The Economic Troubles in the United States - Essay Example

INTRODUCTION The recent economic troubles in the United s as well as the global economy have caught the attention of everyone. Not only have they caused millions of ordinary Americans to lose their savings, they have also contributed to the economic gloom of the present times. They are an indication of the troubled state in which the global economy finds itself in. With the US economy undergoing a crisis of epic proportions, several sectors suffered from the credit crunch and were left without access to credit that they were previously used to. Further, the corporations made several bad loans and resorted to business practices that led to them being in dire straits as far as the financials are concerned once the crisis broke out. The bad state of the economy is cited as one of the reasons for the victory of Barack Obama in the presidential elections of 2008. Subsequent to his election, there was lot of hope and anticipation regarding the kind of stimulus package that his administration would provide to the beleaguered sectors of the economy. There has been much criticism of the way in which the credit bubble was allowed to inflate and the potentially lethal effects it is having now on the World economy. First, much of the blame has been laid at the door of the Federal Reserve and the policies followed by it in allowing excessive liquidity into the system. As Kevin Philips (2009) points out, "the financial sector's malpractice from the mid- 1980s through 2008 was more corrosive than the earlier negligence. This is because in many ways the politics, permissive ideology, and interest-group lobbying during the Multi-bubble years was obliged to be deliberate and uprooting. This involved the capture and disarming of existing agencies and boards, as well as the gutting or repeal of existing statutory protections. Besides Congress and the White House, the centers of this "disregulation" usually included the Federal Reserve Board and often the Treasury department. This paper looks at the happenings in the US economy over the last three years and details how it happened and why it happened along with some measures to fix the crisis and ways to look beyond the current malaise. THE CURRENT CRISIS The sub-prime crisis is a manifestation of the foreclosures of mortgages brought by easy access to cheap credit that went bad after the US housing bubble began to burst. An unusually large number of sub-prime mortgages that originated in 2006 went delinquent only months later. The consequent credit deterioration and liquidity crunch was felt across the financial system with the result that Bear Sterns came close to folding up - to be rescued by JP Morgan at the instance of the US Federal reserve. Nearly 50 percent of the sub-prime credit has disappeared or has been acquired at cheap valuations. The foreclosures have been brought about due to the dashed expectations of the borrowers in being able to refinance their mortgages at favorable terms. The sub-prime borrowers are essentially "walking away" from the property and allowing foreclosure, despite the impact to their credit rating. To have a brief introduction for the present crisis, the housing market was inflated to a large extent because of loans made to borrowers who had bad or no credit history. These kinds of borrowers were called sub-prime of below the prime required for a good credit history. Once the loans were made arbitrarily, the homeowners went for further capitalization by refinancing their mortgages and borrowing against the houses. All this went on till the housing market corrected itself and the housing prices started to come down. This meant that the bubble started to burst. While the housing market bottoming out does not really make the whole economy go bust, it is the aspect of building up value on top of the mortgages through a form known as securitization that we will discuss later. And then the same were collateralized in the form of instruments known as CDS that gave the whole thing the look of a crisis of epic proportions. BUBBLE OF ENORMOUS PROPORTIONS The best way to understand what went wrong is to conduct a postmortem on the twenty-five year metastasis by which the financial sector's influence in America grew from a supporting role with 10-12 percent of the U.S. economy circa 1980 to an arguably crippling 20-21 percent predominance. Many of the products, processes, ambitions, and major financial firms conspicuous in this rapid overexpansion fed on one another and figured prominently in the eventual 2007-2009 debacle. This calamitous nexus is worth the closest scrutiny. Hedge funds, still virtually unregulated, mushroomed from a couple of hundred in the early 1990s to roughly ten thousand in 2007, boasting assets of close to $2 trillion. Back in 1993, the notional or nominal value of U.S. derivative instruments had been some $14 trillion. By 2001, it was approaching $100 trillion. Then over seven years, one of the most extraordinary and perilous transformations in world financial history would lift the 2008 total to $600 trillion. GREED The current crisis has been brought about by a combination of factors that can be defined as "Bad in the systemic sense further applies to letting a financial elite elevate, expand, and entrench itself as a country's GNP-and profits-dominating sector, as has been done in the United States over the last quarter century. Doing this so hurriedly has wound up institutionalizing runaway public and private debt, gross runaway public and private debt, gross speculative biases, tenfold and twenty fold leveraged gambling, unchecked and barely regulated "product" innovation, and a tendency toward periodic panics and instability" (Kevin Philips, 63). Thus, as one event led to another, it was the underlying principle of profit making coupled with an insatiable greed that wanted more instead of being content with the profits that they were earning that led to the bubble being inflated. As the corporates began to expand their balance sheets and post extraordinary profits, it became apparent that the rates of return that they were getting on their capital could not be sustained over a long period of time. However, despite warnings to the contrary, there were few of the big corporations that actually took notice of the impending crisis. In a world that was driven by the lubricant of money, the promise of more seemed alluring and irresistible Though it is not the intention of this author to blame corporate greed for everything, nonetheless it has to be borne in mind that capitalism thrives on excess and hence is the perfect vehicle for profit making as well as risk taking. While the entrepreneurial spirit and the ability to take risks have contributed to the success of the global economy, the fact that reliance on excessive profits has spelled doom for the global economy as well. A term called securitization defined as "What's securitization' Some will ask. A pompous six-syllable word, to begin with, but also a humongous new business launched by Wall Street in the 1990s. To oversimplify somewhat, sophisticated financial institutions discovered gold in tying together five hundred or five thousand loans, mortgages, or whatever, and then selling fresh securities" (Kevin Philips, 8) led to leveraging on a scale never seen before in the economic history of the nation. In layman terms, what this means is that the ever increasing returns that one expects on the underlying asset is then sold off for higher values thus giving rise to a concept called leveraging. The ratio of the "securitized" debts to the value of the underlying assets reached dizzying proportions. And here lies the catch. Once the sub-prime mortgages on which the overlay of the securities was built up, began to default with the housing market flattening out, the "bottom" of the market literally fell apart. Some have called the current crisis as a "race to the bottom". What they are implying is that as the "derived" value of the assets comes crashing down with the fall in value of the underlying asset, it is anybody's guess where the market would flatten out. SOME TOUGH QUESTIONS As is the norm when any crisis erupts in any sector, so is the case with the financial sector. Some questions that are being asked now are: "We advocates of relatively unfettered capitalism have strong exculpatory arguments: Who inflated the housing bubble with 1% money in a strong economy' (The Greenspan Fed.) Who encouraged all sorts of low-income, high-risk borrowers to acquire mortgages and homes they were doomed to lose' (Government agencies of all stripes.) Who created the stock-option mania in big investment companies by capping tax deductions for executive salaries' (Congress, in the early 1990s.) Who prolonged the current crisis with continuing destructive ambiguity, still unresolved, about which institutions would be bailed out and which wouldn't be' (Today's regulators and policy-makers.)" (Foster, 2008). The answers to all these questions depend on the same pivot: lack of regulation and an "irrational exuberance" that though identified was not acted upon. The results are there for all to see. As the panic in the markets refuses to subside and the markets in free fall, the questions may very well lead to recriminations. And in this context, the election of Barack Obama as the 44th president of the United States means that there might be more regulatory oversight and a throwback to the old days where de-regulation was not the buzzword as it is being made out now. OPPORTUNITY While this current crisis may seem to be going out of hand, it is also a good time to think on how to capitalize from it. There can be an expansion of health care and social security benefits to the people who are affected by the crisis. Further, credit availability and Obama's plan of financing the mortgage owners who lost their homes could be a viable alternative. The most obvious opportunity that presents itself as a result of the credit crisis is the fact that American policy makers have the chance to pass legislation that would seek to regulate the financial sector better than the preceding years. Many commentators have laid the blame for the credit crisis at the actions of the Fed and the Government like repealing of the Glass Steagall Act and then allowing for excessive liquidity into the system. Apart from the opportunities presented by the credit crisis to overhaul the banking system, there are other tendencies that need to be checked in the desire to look good before the voters. These include the inclination to adopt protectionist measures and erect trade barriers that would stifle creativity and innovation. These are the hallmarks of the American entrepreneur and the forest should not be lost for the trees. CONCLUSION While we have seen the technicalities of the origins of the current crisis and their implications for the economy, what is unmistakable is that greed was the underlying emotion driving the bubble in asset prices as well as the value built up on the same. Thus, there were no mechanisms to stop unfettered greed and that "the crisis is a result of "crony capitalism and an economic philosophy that sees any regulation at all as unwise and unnecessary." (William Watson, 2008). Thus, another element that got added was hubris and lack of proper regulation. The task before the Obama administration and the Congress is to fix the economy first by injecting liquidity into the system and ensuring that runaway speculation and rampant malpractices are not permitted. Further, the emphasis should be on transparency and openness in financial dealings and doing away with the opaqueness and exotic nature of the financial instruments and reining in the predatory tendencies of the financial speculators. The potentially lethal cocktail of greed, hubris and an infallible faith in the principles of markets and the desire to be free of regulation added to the crisis reaching gigantic proportions. In conclusion, it appears increasingly unlikely that the crisis is going to abate anytime soon. Thus, the focus now should be on next steps and how to prevent another such crisis from engulfing the national economy. SOURCES Philips, Kevin. Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. New York: Penguin, 2008. Philips, Kevin. After the Fall: The Inexcusable failure of American Finance. New York: Penguin, 2009. Foster, Peter. "No Fallen temple". FP Comment. 23 Sep 2008. 22 Nov 2008. http://network.nationalpost.com/np/blogs/fpcomment/archive/2008/09/23/no-fallen-temple.aspx Watson, William. "Regulating Hubris". Financial Post. 18 Sep 2008. 22 Nov 2008. http://www.financialpost.com/story.html'id=798149&p=1 McKinsey Quarterly. Handling the sub-prime crisis http://www.mckinseyquarterly.com/Survivingand_prevailingin_the_US_subprime-mortgage_market_2014 Mtgprofessor.com http://www.mtgprofessor.com/a%20-%20type%20of%20loan%20provider/what_is_a_sub-prime_lender.htm Read More