Economic Crisis of 2008-2009 - Research Paper Example

? 2008-2009 Economic crisis The paper focuses on the root causes of the tremendously loathsome economic crisis encountered by the world, especially the United States of America (USA) in 2008-2009 along with the rigorous steps employed by the US government to stabilize and uplift the economy’s condition from the devastating financial boogie trap. Primarily the focus is stressed on the proximate causes that ignited and spurred up the economic downturn. In the subsequent step, endeavors made by the US government in the stabilizing mechanism of the economy is explained with particular emphasis on the role of President, Congress, Secretary of the State, and Treasury Secretary in order to abolish the adverse consequences on the economy. Eventually, critical evaluation of the policies is exercised in order to execute cross evaluation procedure and suggestion of optimal policies are being stipulated in order to strengthen the policy implication paradigm. The propulsion of the economic crisis in 2008-2009 is the devastating economic crisis that the world faced in the past six decades. The crisis was predicted by a host of economists but it was mainly unforeseen. In the World Economic Outlook, the International Monetary Fund (IMF) even inferred that the threats to the global economy are minimal and for the moment there were no anticipations of any severe economic downturn. The juncture before the crisis was infested with widening global imbalances but owing to the virtue of the world’s largest capital markets and its stable financial regulation and political stability, they saw the global imbalances with sustainability angle. Apart from that the emerging developing countries also found a secure place for investing their funds in order to earn a huge benefit so that they could sustain their position and enhance their credibility in the debt market in the long run. The United States was also considered to possess a superior monetary policy institutions and monetary policy and monetary policy making environment. But the world economy was shattered with the launch of the economic crisis and the crisis shook down the roots of the formidable US economy (Verick & Islam, 2010, p.v). The evil effects of the crisis led to the shattering down of the trade scenario of the world economy with the plight of tremendously declining unemployment rate of the developing economies and subsequent rescue efforts of the government. Launch of the crisis The global economic crisis emerged in September 2008 following the collapse of the strong US financial institution, the Lehman Brothers with the result of the accumulation of the defaults on the mortgages and the derivative products (Lin & Treichel, n.d., p.7). Immediate impact The financial sector crisis very quickly led to the significant decline in the credit volume in the private sector as well as sharp rise in the interest rates. The equity market crashed and the real growth rate around the globe declined significantly below the projections and the US along with the developed economies. The only exception was China and developing Asia who maintained robust growth (Lin & Treichel, n.d., p.8). The root causes The microeconomic dimension Real estate bubble burst The primal reason for the outburst of the crisis was the bubble burst in the US real estate market. As the house price falling rapidly in the second quarter of 2007, the growth rate of the prices of the real estate saw a declining trend since 2005. In the late 1990s, the housing prices began to rise sharply and deviated from their fundamental characteristics. Reaching the summit in April 2006, the bubble burst rose heavily with the tightening of the monetary policy of the Federal Reserve. With signs that the exaggerated rise in the real estate was coming to an end, the banks decided to issue NINJA loans which were made without any prior income declaration from the borrowers to start paying off debt. With the intensification of the downturn in house prices, the mortgage delinquencies, charge-offs and defaults increased at a higher pace. The liquidation of the foreclosed housing further added to the fall in the real estate market. Banks which overextended themselves with the issue of the tremendously high housing loans dramatically reduced with the termination of the housing boom. With the operation of a downward spiral in the house prices helped more and borrowers with adjustable-rate mortgages to default and thus shaking the base of these financial institutions that followed the collection of the sub prime loans securitized through new instruments particularly the Collateralized Debt Obligations (CDO‘s) (Lin & Treichel, n.d., p.11). Financial upheaval As the mortgages were collateralized loans, the banks showed interests in using them as the base for the purpose of issuing other types of profitable securities. For the drive to make the base for these securities the banks prepared three kinds of mortgages. They are zero down securities with adjustable interest rate mortgages with no or low documentation mortgages. With this process, new derivatives worth trillions of dollars got injected into the US and the global economy. The banks primal benefit in this case is situation was the market values of the newly created securities, the collateral debt obligations (CDOs). The investment banks after the generation of the CDOs will receive the commission for the issuance of the loans as well as the commission for their management still existent in the market. As the banks were not responsible for their profitability and liquidity, they were rather inflicted on the increase of the volume of the circulating securities than on their value and reliability. The risks shifted from the CDOs to the buyers. Figure 1 depicts the event of growth and decline of the market of the Centralized Mortgage Obligations (CMOs). The figure depicts that during the time span of 2002-2006 when the real estate market of the CMOs was in the range of 2-3 trillion dollars and encountered a rapid growth. In 2008, the real estate market collapsed with the volume of the CMOs issued dropping more than 30 percent to 1.4 trillion dollars (Katkov, 2011, 900). Fig. 1 (Katkov, 2011, 900) The macroeconomic dimension Economic development strategy of the 1980s The notion of full employment and growth of wages was basically adhered to the economic strategy before 1980s as a precursor of the high growth of productivity. The full employment and the wages growth enhanced the demand of goods and services which in turn supply increased with incentives among the business to invest into new technologies accelerating further growth in the productivity standards. But the phenomenon of the stagflation in the 1970s tremendously damaged the strategy. Rise in demand is deemed to the rise in prices and the rise in supply is associated with the fall in the prices which signifies the decrease in the profit levels for the producers. The producers in order to keep the profitability levels at the constant levels or to increase, the cost of production should be reduced in order which is a rational policy. One optimum way to cut the costs of production the productivity growth should be increased. Enhanced productivity growth will depend upon the new technology which also required a huge variable and fixed cost schedule. But decreasing the costs became a next to impossible task for the US government for the prevalence of the steady growth rates of the wages and increase in the costs of the domestic natural resources. In order to decrease the costs, the manufacturing facilities could be moved to the sources of less expensive resources both the natural and the labor resources. Thus the US shifted a large part of the manufacturing base to the developing countries. The domestic employment sector faced an obnoxious drop in the unemployment rate with 5.5 million job losses within the time span of 1979 and 2007. More employment was clustered around in the sales and financial sector. Thus the country with less manufacturers and highly exceeding sales people led to the economic contraction. As a result the link between the productivity and the growth of wages was broken down with a large increase in the consumption pattern. But the means of financing the growth of the consumption was a serious problem. The solution was found in development of the housing market. The home market was the largest market in America. But the borrowings from the housing loans and loan defaults rose to tremendous heights and the trade balance of the country faced large decline (Katkov, 2011, 903). The trade balance of United States from the period 1997 to 2006 is shown in the following table: 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 -198.1 -246.7 -346.0 -454.4 -427.2 -482.3 -547.3 -665.4 -787.1 -838.2 Table 1. (Katkov, 2011, 903) From 1997, the trade balance showed continuous decline in their magnitude and the default of the home loans exaggerated its severity to another height. Remedial measures adapted and the role of the key actors Congress The US government took resort to both monetary and fiscal policies to curb down the evil effects of the crisis. In October 2008, the congress passed the Economic Stabilization Act of 2008 and adapted the policy of the Troubled Asset Relief Program (TARP) which gave rights to the US Treasury to purchase mortgages and miscellaneous financial instruments amounting to figure of $ 700 dollars. But the recovery mechanism of TARP regarding the lending activities of banks receiving fund from the Federal Government was not successful and the recession deepened the problem further with a sharp decline in the growth rate. In 2009, the congress passed the American Recovery and Reinvestment Act of 2009 which manifested the expenditure of an amount of 787 billion dollars to get out of the crisis including expenditure on health care, unemployment, objects of infrastructure and alternative sources of energy. The stimulus package was intended to increase the job levels and enhance the investment and the consumer spending during the recession. The injection of the stimulus package by the congress resulted in drop in unemployment rate in 2010 to 9.7% from 10 % in 2009 although the overall growth failed to achieve positive magnitudes (Katkov, 2011, pp. 903-904). President In response to the faltering growth rate of the economy, President Obama in 2009 issued a $787 billion bill followed in 2010 the Tax relief, Unemployment Insurance Reauthorization and the job creation Act of 2010. The essential characteristics of the measure were the extension of the unemployment benefits and the allowance of the expansion of the business investment in 2011 (Elwell, 2012, p. 16). A large part of the stimulus package was also dedicated to the reforms of the agricultural sector which was also seriously damaged. Constraints were faced by the president in the declaration of the stimulus package with debate among the republicans centering on the notion of spending cuts and not on the stimulus. The growth rate stagnated again and Obama approached the congress for the passing of an extra $ 447 billion package tax cuts with unemployment benefits along with an additional issue of $ 240 billion dedicated for the modernization of the schools, development on the infrastructure with special focus on education and other economic problems (Economic Stimulus — Jobs Bills, 2012). Chairman of the Federal Reserve & Secretary of the Treasury The unemployment scenario was stressed by the chairman of the Federal Reserve and the secretary of the state. Chairman of the Federal Reserve, Ben S. Bernarke stated that apart from concentrating on the expansion of the output and the income, the employment sector should be focused with responsibility to improve its state. Secretary of the State, Timothy F. Geithner also went on the lines of the chairman of the Federal Reserve and suggested policies for strengthening the employment scenario. As per Bernarke, with the liquefaction of the credit market, the confidence of the consumers takes time to heal. He also suggested on the elimination of the excessive spending for shaping up the economy. Both of them stated that the cost of borrowing will increase with the government’s inclination on the spending programs (Labaton, 2009). Conclusion The stimulus package issued by the President was subjected to criticisms. If seen from an unbiased angle, there lie some loopholes in the strategy. The stimulus package largely depended on the external borrowing from foreign currency which could lead the way to a debt trap of the economy in the future. But the infiltration of the funds is also absolutely necessary for the elevation of the economy. The strategy mix will be focusing on the sustainability of the policies in the development of the quality of life irrespective of economic, social and environmental systems in the present as well as in the future. Congressional mechanism for the spending of the economy can be justified with the enhancement of the stimulus package with the neutralization in the conflict among the representatives of the congress. Larger spending for the generation of the job market through domestic investments in the infrastructure development will be also required to keep the pace of the growth rate accelerating. References Alexander, K. (2011), THE GREAT RECESSION OF 2008-2009 AND GOVERNMENT’S ROLE, Retrieved on June 6, 2012, from: http://asbbs.org/files/2011/ASBBS2011v1/PDF/K/KatkovA.pdf Elwell, C.K. ( 2012), Economic Recovery: Sustaining U.S. Economic Growth in a Post-Crisis Economy, Retrieved on June 6, 2012, from: http://www.fas.org/sgp/crs/misc/R41332.pdf Economic Stimulus- Jobs Bills, (2012), Retrieved on June 6, 2012, from: http://topics.nytimes.com/top/reference/timestopics/subjects/u/united_states_economy/economic_stimulus/index.html Labaton, S (2009), Fed Chief Says Recession Is ‘Very Likely Over’, Retrieved on 30 May, 2012, from: http://www.nytimes.com/2009/09/16/business/economy/16bernanke.html Lin, J, Y & Treichel, V (n.d.), The Unexpected Global Financial Crisis: Researching Its Root Cause, Retrieved on June 6, 2012, from: http://www-wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2012/01/09/000158349_20120109085942/Rendered/PDF/WPS5937.pdf Verick, S, Islam, I (2010), The Great Recession of 2008-2009: Causes, consequences and policy responses, Retrieved on June 6, 2012, from: http://www.ilo.org/wcmsp5/groups/public/---ed_emp/---emp_policy/documents/publication/wcms_174964.pdf Read More