The US Financial Crisis - Essay Example

Published: 2021-03-15
The US Financial Crisis - Essay Example
Categories:  United States Finance
Pages: 7
Wordcount: 1870 words
16 min read

The US financial crisis in 2008 had its origins traced to the asset price bubble that unfortunately countered new and varied financial models that were risky. Most of the companies failed to carry due diligence in risk management. The blame was also shifted to supervisors and regulators that failed to control excessive risk-taking. The subprime borrowers were largely lent money by financial institutions in the wake of attractive property offers. Before 2000, these borrowers were not qualified for mortgagees. With the rising property prices, many of the mortgage markets saw these risky sub-prime borrowers as attractive.

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The mortgage companies did so by tailor-making financial products such Adjust Rate Mortgages with no down payments, teaser rates. Others went to the extent of postponing some of the interest due monthly and adding it on the loan principle amount. The innovation witnessed in the mortgage design was not key to enabling many subprime borrowers to access credit facilities without other notable innovations that would aid in mortgage securitization. The subprime mortgages needed very minimal down payment and documentation For this reason the loans extended to the borrowers were branded liar loans. In the years between 2000-2006 increased from 7% to 20% highlighting the concerted efforts taken by lenders to award the individuals for mortgages.

All these innovations led to a boom in the properties market. The new financial innovations flourished in an environment of eased Federal Reserve monetary policies and poor regulation. With low interests and poor oversight, a number of financial institutions enhanced their advantage to buy mortgage-related securities. This however changed in 2007. The market panicked in 2007 with sudden uncertainty over asset prices. Housing prices plummeted from their previous record highs and investment banks (lenders) refused to roll over debts taken by financial institutions. Most of the over-leveraged banks found themselves in a precarious position and fully vulnerable to the falling asset prices with very limited capital.

The 2008 US Economic Crisis brought about much uproar globally and within the American public sphere. The crisis was linked to a number of causes and elements that all point to an increasingly unequal distribution of income. Many pundits such as Robert Reich have advanced this notion. The inequality is cited to be the chief reason why many of the large American middle class took much credit to sustain their lifestyles. Many would term such decisions as reckless and economically unsound but Reich thinks differently. According him, its not that Americans spent or lived beyond their means but rather that the means did not keep up with what the American economy could avail to them. The economy was growing rapidly and much of the Americans expected to share in its prosperity. Their expectations came short as the perceived economic winnings only ended to the rich.

Inequality and US Economic Crisis

Income inequality has substantially increased over the past decades. The inequality was observed as early as in the 1920s when the inequality levels were deemed highest in the American history. The inequality soared against the backdrop of World War 1, which saw much of the unemployment levels rise. The 1920s was dubbed as the Roaring 20s due to the different phases observed of the American economy. There were the few contented rich that enjoyed lowered income tax rates that enabled majority of them that were investors to partake in the most notable bull markets of the US history (Barth,Tong Li, Wenling Lu and Triphon 98), The American rural folk, however, faced different predicaments. Much of them were stuck with farm produce after closure of European markets that had recovered after World War 1.Much of the rural-folk had taken loans that were no longer hard to finance. Alot of the rural-folk went bankrupt while their urban counterparts continued to grow in wealth. This created a sharp divide between the haves (the rich urbanites) versus (the poor rural masses). This era lasted to 1937.The inequality receded as decades went by due to elaborate measures undertaken by the then governments of the day. In the end of 19700s the richest Americans

In 1937-1947, a decade of relative decrease in income inequality was observed in America. The Great Compression, as its known, was heralded by reforms pursued by various administrations. The strengthening of labor unions and the New Deal progressive taxation. The initiatives such as the National War Labor Board lowered the incomes of top earners and increased those that fell in the working class and the poor. The narrative ,however, changed in 1970s when the Great Divergence emerged (Goyette 122). The income growth of the poor and working class stagnated while it grew for the few at the top grew exponentially. The trend has been observed to continue to date. The inequality gap has continued to expand with no signs of any Great Compression as witnessed in 1937-1947 in sight.

According to Robert Reich, the US economic crisis will not subside any time in the near future. This is because all the great depressions an crisis in the economic realm are linked to income inequalities, which sadly have not been fully attended to. The 2008 crisis, for instance, could have been met with proper strategies but the government failed to establish them. They chose free markets, privatization, reduced taxes for the wealthy and destruction of social safety nets. The outcome of all these poor policies were stagnant wages for many Americans, decreased opportunities and enhanced inequality. The economic fruits continued to be shared by few individuals at the expense of a majority.

At the end of the 1970s the richest Americans had only 9% of the national income as compared to the current statistics that point to a 24% of the national income held by the top 1%. Due stagnation of incomes and the glaring inequality, the only option is to take more debts for many Americans (Wilensky 112). It is prudent to note that many Americans take up debts in order to meet their consumption. In turn consumption enhances economic growth and creates more job opportunities This cycle, however, cannot run for long as the purchasing power of many middle class Americans cannot in any way bring about economic growth. The borrowing eventually catches up with most of them (Leicht and Sc This is well depicted with the roaring 20s and the most recent 2008 crisis. Payback time comes sooner than later.

The debt levels are only a consequence and not a cause of economic downturns as highlighted above by Reichs position. The government and policymakers are only interested in short-term fixes that avoid impinging on the top wealthy class that have much stakes in the leadership of the country. The 2008 meltdown, according to Reich, only exposed the flaws that have riddled the American economy over the decades. The government initiated bailouts for companies, directed billions to infrastructure, and sustenance of the unemployment benefits. The real problem that Reich believes is the real cause of the economic crisis, income inequality, was nt solved but ignored.

There are notable parallel noted by Reich in his Inequality for All Documentary between the 1928 and 2007 financial crises. In both scenarios, a limited number of assets was looked into by capital creating a speculative bubble. Another notable similarity is the presence of middle classs incomes stagnate. Much of the members of the middle class had to take loans to sustain their living standards. The debt bubble, as we know it, burst in both cases.

The Impact of the Global Crisis

The meltdown affected many areas in the economic realm. Foreclosures became common, housing rates crashed, decline in manufacturing, and high unemployment rates. There was notable global power shift with America loosing ground to India, Brazil and other developing countries.

Foreclosures: Much of the declining real-estate prices led to the negating effects experienced in various economic spheres. Many Americans were unable to purchase homes which translated to many home-builders abandoning construction projects. The devaluing of houses further made many homeowners somewhat insecure economically. The recession and the notable decline in real estate markets dealt a blow to the real estate demand. Despite the decline in prices, many homeowners were required to foot taxes and spend on maintenance costs. Due to high unemployment levels many homeowners were forced to foreclosure due to their strong credit.

Decline in manufacturing: The crisis saw the decline of the automotive industry with Chrysler and General Motors declaring bankruptcy. Many of their dealerships and factories were closed down despite the great bail outs handed to them by the government. It also affected other countries such as Taiwan where the industrial production was reduced by 43%.

Global Power Shift : The recession brought about changes in the global political economy. BRIC countries, for instance, enhanced their clout as compared to Russia, Brazil, China and India. In the European Union, for example, Germany emerged as a new force in both economic and financial systems as well as political and economic realms. Many countries that survived the recession managed due to their conservative approach to economic management (Schmidt and Curtis 51). The BRIC nations are also keen on tapping their strengths in the management of the large financial institutions such as World Bank. Americas clout is further affected by the fact that it has a great reliance on foreign creditors such as China. It has also affected the US dollars status in global trade. Many nations are contemplating of choosing other currencies to deal with. Due to the waning US influence, many of the G20 nations are now keen taking over much of the global pinnacle of economic influence.

The US response to the global financial crisis

The US opted to nationalize aspects of its manufacturing and financial sectors. A stimulus package was initiated through an unanimous agreement by both the United States and Democrats. The stimulus package was the brainchild, Henry Paulson the Secretary of Treasury. The package was essentially to rescue financial institutions and also to restore hope to the public regarding their savings and investments. The country further initiated another stimulus package dubbed quantitative easing or QE. QE was used to buy $600 billion long-term treasury bonds with the aim of reducing the long-term interests. The move served to depreciate the value of the dollar which in turn made the exports cheaper while at the same time raising the import costs. The move was dubbed controversial as it instigated currency wars. Massive layoffs were also undertaken in order to reduce the deficits observed in the state and national levels. Consequently, many public service workers lost their jobs and unions weakened.

In conclusion, the economic meltdown in the US would have been highly managed if much of the key players exercised due diligence in risk-taking. Much of the activities that led to the meltdown were brought about greed by the corporate world. The mortgage companies wanted to tap into new markets at the expense of the right risk management processes. The government also failed in establishing regulatory mechanisms to note such fraudulent transactions. Despite the varied causes of the crisis, there are various school of thoughts pursued by pundits such as Robert Reich. Reich admits that the American government only used a cosmetic approach in managing the whole economic crisis. The income inequality, as posited by Reich focusses on the historical stagnation of incomes of the poor and middle class. The only remedy for this situation is the rebalancing of t...

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