Introduction
The financial crisis, which was witnessed in the United States and the world over, has been described as one of the worst economic crises of the 21st century. Economists have termed it as the worst crisis in the economy to occur since the great depression of the 1930s. The crisis began in the year 2007.
It emanated from the housing sector of the U.S. The crisis extended to other sectors of the economy. The financial sector, which is one of the pillars in the economy, was the worst hit. The crisis had a devastating impact on the US economy, with macroeconomic forces of inflation and employment being negatively affected.
With the widespread effects of the crisis, policy makers were forces to come up with measures of mitigating the crisis and its effects. As it is with policies, there are long-term effects (Marshall, pp. 3). This paper discuses the recent economic crisis that hit the US. It discussed the underlying causes of the crisis and the impact it has had on the economy of the United States.
The paper also looks into the policies that have been coined in order to mitigate the crisis and their impact on macroeconomic forces – employment, inflation and economic growth. Finally, the paper highlight the possible gaps that are prevalent the economy in line with the crisis and the possible routes stabilizing the economy.
Causes of the US Financial Crisis
The financial crisis of the United States is a crisis which smoldered from the late 1990s. As many analysts have pointed out, it began in the US housing market. From the late 1900s, the prices of houses in the United States swelled at an unusually quicker pace. The swelling of house prices can be linked to three main triggering factors.
These are low rates of interests which were persisted during those times, overgenerous lending by the financial institutions, as well as speculations by the investors in the financial and the housing sectors. The housing bubble busted, and this was coupled with a crushing of other asset bubbles.
This resulted in the credit crisis. Many economists have pointed out that there was a possibility of stopping the crisis could be averted at these early stages. However, many complex financial innovations were made in order to reduce the risk. It is these complex solutions that made the crisis spill to the financial market of the United States and the US economy.
All financial institutions, which work for profits, came up with quite complicated financial processes. These processes had similar characteristics – lack of adequate risk analysis, highly leveraged borrowing and lack of adequate regulation of betting on outcomes. These processes proved inefficient when the asset prices flopped (“The Financial Crisis Inquiry Report”, pp. 417).
The real effect of the shouldering financial turmoil was witnessed between 2007 and 2009. It began in the US mortgage lending market. Real problems began in 2007 when the Federal Home Mortgage Corporation– Freddie Mac made an announcement that it was stopping the purchasing of high-risk mortgages.
At the same time, New Century Financial Corporation, which was the US leading lender of mortgages to riskier customers, became bankrupt. These two events ushered in a real turmoil in the housing sector as the price of houses began to drop in a dramatic way. US credit rating agencies began downgrading risk assessments of the asset-backed instruments of finance.
In the middle of the year 2007, the risk rose disabling financial product issuers from paying interests. Thence, it was realized that the credit bubbles and the burst in housing would result in losses on the asset-backed financial instruments. Mortgage-backed securities were downgraded from that period into the year 2008 so that they could reassess their risk. This severely dislocated the financial markets (Jansen, Beulig and Kai, pp. 1).
The credit markets continued to be tight, the financial and mortgage companies were given support by the Federal Reserve. The support was given through lending facilities that offered credit on a short-term basis as well as auctions arising from the sale of mortgage-related products. These actions were inadequate or insufficient as far as the rapid falling prices of assets were concerned.
It could not stop the price of assets from further falling. Institutions that were trusted with funds opted to relieve themselves from the financial risks through replenishing the risk-weighted capital rations. Bear Stearns, which is one of the largest Investment banks in America, had heavily invested in mortgage backed securities. As a result of the downgrading of the credit ratings, the bank was severely impacted.
The bank could not recapitalize and adequately cover itself from the losses. Its stock ended up collapsing in the year 2008. The bank was acquired the Morgan Chase bank in March 2008.
The takeover was facilitated by the government. The mortgage default rates continued to rise causing a problem to mortgage lenders as the collateral value fell. The largest United States mortgage lender – IndyMac collapsed in July 2008. Its assets were incorporated into the federal ownership (Marshall, pp. 3).
The crisis spilt in the financial industry as mortgage firms sought to increase their capital due to downgraded securities. On the leading list was Lehman Brothers Bank, which became bankrupt. The bank was unable to raise enough capital to cover the downgraded securities.
This demonstrated that the US government was segregate on bank bailouts, which further resulted to a rise in lending rates between banks. America International Group, which was a leading credit default insurer in the United States, was suffering from liquidity problems.
AIG was bailed out by the Federal Reserve – 85 billion dollars. The Group offered 79.9 per cent equity. The conflict in the industry continued to take the course with activities that further worsened the crisis (Marshall, pp. 10).
As a result, the activities, in the banking industry caused the increase in the volatility in the financial market. The Down Jones Industrial Average which is an index which covers analysis on the largest 30 publicly listed companies among them large banks kept registering a drop. The largest drop was recorded on 29 September the year 2008. The investor confidence fell significantly.
Investors opted to invest in safer assets like oil, the US dollar and gold. There was a rise in demand for treasury bills, which resulted in a drop in their returns. Market firms continued facing lost of pressures (Marshall, pp. 15).
From the discussion above, we can summarize the causes of the financial crisis in the US as the problem in the US housing sector. Under this, we have the creation and collapse of the housing bubble. We also have the role played by the financial industry – the interaction of financial instruments and the response to the housing crash by the financial industry.
Effects of the US Financial Crisis
The financial crisis has an extremely significant impact on the economy of the US. These effects even spilt to other economies of the world. The overall economic impact of the financial crisis is that it created conditions that led to a downturn of the US economy. With the setting, of recession – all the effects related to a recessing economy have been witnessed (Suter and Mark, pp. 24).
The great recession resulting for the financial crisis has extremely harmful effects on the labor industry of the US. Thus unemployment became inevitable. Most financial institutions could not sustain themselves in the market and had to close down with some undergoing buyouts and acquisitions.
The banking and financial industry had a lot of staffs laid off. The financial industry had been destabilized and was so weakened. Investors ended up loosing trust in the financial institutions. The financial industry is supportive of the manufacturing industry and all other sectors.
The accessibility to credit was jeopardized leading to layoffs in the manufacturing industry as companies struggled to adjust to the realities in the economy. A research that was conducted between November 2008 and April of 2010 approximately 40 percent of households in the US has been laid off (Suter and Mark, pp. 24).
Inflation came to be a reality in the United States. As part of the measures of adjusting to the crisis, industries had to raise the prices of their products. There was a sharp rise in prices of goods and services. Coupled with the unemployment and the inability of people to pay the house mortgages, the United States saw a sharp downturn in economic growth.
The economic crisis has led to a cut down in household expenditure with high cut downs seen in families with the unemployed populations. The standards of living of the Americans dropped drastically. People could not access finances for investments. The social welfare of the Americans was highly compromised with the cut down in earnings and the inflation.
Business went down with closures being common for weak businesses. The crisis impacted the trading environment in the United States with the volume of international trade drastically dropped.
The US lost trading ground in the international market with its competitors like China taking advantage of the crisis to gain grounds in international trade. This further contributed to the reduction in economic growth of the US (Suter and Mark, pp. 24).
Measures of Averting the Crisis – Fiscal and Monetary
The United States government and policy makers had to come up with both physical and monetary measures embedded in legislation.
These were aimed at mitigating the consequences that the crisis was on the economy. Several responses were developed with some hitting the walls (“The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States,” p. 112).
As the crisis continued to smolder, a number of policy measures were taken with the aim of stopping the crisis from sprouting to the entire economy. The first measure was the lowering of interest rates and introduction of schemes to prevent enhanced liquidity in order to abate the credit crisis that was emerging. The second measure was the taking over of the Bear Stearns bank which was facilitated by the state.
Legislation was also passed at this pint which sought to mitigate mortgage foreclosure via demand stimulation. All these failed to stop the crisis with the Federal Reserve being accused of favoring certain banks in offering credit (Marshall, pp. 3).
After the real shocks of the crisis were felt, the government of United States had to move to cub the recession. The treasury was to lead in implementing the Emergency Economy Stabilization Act. The act was passed in October the year 2008. The treasury injected a capital into the financial institutions in exchange for common equity stakes and preferred stock.
This was followed by massive bailouts of financial institutions for instance AIG. The other policy was the lowering of the rates of interests by the Federal Reserve and the raising of liquidity. The credit easing policy supported the purchasing treasury bills and the mortgage-backed securities.
The Securities and Exchange Commission suspended the short-selling of the institutions of finance. Also, a fiscal plan known as Homeowner Affordability and Stability Plan was initiated which helped the struggling home owners in the refinancing of their mortgages (Marshall, pp. 3).
One of the most famous policy responses to the crisis is the famous fiscal stimulus. This policy response was developed by the Obama administration and voted into law by the US senate. Under this policy, the government of US government released 787 billion dollars.
The legislation was transformed into law in 2009. This piece of legislation awarded cuts in taxes in a number of sensitive areas in the economy. 273 billion dollars were to be awarded to individuals and 51 billion dollars set apart for companies. 111 billion was reserved for infrastructural investment, 59 billion for healthcare, 43 billion for energy and 53 billion for education (Marshall, pp. 3).
Criticism of the Policies and Suggestions
Some of these policy measures were extremely resourceful in stopping the crisis from further advancing. The economic bailouts and the reduction in the rates of interests helped the economy to recover. The bailouts helped to increase the reserves of the financial institutions.
Though the bailout was effective, it has had certain level f inefficiency. Most financial institutions have been accused of taking advantage of the bailout funds. They manipulate it and use it making more profits on their side while leaving those who were to benefit to suffer from large burden of interests (Kolb, pp. 59).
The failure to bail some banks by the Federal Reserve and the treasury bills was meant to ensure that banks exercised responsibility.
However, this step had negative consequences on bank investments. Many banks collapsed leading to a lapse in investor confidence. The Lehman Bank was left to collapse because of bankruptcy. Inter-banking lending rates shoot up leading to the development of a crisis in the banking industry (Kolb, pp. 59).
The government of the United States through the treasury managed in stopping the crisis from spreading further. However, the crisis had already reached a level where almost all sectors of the economy had been infected or affected.
The financial stability plan is still being implemented by the treasury with a lot of loopholes being witnessed. A number of economic analysts are still not satisfied with the scope of the plan. They argue that the plan is not comprehensive enough to address the financial challenges facing the financial institutions and the economy of the US.
The banking sector of the US still remains troubled. The amount of money set aside for the financial stability plan has been critiqued. Many analysts point that the money is far too little to addresses the asset problem in US banks (Kolb, pp. 59).
More fiscal and monetary policies that have long term goals or objectives of eliminating possible problems in the financial sector need to be developed. The US government has focused a lot of the short-term goals in of ensuring the direct effects of the crisis have been addressed.
Tighter monetary policies of addressing the challenges that are born from institutions for instance speculation can be part of the long-term policies. Speculation was one of the roots caused of the crisis that engulfed the housing sector of the US paving the way to problems in banking and financial markets (Kroszner and Benjamin, pp. 25).
The United stated economy has to some extend recovered from the impacts of the financial crisis. The economy has not fully recovered as it is being implied by treasury and the recovery plan. The Federal Reserve should continue with plans of offering more loans as most financial institutions have not regained the optimum capacity of service offering.
As the economy continued to recover through the short-term policies, the focus has to be on the long term economic measures of regulating the financial sector. Such policies will govern actions and activities of financial institutions thereby preventing unitary actions, which are likely to destabilize the sector (Kroszner and Benjamin, pp. 25).
Conclusion
The Financial crisis, which hit the United States, began in the housing sector though the housing sector was not the main crisis. The crisis was transitional moving from the problems in the housing sector to the banking industry and the financial markets and the entire economy.
A number of fiscal and monetary policies have been used to avert the crisis. Some are still in in implementation. The government has to shift and focus on long-term regulatory policies that will prevent such crises in the future.
Works Cited
Jansen, Leo H, Nick Beulig, and Kai Linsmann. Us Subprime and Financial Crisis – to What Extent Can You Safeguard Financial System Risks?: [research Paper]. München ; Ravensburg: Grinverl, 2008. Print.
Marshall, John. 2009. The financial crisis in the US: key events, causes and responses. Web.
Kolb, Robert W. Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future. Hoboken, N.J: Wiley, 2010. Print.
Kroszner, Randy, and Benjamin M. Friedman. Reforming U.S. Financial Markets: Reflections Before and Beyond Dodd-Frank. Cambridge, Mass: MIT Press, 2011. Print.
Suter, Christian, and Mark Herkenrath. World Society in the Global Economic Crisis. Berlin: Lit, 2012. Print.
The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States. Washington, DC: Financial Crisis Inquiry Commission, 2010. Print.