Power of the American Economy - Essay Example

?Since the global economic collapse of 2008-9, the U.S. government has passed legislation based on Keynesian stimulus response to recessionary economic growth, and the Federal Reserve has acted in tandem by reducing interest rates to record lows, supporting market firms through direct purchases of financial assets, and promoting quantitative easing to increase money supply. The economic crisis itself, which some have called the “Great Recession,” can be viewed as having two stages related to the two political administrations in the U.S. and their responses during the evolution of the issues and events. Critically, the U.S. financial collapse took place during the very last days of the Bush administration and during a U.S. Presidential election. The Fed’s response can be viewed separately and as working in tandem with the political approach of both political administrations and Congress. The historical characteristics of the period preceding the crisis itself can be seen as related to the severity of the crisis, while the aftermath or recovery period can suggest projections about the future consequences of the policies referenced drawn from economic studies and historical parallels in order to illustrate the possible dangers to the macro-economic environment that remain for the global economy. In the period preceding the financial crisis of 2008-9, the major issue of importance is the real estate market, particularly the sub-prime mortgage market in America, and its lending standards which may have led to the creation of a real estate bubble in the country. By some analysts’ regard, the Clinton administration encouraged Fannie Mae and Freddie Mac to promote financing policies that made it very easy for even the lower income families to get mortgages for home purchases. This type of encouragement was related to a general deregulation of the financial industry that proceeded under both the Clinton and Bush administrations, which included repeal of Depression era statutes like the Glass-Steagall Act that regulated the trading and investment functions of banks. Ratings agencies oversaw the process through which the Wall St. investment banks packaged thousands of mortgages in both commercial and residential real estate contracts into massive, billion dollar bonds known as MBS (Mortgage Backed Securities) that could be sold by the investment banks to groups like pension funds or hedge funds who were interested in fixed-rate or adjustable-rate long term returns. The contagion of global markets is seen in the way that these MBS entered portfolios around the world of all manner of different public and private sector investors, corporations, and banks. Risk management, as practiced not only by the investors who purchased these MBS but also by the ratings agencies, failed to recognize that these securities could fail in the manner that they did because they underestimated the deflationary aspects of real estate and overestimated the reliability of the lending standards at their basis. This is the “Black Swan” aspect of Nicholas Taleb’s analysis, who wrote: “Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur ….I shiver at the thought.” (Taleb, 2010) If Wall St. planners, securities ratings agencies, and government regulators associated with the Fed, SEC, FDIC, and other agencies failed to plan adequately in the context of risk management for the conditions of a “black swan event” that would precipitate the financial collapse, they can be considered irresponsible, unprofessional, and reckless historically for their actions because they had warnings and alternative options. The Wall St. Bailout already has cost the taxpayers $4.7 to $13.9 trillion dollars in the United States alone as a result of the government response to the financial crisis. (SourceWatch, 2011) In analyzing the U.S. government and Federal Reserve’s response to the financial crisis of 2008-9, the first issue is to whether it encouraged the problem by deregulating the industry and providing lax oversight of the finance industry. The second issue is the actual response of both the administrations politically after the critical issues arose. Historically, the Lehman bankruptcy can be seen as the cause for the “fee-fall” market conditions at the end of the Bush administration that signaled the high-point of the crisis. Thereafter, no other TBTF entity would be allowed to go bankrupt, leading to AIG, CITI, and other banks receiving billions in aid from the government and Federal Reserve. At this point in the crisis, market contagion can be considered an essential aspect of globalization and the Lehman bankruptcy brought down asset & equity prices in all markets globally. With the Lehman Brother’s bankruptcy leading to so many further bail-outs and such a large cost, the Bush administration will be questioned in not preventing this by actually saving Lehman Brothers and thus avoiding the downward spiral of the markets. The second stage of the crisis is characterized by the Obama stimulus programs which injected billions of dollars of government spending into the economy to combat unemployment and promote job growth, with high unemployment seen as an outgrowth of the first stage of the financial crisis. The Obama administration nationalized the iconic American corporations General Motors and Chrysler, guiding the companies through bankruptcy and providing billions of financing in return for stock ownership. Similar arrangements were made with major banks for liquidity injections in exchange for partial government ownership in the companies through stock, and this government intervention to save banking was unprecedented, leading to the final collapse of the stock market and the historical lows on March 2009. The response of the Federal Reserve to the crisis can be analyzed in three aspects, though many have found the policies of former Chairman Alan Greenspan complicit in creating the problem through the stimulation of the real estate bubble. In this view, the decision to cut interest rates to stimulate the economy following the crash of the Dotcom bubble led to the creation of a real estate bubble which affected an even larger section of society when it popped in 2008. The decision of the Federal Reserve to cut prime-lender interest rates to zero as a response to the financial crisis was intended to address both the problems of deflation in the real estate market and also the crisis in liquidity experienced by banks internationally. This was combined with direct asset purchases of bonds particularly through TARP as an attempt to provide support to the industry, represented in the Maiden Lane holdings. Maiden Lane is a “portfolio that was created during the depths of the financial crisis to absorb the troubled ‘private-label’ mortgage bonds from AIG (AIG.N) and help prevent the collapse of what was the world's largest insurer.” (Yoon, 2011) The result of the Fed’s direct purchase of market securities was that toxic assets were taken off the books at AIG and into Maiden Lane. Historically both administrations will be criticized particularly for the deep connections between the political lawmakers in Congress and the White House to Wall St. and TBTF financial interests. Positively, it can be said that unemployment has been reduced since the height of the financial crisis in 2008-9, and positive economic growth has returned to the American economy signaling an emergence from recession. “Unemployment dropped to 8.8% in March, 2011, according to figures released by the Bureau of Labor Statistics on April 1, 2011. That marks the fourth month in a row that the national unemployment rate has decreased.” (NCSL, 2011) Two years after the market lows of 2009, there has been a modest recovery in real estate prices though millions are still underwater on their mortgages, owing more in loans to the bank than the houses are worth. Many of the Federal Reserve’s policies, especially low interest rates and quantitative easing, are designed to produce inflation precisely because of the terrifying aspects of deflation they are combating in the financial crisis. Deflation is the biggest issue – it is represented in the stock market crash, the decline in real estate values, people losing jobs, and being unable to pay their bills. Deflation is the cause of the Great Depression and deflation crushes government income incurred through taxation. Thus, in identifying deflation as a type of existential risk to the entire system, the Federal Reserve is required in many ways to promote “controlled inflation”. The use of controlled inflation to escape depression or recession is a fundamental of Keynesianism but it results in several major consequences that should be considered. The first is the rise in asset classes across the board, meaning that when the Federal Reserve funnels money into the economy through TBTF institutions to inflate the stock market it will also influence commodities, leading to a rise in the price of oil, gasoline, food, transportation, etc. in society. To the greater economy suffering from structural issues related to globalism, this may not address any of their problems but rather worsen financial conditions by making the cost of basic commodities like food, gas, and transport more expensive in relation to any rise in wages. Many workers find themselves downsized or underemployed in this economy, and taking jobs that pay less than they would hope. Yet, they have no control over the price of commodities which may rise with inflation faster than the general economic improvement and whose price inflation hits the poorest in the world the hardest. This is the social aspect of contagion that leads to food and gas riots all over the world, and rising discontent. The other consequence of quantitative easing and low interest rates is the devaluation of the U.S. dollar. In the context of the recovery from the financial crisis, most major economies intervened through government and central bank policies to support minority interests in the economy in order to create a broader recovery. Thus, in comparing the U.S. dollar to other currencies, the pronouncement of the loss of value will be less than when comparing it to the price of precious metals such as gold and silver. The explosion in price of gold and silver following the announcement of policies by the U.S. government, Federal Reserve, and other countries to engage in further debt spending in order to recover from the financial crisis is the distinctive tell as to the degree to which inflation is manifest covertly through currency debasement. Where there clearly is not enough income to pay for the Federal Budget as currently established, the nation must issue Treasury debt in order to finance operations in excess of receipts. Typically, this debt is bought by private investors, corporations, banks, and other countries who view the low rate of return on the bond as related to the absolute security of the investment. As such, U.S. Treasury bonds are rated “AAA” and the U.S. Treasury Secretary Timothy Geithner says that the U.S. will never lose that rating. (Bloomberg, 2010) However, recent events have seen such countries as Ireland, Greece, Portugal, and Spain lose their “AAA” debt ratings as sovereign nations. The example of Japan shows how severely an advanced industrial nation can be affected economically by natural disaster. Indeed, the Japanese debt level and current demands of their economic crisis may force Japanese bonds to be downgraded at some point in the future. (Middleton, 2011) The inevitable progress model suggests that the U.S. economy will recover in the short term but struggle with longer term socio-economic conditions related to the uniqueness of its position as the world’s largest economy challenged by rising international powers with distinct advantages. Market forces are known to be cyclical and operate upon their own accord and contrary to even the most ardent policies of the State. The Clinton and Bush administrations encouraged deregulation in the banking and finance industries that created the conditions of moral hazard that symbolize the causes of the crisis. Contagion can be seen as a characteristic of markets in the era of globalization and information technology, with trading instant and computer-driven. Quants and short-sellers exacerbated a crisis caused by liquidity and forced-selling with the bankruptcy of Lehman Brothers. Historically, allowing Lehman Brother’s to fail while bailing out the rest of the TBTF banks and institutions is questionable, because it led to the free fall in the markets. The motive of corruption and insider-trading in the actual construction of the collapse, and its presentation in the media symbolically in the context of the Presidential elections will make it a continued subject of investigation for historians. The relationship between the TBTF banks and institutions and the political class of government representatives who made the legislation both authorizing the bailout and the regulation of the industry is critically suspect. Sources Cited: Barth, James R. et al. Policy Watch: The Repeal of Glass-Steagall and the Advent of Broad Banking. The Journal of Economic Perspectives, Vol. 14, No. 2 (Spring, 2000), pp. 191-204. Web. 10 April 2011. Bezroukov, Dr. Nikolai. Phil Gramm, the senator who converted the USA into one big Enron. Softpanorama, pp. 880-890. Web. 10 April 2011. Christie, Rebecca. Geithner Says U.S. Will ‘Never’ Lose Aaa Debt Rating (Update1). Bloomberg, February 8, 2010. Web. 10 April 2011. Durden, Tyler. The Only Two Charts That Matter For The US, And A Q&A On The Fiscal "Debate" From Goldman Sachs. Zero Hedge, 04/09/2011. Web. 10 April 2011. Economist, the. Goldman Sachs charged by the SEC: A volcanic cloud over Wall Street, The charges against Goldman could have far wider consequences. The Economist, Apr 16th 2010. Web. 10 April 2011. Federal Reserve. Frequently Asked Questions: Federal Reserve System. The Federal Reserve Website, Last update: March 7, 2007. Web. 10 April 2011. Marshall, John M.. Moral Hazard. The American Economic Review, Vol. 66, No. 5 (Dec., 1976), pp. 880-890. Web. 10 April 2011. McCool, Grant. SEC, Goldman's Tourre battle in Abacus fraud case. Reuters, Feb 14, 2011. Web. 10 April 2011. Middleton, Reggie. Japanese Downgrade Illustrates Potential Paths To Contagion. Boom Bust Blog, 1/27/2011. Web. 10 April 2011. NCSL. Unemployment Drops to 8.8% in March 2011. National Employment Monthly Update Go 13307, Apr 1st 2010. Web. 10 April 2011. Parsons, J. Housing Bubble Graphs. Housing Bubble, 2011. Web. 10 April 2011. Reynolds, Alan. $646,214 Per Government Job: Spending where unemployment is already low. Wall St. Journal, Jan 28th 2009. Web. 10 April 2011. Source Watch. Total Wall Street Bailout Cost. The Real Economy Project of the Center for Media and Democracy, 2011. Web. 10 April 2011. Taleb, Nassim Nicholas. The Black Swan: The Impact of the Highly Improbable. New York: Random House, 2010. Timmer, Jurrien. Jurrien Timmer: The Fed's punch bowl. Fidelity Investments, 2011. Web. 10 April 2011. Wachtel, Katya. Goldman Sachs Can't Say It Didn't Get Bailed Out Anymore -- It Kept Billions From AIG. Business Insider, Jan. 27, 2011. Web. 10 April 2011. Yoon, Al. UPDATE 1-NY Fed plans pair of Maiden Lane sales next week. Reuters, Apr 8, 2011. Web. 10 April 2011. Read More

 

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