Introduction
A liquidity shortfall in the years 2008-2009 in the United States led to a credit crunch that brought devastating effects in the world economy. The US financial system neared collapse with big financial players in the industry surviving on bailouts by national governments.
Falling confidence of investors led to the fall of stock markets worldwide. One of the most affected sectors and one that many analysts point as the trigger of the crisis was the housing market. Real estate securities against which people had taken mortgages depreciated upon the bursting of the United States housing bubble.
Many financial institutions that had invested in the housing markets and those that had lent out their money were damaged financially. The housing market was characterized by foreclosures and evictions of the owners who could not service their mortgage loans. Many businesses especially the small and medium enterprises crumbled with consumer wealth shrinking considerably and governments had to make huge financial commitments to save the ailing systems and the declining economy.
There is no particular cause that was solely responsible for the crisis; the complexity and interconnectedness that characterize the global financial world and failure of the overseeing institutions to foresee the growing risk triggered the meltdown. However, there are those that stand out.
Causes of the Global Financial Crisis
In January 2010, Federal Reserve Chairman Ben Bernanke alluded that lax oversight was responsible for the financial troubles that the US experienced in the last three years (Rampell, 2003). As earlier said the causes are complex and interconnected.
They can be grouped in various categories and according to the level of effect that they had, the housing market which is thought to have triggered the crisis is one such category. The housing bubble bust, foreclosures, and mortgage sub prime lending comprised the major sources of the crisis in the housing market.
There are other factors that worked under the financial system or weak regulation rules that also contributed to the crisis. Easy credit conditions, weak and fraudulent underwriting practices, sub-prime lending, predatory lending, deregulation, overleveraging, incorrect pricing, collapse of the shadowy financial system and financial innovation and complexity, all had a huge role to play in the development of the crisis (Adams & Vines, 2009).
Housing bubble and foreclosures and sub-prime Lending
In the years leading to the financial crisis, the US received a lot of inflows of foreign funds to its economy. Coupled with low interest rates, financial institutions were ready to lend out the excess money and people were ready to borrow. This led to a debt driven consumer culture through mortgages, credit cards and even car loans.
Million of mortgages were issued by banks leading to a construction boom in the US. The period between 1997 and 2006 marked the peak of the housing boom. The average price of the American home increased to over 120%. By the year 2008, the price of homes had fallen by over twenty percentage points. Many people especially sub-prime borrowers had taken adjustable rate mortgages with the hope that housing prices were going to rise.
People took mortgage offers from banks and other financial institutions at very low rates. The borrowers were to enjoy the low interest rates for predetermined period and there after they market rates were to apply.
A good number of borrowers found themselves unable to repay the loans in market rates and the only option available to them was refinancing. Many could not refinance their mortgages especially from 2007 because the prices of houses began to fall. When refinancing failed, loanees began defaulting leading to unprecedented rate of foreclosures.
Un-credit worth sub prime borrowers were allowed access to credit against the standard industry rules. There was a high risk of defaulting by these people and that is what exactly happened. As said above the high rate of defaulting led to financial institutions incurring huge losses, effectively triggering the crisis.
Defaulting and foreclosures led to massive losses for banks and non-bank financial institutions. The blow to the rest of the economy happened through the loss making banks. Loans for investments, consumer spending and household loans like mortgages are all dependent on credit flow from banks, hence lack of which is detrimental to the economy.
The losses that banks incurred led to reduced bank capital and therefore a reduction in bank lending which popularly came to be known as the credit crunch. The credit crunch therefore resulted from the need by banks to maintain an acceptable loan to capital ratios. The lack of credit therefore thrust the US economy and that of the entire world to recession.
After the crisis was detected, various governments rushed measures to try and save the economy from collapse. The US governments enacted the Troubled Assets Relief Program to bail out the failing financial institutions. It prevented the escalation of the recession and initiated a recovery phase for the economy albeit a weak one (Nanto, 2009, par. 5).
Among the constitutional office holders and institutions in the US whose role proved critical in saving the US economy included the president, congress, treasury secretary and chairman of Federal Reserve. The government policies meant to save the economy from a severe recession and possible depression have been successful in the short run. The above characters have all played a role in formulation and implementing the strategies.
President
President of the United States is the head of government who is surrounded by hundreds of advisors who advise him on weight matters like the economy. By virtue that he is the leader of government his government policies oversee the general economic activities which aim at maintaining a steady pace on economic growth, high employments rates and low inflation rates. The government through other branches influences both fiscal and monetary policy to speed or slow economic growth.
The president rarely works on his own, and if he does, it is through the executive orders. The president works with congress to control spending and taxes of the US economy. He relies on the relevant institutions for the implementation of fiscal policies to maintain a stable pace of the economy. The president leads in the formulation of policies that will affect the nation’s employment rates, inflation, budget deficits and economic growth.
Two presidents have presided over formulation of policies and strategies to counter the global financial crisis. In late 2007, President George W Bush through congress authorized the distribution of TARP money to troubles banks and other financial institutions to a void a possible total collapse of the financial system.
Institutions like Fannie Mae and Freddie Mac and AIG received billions of money from the program and were effectively acquired by the government. The government did pump billions into the auto sector whose fortunes had shrunk due to plummeting sales.
After coming to office, President Barack Obama pushed through congress an $850 billion stimulus package that was meant to kick-start the US economy. According to the president, the package was meant to boost spending in new projects in infrastructure development and renewable energy projects. These initiatives were as a result of policies that were the brainchild of the president’s economic advisers and which congress acted on upon their request. Success of the program was modest as it pulled the country out of recession but failed to initiate the strong recovery it was supposed to have done.
Congress
Congress has enormous powers and its actions more often than not touch on many sectors of the US economy. It controls the federal budget and controls formulation of policies touching on trade and finance. Its charged with a responsibility of enacting bills that shape various economic policies as may be required.
In the wake of the financial crisis, congress has enacted a number of laws that are meant to stop recurrence of a similar crisis again (Moseley, 2009). One of the laws was the Dodd-Frank Wall street reform and consumer protection act.
Among the proposals of the bill is to consolidate regulatory agencies, eliminate the national thrift charter and establishment of a national oversight council to evaluate systemic risk in the US economy. It also seeks a close regulation of the financial markets especially in the trade of derivatives. Consumers and investors are also protected through the creation of a consumer protection agency.
The bill anticipates other financial crises like the one the country experienced in 2008-2009 and it proposes a resolute regime which complements the FDIC authority mandated to wind down firms suspected to be bankrupt and the possibility that the Federal Reserve can be allowed by the Treasury to extend credit to such firms.
The bill too sought to enhance cooperation between international financial partners and improved regulation of credit rating agencies. There was also the $168 billion stimulus enacted in February offering tax incentives to households and businesses.
Many states were in the red and so were programs funded by both federal and states funds. Education, public works, unemployment benefits and state were some of the programs facing severe spending cuts. The $850 billion stimulus package that congress passed targeted the above projects as well as plaguing the holes in state budgets.
In June 2008, congress again enacted an anti –foreclosure measure that allowed defaulters to refinance existing mortgages. The new mortgages would have 85%of the current market value and would receive guarantee by the Federal Housing Commission.
Treasury Secretary
Treasury secretary heads the department of treasury. He is the chief economic advisor to the president. He is critical in decision making regarding the crafting of policies concerning the economy and government finances.
The secretary carries the responsibility of the general management of Federal budget, financial and tax policies on an international level as well as the responsibility of crafting domestic and international policies that touch on financial and trade matter of the US. The secretary too does oversee all operations undertaken by law enforcement agencies under the department of treasury, manufacture of money and as principle financial agent of the US government.
Like in the presidency, there have been two Treasury secretaries during the global financial crisis. Paulson, the secretary under President Bush recommended a series of measures to tackle the crisis that the president and congress worked on. The initial $160 billion stimulus and the subsequent $700 billion bailout package were the secretary’s recommendation. Timothy Geithner oversaw the auto industry restructuring and the administration of the second stimulus package.
Chairman of the Federal Reserve
The chairman of the Federal Reserve is the overall leader and chief policy maker of the US central bank. He helps in the formulation of policy especially monetary policy by government in line with the macroclimate of the country. The chairman regularly briefs congress on the policies and progress the economy is making.
. The chairman has influence on all decisions made by the Federal Reserve. The Federal Reserve thought it necessary to boost lending in the market which had been severely crippled by the credit crunch. Measures taken by the bank included the lowering interest rates and increasing the amounts of money that it lent out to banking institutions.
The central banks lent out huge sums of money to the private markets in an effort to restore normal functioning (Irwin, 2008). The Federal Reserve further relaxed the eligibility status of collaterals for giving out loans (Cochrane, 2009, par. 5). Initially, only treasury bonds were eligible but after the crisis, in order to improve liquidity, the Fed decided to accept mortgage based securities which were by far more risky.
The steps described above reflect the various fiscal and monetary policies taken by the concerned arms of government. Monetary expansionary policies aimed at increasing credit flow in the market have been dominant. The US government is even considering another stimulus package to support the fragile recovery.
In addition to the expansionary policies, the US government is considering extending tax cuts that were introduced by former president Bush. The cuts will however be for the wealth Americans who are though to be high spenders in the economy. However, there other plans too to include the rest of the population in the tax cuts bracket so as to increase consumer spending.
Success of the monetary and fiscal policies
The effects of the financial crisis on global economies are still evident. Many economies including threat of the United States are yet to post concrete data on recovery. A weak housing market coupled with high unemployment rates have characterized the aftermath of the financial crisis in the US.
However there has been marked success especially through the expansionary monetary policies that the Federal Reserve implemented. The government has increased its spending programmes in a move aimed at pumping more resources to the economy. Infrastructure spending by the government has been credited for creating jobs in the economy.
The credit extended to small businesses has ensured many of them return to business and haul more people out of the economic quagmire. Tax cuts to many middle class families have boosted their disposable incomes effectively increasing consumer spending.
The once troubled financial institutions which were on the brink of collapse have returned to profitability and people can now access credit, though sparingly. The auto industry too recovered and automakers like General Motors and Chrysler have reported steady progress. The crashing stock markets have since regained signifying increased confidence by investors on the health of the economy. Extension of the Bush era tax cuts too is on the cards as one of the fiscal policy proposals that are meant to help the economy to grow.
Conclusion
The financial crisis is far from over and some countries are still reeling from the crisis. For instance, Greece underwent a debt crisis whose root cause can be traced to the financial crisis. Full recovery of the US housing market is yet to be realized. Before it happens, many people are going to default and foreclosures will continue.
Refinancing of mortgages will not be easy as many more have lost their jobs and cant seem to find any. The stimulus packages fronted by the government are only short-term measures whose positive effects will fizzle out once the money is exhausted. A long-term solution therefore is inevitable.
The control of the financial system that has been authorized by the senate proved laws too were long overdue. Still, more regulation is needed since causes of such crises accrue over time due to limited oversight. Though the Federal Reserve and Treasury department have been working together, there is a need to increase cooperation so as to foresee the happening of a crisis of such magnitude.
References
Adam, C & Vines, D. (2009). Remaking macroeconomic policy after the global financial crisis: a balance-sheet approach. Oxford Review of Economic Policy, Vol 25, Issue 4.
Cochrane, H. J. (2009). Fiscal theory, and fiscal and monetary policy in the Financial crisis. Web.
Irwin, N. (2008). Fed’s Role in Crisis Is Giant, if Opaque. Washington Post p 1. Web.
Moseley F. (2009). The U.S. economic crisis: Causes and solutions. Web.
Nanto, K. D. (2009). The Global Financial Crisis: Analysis and Policy Implications. Web.
Rampell, C. (2010 January 3rd). Lax Oversight Caused Crisis, Bernanke Says. New York Times p 1. Web.