World Finacial Crisis - Impact in the American Economy - Term Paper Example

?World Financial Crisis - Impact in the American Economy Contents Contents Introduction 2 Growth in the GDP 4 Impact in the Employment Sector 5 Bank Failure 6 Changes in Values of Dollar 7 Impact in Various Other Sectors of the Economy– Agriculture Industry and Service Industry 8 Problems 9 Reference 9 Introduction The main cause of the financial crisis of 2007-09 was the housing market of U.S. From the decade of 1990s policy of financial deregulation was taken by the U.S. government. The monetary policy became loose in 2002-2005. From the year 2006 the delinquency rate on the home loan has increased and it got severe in the year 2007 because the Federal Reserve has started to increase the interest rates. The house loan where the debtors have to pay floating rate interest they were in problem. So the increase of bad loans led to the failure of the mortgage lenders mainly the banks. Because of the complexity of the financial products the investors and the banks didn’t know the actual size of the losses. As a result the liquidity of the market became less and the lending decrease, as a result the credit crunch has begun. The other reasons for the financial crisis are the borrowing of the households which were beyond their means, poor lending standards taken by the financial institutions, more over the counter transactions, more reliance on short term debts and the credit rating agencies failure to assess the risk. In the era of globalization the financial crisis of world’s strongest economy also affected the economy of the other countries. In September 2008 Lehmann Brothers was bankrupted and the financial crisis taken place. The report is an attempt to assess the impact on the American economy due to the world financial crisis. This report would find out the GDP growth rate, the changes in the value of dollar, the sector wise impact and the consequent problems caused by the crisis. Growth in the GDP Figure 1: United States GDP Growth Rate Data Source: (Bureau of Economic Analysis, 2011) Gross Domestic Product (GDP) of a country is the representative of the standard of leaving of that particular country and it refers to the value of goods and services produced by the country. The GDP growth of U.S. was affected severely for the financial crisis of 2007-09. The GDP growth has increased 1.9% in the fourth quarter of 2007 from the last quarter. 2008 and 2009, these two years were the two worst years for American economy. In 2008 excluding the 2nd quarter the GDP growth was negative throughout the year. In the 4th quarter of 2008 the GDP growth was -9% which was the lowest for a quarter in the period of Economic recession. From the 3rd quarter of 2009 the GDP growth was tend to positive and after that the growth was always positive. This statistics shows that in that time period the economy was not productive at all. All the sectors were affected by the credit crunch situation more or less, as a result the total GDP of the strongest economy declined. The manufacturing industries were unable to get the credit as they get it in the earlier time. The banks and other financial institutions didn’t get the payment from the debtors, so several banks were declared bankrupted, as a result they were unable to issue credit to the business entities when the business organizations are largely depends on debt from the banks. So the productivity of the organizations became less and the GDP growth rate declined. Impact in the Employment Sector Figure 2: The Layoff due to the Financial Crisis Data Source: (Auer, Auer and Wehrmuller, 2008) From the above graph it can be said that since the 9/11 the layoffs has risen to the highest level. It can be concluded from the statistics that for the financial crisis not only the GDP of the country declined, the layoff rate also reached to the country’s highest level. The cause of the financial crisis was the disability to pay the debts of the households; as a result the bad debt of the financial institutions has increased. Some financial institutions also got bankrupted. It was hard for the banks to easily survive from this situation. They also decreased to provide credit and the cost of the issued credit was more. So it was getting tough for the firms who are dependent on the external finance as the cost of capital increased. As the cost of capital increased the companies has taken the way of mass layoff of workers as cheap capital is needed for employment. When it is not available for the companies they have chosen the way of layoff for decreasing the costs. From September 2006, 660000 workers have lost their jobs only in the construction sector from its peak (Auer, Auer and Wehrmuller, 2008). Bank Failure The statistics has showed that the number of the commercial banks in the year 2009 was less than half of the number of banks in 1984. There are many banks in U.S whose area of operation is only in some areas. Some local economic shocks caused the failures of the local banks. The credit crunch and the resultant financial crisis were the main cause of the failures of the banks in the period 2007-10 (Aubuchon and Wheelock, 2010, p.405-406). The main cause of failure is the increase of bad debts of the banks. The households failed to pay back its debt for the increase of the interest on the loans they have taken. In addition to this the causes of failure of the bank are the decline in the personal income, increase of unemployment rate, the decrease of GDP growth rate. As banks found it tough to surviving from the increasing bad debts in their accounts, so the credit crunch has begun. The business organizations were unable to get the needed credit and though they get it the cost of the credit was high. So the organizations have taken the way of mass lay-off. As a result the unemployment rate of the country has increased, as well as the personal income of the individuals have also decreased. The decrease of the GDP growth rate also hampered at that time. For the causes the savings of the banks get decreased and so lots of banks including some major banks like Lehmann Brothers bankrupted in the period of the financial crisis of the period 2007-10. Changes in Values of Dollar Date Value of 1 Euro in Dollar 29th June, 2007 1.3520 28th September, 2007 1.4219 31st December, 2007 1.4603 31st March, 2008 1.5805 30th June, 2008 1.5748 30th September, 2008 1.4081 31st December, 2008 1.3919 31st March, 2009 1.3261 30th June, 2009 1.4020 30th September, 2009 1.4630 31st December, 2009 1.4332 31st March, 2010 1.3526 30th June, 2010 1.2291 30th September, 20010 1.3601 30th December, 2010 1.3269 Data Source: (Board of Governors of Federal Reserve System, 2011) In the above table the exchange rate of dollar with respect to Euro is listed. In the period 2007-10 the financial crisis hit the world economy. From the middle of 2007 the crisis has started. The value of Dollar on 29th June, 2007 was 1.3520. After that the financial crisis has started and the value of Dollar has decreased. On 31st March, 2008 the value of Dollar was lowest. The value of 1 Euro was 1.5805 Dollar that time. After that the value went upwards gradually and the value was highest on 31st March, 2009, the value of 1 Euro was 1.3261. After that certain fluctuations happened and the value of Dollar became stabilized. The fact should be reminded that the recession not only hit the American economy, but the whole world. A clear picture can’t be getting only by analyzing the value of Dollar with respect to Euro. The European Union also suffered due to the financial crisis. The value of Euro also decreased. From the historical value of Dollar with respect to Euro it is clear that the value of dollar decreased more than the value of Euro. So it can be said that the American economy was the worst affected among the world economy. Impact in Various Other Sectors of the Economy– Agriculture Industry and Service Industry The impact of economic crisis was a lot on the U.S. agricultural sector, though it was not as severe as the other sectors. In the year 2007 and 2008 the agricultural exports, income from the firms went to the record high for the sector. The debt equity mix of this sector is conservative than the other sectors. But in the year 2009 the changing economic scenario of the world also affected the agricultural industry of U.S.A. The reasons of declining the income of the sector are the depreciation of the Dollar value, declining of export of the agricultural products and the lower sales price of the products. As there was less demand from the foreign countries so the export went down, also the prices of the products became less. But the sector is less affected than the other sectors as it has not to face the credit crunch situation severely (the debt percentage was less) and the chance of recovery was well for the sector due to the technological advance (Shane et al, 2009, p.8-26). As unemployment increased due to the financial crisis over the country, also the personal income of the individual decreased so the buying behaviour of the customers changed. They were unable to spend that much as the earlier situation. The service industry got affected for this matter. There revenue decreased and some companies also get bankrupted then. Great Atlantic and Pacific Tea Co., which was the largest grocer once got bankrupted in the year 2010, they were the victim of the financial situation that time and the tough competition in the service industry (Erman and Humer, 2010,). Problems The main cause for the financial crisis lied in U.S. The financial institutions filed for bankruptcy for the increased bad loan. U.S.A. is the strongest economy of the world. The failure of the financial institution affects the whole world and the financial crisis affected the whole world. U.S.A. government has taken some policies for getting out from the situation. But the policies taken by them are questionable and recently the credit rating of U.S.A. got downgraded. The world was unable to totally come out from the situation as there is chance of another recession as the Greece situation has showed that. Analyzing the reasons of the financial crisis the researcher has got that that the basic problems is the bankruptcy of the banks. As the banks got bankrupted, the business organizations were also unable to produce as the earlier time. So the credit ratings of those organizations also get downgraded. So the GDP growth rate of the country has decreased as well as the probability of the growth rate. So there is a need of a major economic reform for the country so that the country became economically more robust. Reference Bureau of Economic Analysis. (2011). U.S. Economy at a Glance: Perspective from the BEA Accounts. Retrieved on December 26, 2011 from http://www.bea.gov/newsreleases/glance.htm. Auer, P. Auer, R. and Wehrmuller, S. (2008). Assessing the impact of the financial crisis on the US labour market. Retrieved on December 26, 2011 from http://voxeu.org/index.php?q=node/2603. Aubuchon, C. and Wheelock, D. (2010). The Geographic Distribution and Characteristics of U.S. Bank Failures, 2007-2010: Do Bank Failures Still Reflect Local Economic Conditions? Retrieved on December 26, 2011 from http://research.stlouisfed.org/publications/review/10/09/Aubuchon.pdf. Board of Governors of Federal Reserve System. (2011). Foreign Exchange Rates – H.10. Economic Research & Data. Retrieved on December 26, 2011 from http://www.federalreserve.gov/releases/h10/hist/dat00_eu.htm. Shane, M. et al. (2009). The 2008/2009 World Economic Crisis What it Means for U.S. Agriculture. Retrieved on December 26, 2011 from http://www.ers.usda.gov/Publications/WRS0902/WRS0902.pdf. Erman, M. and Humer, C. (2010). Grocery Chain A & P Files for Bankruptcy. Retrieved on December 26, 2011 from http://www.reuters.com/article/2010/12/13/us-atlanticpacific-bankruptcy-idUSTRE6BC04720101213. Read More