many investors like Mr A suffered huge losses from the investment. Other investors who are investing started to panic and withdraw money from the banks when they found out what happen in US and Europe. These events caused the fall of index in Dow Jones. Each country's stock market started to fall after what happen to Dow Jones.

Basically a public-listed company rely heavily on blue-chip stocks. These stocks are bought by ordinary investors. When investors bought it, the money will be use by the company to carry out its operation. However, when the financial crisis strike, the country's index like KLCI (Malaysia), Han Seng (Hong Kong), SGX (Singapore) etc fall. The fall also devalue the blue chips. These public listed company had no option, after seeing what happen to the financial crisis, resorted to cut down its production and prices. When many industries did the same thing, the country's economy started to slow down. So, how could the fall of stock index, not affect the country's economy?

I would like to quote an example from Times Magazine :

Xu Lejiang says it's already happening. He's chairman of Baosteel, one of China's giant steelmakers, and since August, he has had to cut prices twice as demands suddenly cooled off. The era of rapid growth for Chinese steel "will be remembered as history," he says. The Chinese stock market has also been hit hard - its down by 60% this year- although the banking system is largely sheltered from the financial crisis.

Another good example would be - Great Depression. Great Depression is the world's economic crisis in modern time, that happen primarily because of STOCK MARKET CRASHES, which is similar to what happen today. When Wall Street crashes, it was so devastating that everyone who bought stocks in 1929 losses everything. Even Warren Buffet's mentor, Benjamin Graham losses most of his assets. The decline in stock market in 1929 and Great Depression is classified as financial crisis.