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Economic Crisis in the United States - Research Paper Example

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Economic Crisis in the United States POL 201 Janice Hodge Professor Dovie Dawson March 19, 2012 Analysis of the 2008-2009 Economic Crisis in the US: The Root Causes and the Policies Implemented The magnitude of the US economic crisis in 2008-2009, having affected millions of peoples’ lives not only within and outside the nation, is comparable to 1930’s ‘Great Depression’; thus it is dubbed the ‘Great Recession’ (Katkov, 2011, p…
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Download file to see previous pages widespread failure in regulatory oversight) (Barclift, 2011, p. 450). However, deeper analysis of the crisis shows that though the crisis is financial in nature, the culprit is not financial as many have explained but structural; it is caused by the faulty macroeconomic strategies of US – the reliance on bubble economy and dependency on international credits and imports. I. Understanding the Crisis Experts, policymakers and observers (BBC, 2007; Zaman, 2009, p. 64; Katkov, 2011, p. 898) perceive the crisis in contending ways, depending on which spectrum one aligns. But as the events unfold, everyone seems to agree that the crisis has started to manifest itself in the burst of the housing bubble in 2007 followed by the financial market crash. How did this happen? This question must have been asked with the shocking realization that this actually happens in the US – the seat of world power and the home of distinguished economists, financial analysts, and bankers. But after understanding the events, one would probably say that this kind of crisis would be most highly probable in the US. Why? The answer to this would come later. Going back to the first question, to answer this requires one to understand the mortgage lending in the US. One good simple explanation on this is to understand the effects of the changes made on the traditional model of mortgage lending to the sub-prime model as illustrated below. The differences between the two models rest on three important factors: First, the reliance on real assets for banks to lend; second, the guarantee on the capacity of borrowers to pay; and third, the transparency in the conditions of loans – i.e. that sub-prime loans are usually adjustable rate mortgages (ARM); toxic instruments, like the collateralized debt obligations (CDO) that the biggest investment banks of the world pump out (BBC, 2007, p. 1). In short, there are solid bases by which banks and borrowers conduct business, giving both parties clear indicators by which to act. Unfortunately, these three important factors on which banks traditionally operate are disregarded in the new sub-prime model. Though it is true that selling on the mortgages to the bond markets has given banks additional leverage to fund more borrowings, however, it has resulted to fraudulent practices, which banks no longer have the incentive to check (BBC, 2007, p. 1) – i.e., falsifying credit histories or income of borrowers by mortgage brokers to qualify borrowers so that brokers can earn fees and commission (Zaman, 2009, p. 65). Truly, the sub-prime model has succeeded in raising the demand for housing, which caused the housing bubble, but in the end caused the financial crisis. Freeman (2002) explained that the housing bubble created a hyperinflationary spiral, fuelling speculative investments in real estate. Consequently, this sent prices, assessments, real estate and mortgage credit volume also spiraling upwards. Such was actually the objective of the City of London-Wall Street financier and Fannie Mae. On the contrary, the productive economy that would have given debtors the capacity to pay and that would have given resilience to the US economy was staggering downward. (pp. 12, 17) Expectantly, as BBC (2007) reported, sub-prime borrowers, which make-up 22% ($1.3 trillion) of the $6 trillion mortgage ...Download file to see next pagesRead More
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