Recession on the Scale of the Great Depression 2008 in the US - Research Paper Example

? The Financial Crisis Introduction While the 20th century was a period of substantial economic growth for the United s, it was not without recessionary periods. In 1929 the Great Depression hitting placing millions of Americans out of works and sending the country into a recession that would be impactful for the following decade. It was not until after World War II that the United States would emerge as an unchallenged superpower and economic force. In 2008 the United States experienced a recession nearly on the scale of the Great Depression. Termed the Great Recession by some, this economic collapse would again shake the country’s very foundations and lead many Americans and politicians to question the very structure of Wall Street. Although greatly linked to the sub-prime mortgage crisis, the causes of the 2008 recession are complex and multi-varied. This essay discusses the role of government policy, the role of mortgage originators, securitization, and moral hazards. Additionally, it presents an explanation of how the following work as well as what role they played in the crisis: subprime mortgages, mortgage backed securities, credit derivative obligations, credit default swaps; the consequences on U.S. financial markets; and the U.S. government response. Finally, it presents the authors own perspective on the financial crisis. Analysis Perhaps the most overarching consideration in terms of the financial crisis is the role of mortgage originators, securitization, and moral hazards played. Referred to as subprime lending this process is highly complex. Throughout the late 90s and early 00s competition in the housing market greatly increased. As a means of keeping pace with the increasing competitive markets mortgage lenders increasingly increased their borrowing restrictions to individuals with less than stellar credit ratings. This process is intimately connected with government policy as in many situations it was the government that contributed through policy and pressure to loosen up the lending standards. Indeed, some researchers linked the beginning of the housing bubble to 2003 (Krugman 2009). Prior to this period Government Sponsored Enterprises (GSEs) were required to maintain conservative lending practices. As a means of enticing individuals to enter into subprime loans, lending agencies implemented high-pressure tactics, including loan incentives (Krugman 2009). This predatory lending constituted a great contributing factor to the crisis. Additionally, the rising costs of housing prices created an environment were people increasingly believed that their home purchases would continue to rise. The exact originators of this crisis are complex. One of the most frequently cited considerations is that government policies that sought to increase home ownership greatly contributed to the institutional environment that would allow for such practices to occur. Indeed, since as early as the Reagan administration the government has sought policy to increase home ownership (Wright 2010). However, it wasn’t until 1995 that the government became more actively involved in the process. In 1995, Government Sponsored Enterprises, including Fannie Mae and Freddie Mac, began receiving government incentives for purchasing mortgage-backed securities (Wright 2010). These mortgaged backed securities included loans to low-income borrowers. In 1996 this process was further enhanced as the Housing and Urban Development Department (HUD) set a goal for both Fannie Mae and Freddie Mac to purchase at least 42% of mortgage backed securities that contained households with incomes below the median for the specific area (Wright 2010). An important consideration is the notion of the Credit Default Swap. These swaps were largely implemented during the period preceding the economic meltdown. The process is highly complex, as it implements derivatives in the process, contributing to the overarching considerations regarding the difficulty in regulatory processes. Essentially what was occurring was that the institutions would issue substantial amounts of mortgages to individuals living below the median income level (Ferguson 2010). These subprime mortgages would then be bundled in packages that could be purchased by other agencies (Ferguson 2010). The specific bundled packages would then be given a rating based on their strength (Ferguson 2010). While the specific subprime bundles were supposed to be given poor ratings, the agencies that rated these agencies were both pressured, but also benefited from granting them Triple AAA credit ratings – the highest possible rating (Ferguson 2010). Another agency would then purchase these credit bundles from the original group and sell them to the public as top-rated investment packages (Ferguson 2010). One of the cornerstone recognitions of the financial crisis then is the understanding that the agencies that purchased these subprime loans did so with such impunity and lack of ultimate risk that when the packages ultimately failed the government had to bail these institutions out or risk the complete collapse of the American economy (Ferguson 2010). This process resulted in the ‘too big to fail’ moniker. This process had profound implications for the United States financial markets. The gross domestic product began shrinking towards the end of 2008. By 2009 this rate was dropping at a rate that had not occurred since the 1950s (Tanous 2011). This alarming of decline was not confined to statistical figures, or even production within the United States alone, but held profound implications for foreign investment as well. While before the economic collapse domestic and international investment in housing and real estate had been extremely robust, following these incidents there was a dramatic decline. One considers that in the first quarter of 2009 housing investment declined by 23.2% (Tanous 2011). Housing was not the only area to experience sharp declines; in addition to the dramatic decline in housing investment, domestic demand in the United States also experienced tremendous decline. This concerns then extended to United States equity valuations, as the entirety of value in American publically traded companies receded drastically. Perhaps the most troubling aspect of these impacts on the financial markets is the understanding that there were not only confined to the United States, but extended internationally. Indeed, the impact of the United States recession internationally highlighted just how truly globalized the world has become. China, which had been growing at staggering rate, experienced a halt in growth in the period immediately following the recession (Tanous 2011). The recognition is that China is an export driven economy that is heavily reliant on American consumption. Still, the recession was perhaps felt the greatest in Europe were it in-turn enacted an entirely new recessionary period – the European Sovereign Debt Crisis. This recession, which included near economic collapse in Italy and Spain, has functioned both as an extension of the American financial crisis, but also an indictment of the European Well-fare State (Tanous 2011). While the American economy has experienced slow growth – 2.3% in 2011, as well as a declining unemployment rate – the European Union has entered into a double dip recession. The United States government has responded to the financial crisis in a variety of ways. The most prominent such considerations are the recognition that the government has largely implemented a Keynesian theoretical approach. Keynes believed that one of the major mistakes the American government made following the Great Depression was that they did not go far enough in infusing liquidity into the American markets (Krugman 2009). Keynes’ central insight was slightly paradoxical. Essentially, he was arguing that when the economy was experiencing expansion and an upward trajectory it would influence investment both domestically and from abroad, which would in-turn enact real growth (Krugman 2009). Following these beliefs beginning with President Bush billions of dollars were infused into the American economy. When President Obama took office he put into policy the American Recovery and Reinvestment Act of 2009, a $552 billion dollar package designed to stimulate economic growth. In addition to this stimulus package, the Obama administration enacted a number of corporate bailouts designed to prevent the complete collapse of the American economy (Muolo 2011). This program, referred to as the Troubled Asset Relief Program or ‘TARP’ implemented $700 billion in strategic bailouts (Muolo 2011). Specifically, the GSEs Fannie Mac and Freddie Mac, financial institution AIG, and major corporations in the American auto industry received funds. When examining the American recession a number of prominent considerations come to mind. While politicians and political pundits find it helpful to criticize the rampant greed and moral impropriety that occurred, it seems that instead that was more of a problem with American culture. One considers that even while unethical means were implemented in securing mortgages, the individuals that entered into these contracts can partly be held responsible for their actions in not properly managing their finances. The issue then became both a nation and capitalist system that was so passionately committed to accruing wealth that it lost sight of the very purpose of moral restrictions. In this sense, morality and ethics need not be understood in terms of timeless or religious commandments, but rather naturally emerging lines that should not be crossed to ensure the well-being and functioning society. Conclusion In conclusion this essay has examined the American financial crisis. Within this spectrum of investigation it has examined the crisis from the perspective of the mortgage crisis, securitization, and the subsequent economic fallout these incidents had on the rest of the American system. The research has also argued that the international impact of the American recession has highlighted global-interconnectedness. Additionally, it has posited that the financial collapse operates as a reminder of the function of moral and ethical restraints in both financial institutions and the broader social apparatus. References Ferguson, C. (2010) Inside Job. Columbia Pictures. Krugman, P. (2009). The Return of Depression Economics and the Crisis of 2008. W. W. Norton & Company Muolo, P. $700 Billion Bailout. (2011) New York: John Wiley and Sons. Tanous, P. (2011). Debt, Deficits, and the Demise of the American Economy. New York: Wiley Press. Wright, R. (2010) Fubarnomics: A Lighthearted, Serious Look at America's Economic Ills. Buffalo, N.Y.: Prometheus. Read More