The 2007-09 Financial Crisis and Credit Crunch - Essay Example

?The Financial Crisis and Credit Crunch that occurred World-wide during 2007-09 Introduction Recessions played a key role in destroying several economies of the world. These recessions not only put the economies into depressions but also make a country extremely vulnerable towards meeting its financial obligations. This article mainly highlights the impact of the recent recession of 2008 on Unites States economy. The other part of this article highlights the key measures taken by the US government officials in order to rehabilitate the economy once again (2008 Financial Crisis & Global Recession, n.d.). Impact of Recession on Economy of United States The main reason behind the occurrence of any recession is decrease in the total expenditure of a country. Real GDP is considered as the most appropriate indicator which gauges an economy’s movement. If the real GDP of any economy speeds up its growth rate, the chances for the economy to grow in the broader respects increases sharply and a “boom” stage of business cycle can be observed. On the other hand, once people start sensing that their income would no longer be enough to manage their expenditures, they start cutting their expenditures. As a result, the overall confidence level of the people shakes up which in turn leads to a massive decrease in the overall expenditures of the people. The demand side gets shrink thus putting a stoppage to the overall production of the country. In this way, the production process suffers and experiences severe thus inviting a recession. It takes years for the people to believe that their expenditures would be met easily and they would be able to incur expenditure on luxury items (2008 Financial Crisis & Global Recession, n.d.). 1. Residential Investments In United States, the collapse of the housing market and sub prime mortgage was the major reason behind this whole debacle which pushed the US economy into dark valleys of recession. US economy experienced such a massive decline in its real GDP after post Word War II era, but at this time tight monetary policy was the main reason behind the recession. The tumbling situation of the housing market of US stated off showing its deeper effects in the last quarter of 2005 where the growth rate in terms of housing investment remained at breakeven level and did not find any increase. That was the first sign of the recession of the US economy (2008 Financial Crisis & Global Recession, n.d.). First quarter of 2006 reflected a decline of around -3.6% in the residential housing which was the first real shock to the economists. But with a massive and sharp decline of -16.6% in the growth rate of US economy buzzed the voice of a major financial crisis which eroded almost everything in later 2008. The same declining phase kept going along till the first quarter of 2009 when they reported a negative growth of around -32%. So overall it is basically the extreme underperformance of the US housing market that lead to a major debacle which turned into a global financial crisis and took every country into its effects (2008 Financial Crisis & Global Recession, n.d.). 2. Labor Market The effect of recession that started off in 2006 due to steep declines in growth faced by the housing market, hit labor market in late 2007. Since the inception of the housing market down fall in late 2006, the unemployment rate remained constant at 4.4%. That unemployment rate of 4.4% lasted till December 2007 and after that it just began to climb up so rapidly that in mid 2009 it reached to more than double of what used to be in December 2007 such that it amounted to around 9.4% in the mid 2009 which has been the highest unemployment rate since 1983. 3. Business Investments The recession also created mess on different other investment areas such that the all other kinds of investments followed the same track the one followed by residential investment sector. Business investment especially investments in respect of equipments and software started their declining pattern in the beginning of 2008 and the whole journey of decline kept moving along till the start of 2009 with a humongous decline of 33.5% in just one year time period. Not only this, investments in non-residential areas also displayed some real downfalls such that in a very short span of time from last quarter of 2008 till the first quarter of 2009. The total investment in this particular sector fell by some roughly 50% which was a huge cut in the overall investment sectors (2008 Financial Crisis & Global Recession, n.d.). 4. Consumer Spending As far as the level of consumer spending is concerned in making the recession more horrible, it is important to note that consumer spending accumulates around 70% of the total spending. The role of consumer spending has key importance as it sets out the duration of the recessionary period. If the personal consumption expenditure of public is taken into consideration, then it can be observed that there was a decline in the consumer spending of about -3.8% during the 3rd quarter of 2008. That decline went steeper in the last quarter of 2008 such it reached to around -4.3% which was a real setback to the economy (2008 Financial Crisis & Global Recession, n.d.). The main ingredient of consumer spending that actually added the fuel to fire was the sharpest declining growth rate of spending on durable goods. The consumer spending for durable goods made a sharp slide in the year 2008 such that a decrease of around 22% was reported for the whole year. The mainstream reason behind the shrinkage in the spending for the durable goods is the declining investment in the housing market. The time when people cannot afford to buy or build a new house, they in fact cut off their expenditures in terms of furnishing homes, buying homes appliances and other related expenditure on durable goods. Spending on non-durable goods also faced a declining stage such that it decreased by around -7.1% during the third quarter of 2008 and it followed the similar pattern for very next quarter as well showing a decrease of around -9.4%. Fundamentally, income is the driving force behind the consumption of non-durable goods. The third quarter of 2008 was turned out to be the most devastating period of recession such that the real GDP began to fall sharply which led to a massive decline in the disposable income of a common person. This reduction in the income of the people also caused the less expenditure even in the consumption of non-durable items. If services are considered which is also a part of consumption, the situation was not that bad because during the third quarter of 2008, services experienced a fairly marginal decline of about -0.1% which is very low. Thus, it added to the confidence level of the public and the growth rate for services increased sharply during the last quarter of 2008 by some 1.5% (2008 Financial Crisis & Global Recession, n.d.). 5. Impact on Exports The housing turbulence also affected the last hope of avoiding the recession which was net exports. Since the time when initial decline was experienced in the housing market that is late 2006 till 2nd quarter of 2008, the net exports of US remained successful at the growth rate of 10% per annum. This excessive growth rate was undoubtedly a last hope to the economists as it could have avoided the recession. But unfortunately, with the drastic spreading of the recession all over the world in some real quick times, the net exports started tumbling in the 3rd quarter of 2008 and sharply declined in the last quarter of 2008 by around 23.6%. The next quarter also proved to be the worst in respect of net export growth as it experienced a reduction of some 28.7%. The core reason behind such decrease in the export growth was the less demand presented by the other countries for the US goods (2008 Financial Crisis & Global Recession, n.d.). 6. Import Effects On the other hand, if the effect of recession is considered over the US imports, some serious downfalls can be observed as well. During the last quarter of 2007, the US imports turned into negative figures and the pattern continued and burst after exactly one year such that a double digit decline of around 17.5% was observed in US imports. The journey of downfall did not end till the 1st quarter of 2009 such that a massive decline of some 40% was observed in early 2009 which devastated the economy badly. Apparently it seems as if decline in the imports have adjusted the impact of reduction in the exports. However, the main damage was done by the export declines which simply abandoned the economic growth of US economy. Summarized Impacts It can be summarized that the financial crisis that started with the collapse of US housing market significantly covered almost every area of the US economy sooner or later. Beginning with the housing disaster in 2006, the impacts of the housing disaster reached to other areas of economic growth in which business investments, consumer spending on durable and non-durable goods, services and the net exports of US. Business investments and consumptions patterns absorbed the recessionary impact rather quickly. However, services sector remained a bit stable with very slight decline in a quarter or so. Net export was the only hope left that could have prevented the whole economy from a collapse, but it also got failed in the 3rd quarter of 2008 encircling the effect of recession all over United States. Actions Taken by US Government and Administration Booms and recessions are considered as trough and crust of the business cycle and it is considered a very natural activity that the economy floats on the wave of the business cycles. When the booms occur, nobody actually tries to stabilize the booming periods rather it is intended to get those period higher and higher without taking into account the bubble effect that is created due to such high climbing without any rationality (Katkov, 2011). On the other hand, when economies are into their recessionary periods, everybody just freaks up and even do stupidities which simply devastate the economic position more viciously and put the recession into depression. This particular area highlights the actions taken by the US Administration to come out of the deepest black holes of this economic crisis in which few attempts were made in rush which in fact messed the economy even harder and few of them really supported the economy for its rehabilitation (Katkov, 2011). 1. The Emergency Economic Stabilization Act of 2008 As far as the administrative side of US is considered, in October 2008, the Congress passed a bill namely as The Emergency Economic Stabilization Act of 2008 in which a new package was issued by the Congress to assist the economy named as “Troubles Asset Relief Program” (TARP). TARP was mainly intended to provide more liquidity by allowing the treasure to purchase the distressed assets such as mortgage backed securities and other related assets and for this purpose around $700 billion was ensured to be supplied by the Congress. This package was provided in rush and it did not cover other financial institutions and bank which were also facing some real difficulties. As a result of it, in the last quarter of 2008 and in the first quarter of 2009, the growth rate of national economy further went down such that the negative growths of -5.4% and -6.4% were observed in both the quarters respectively just after the promulgation of The Emergency Economic Stabilization Act of 2008 (Katkov, 2011). 2. The American Recovery and Reinvestment Act of 2009 The Congress realized that the first financial aid was not enough to get the economy out of such troublesome situations, it passed yet another bill named as The American Recovery and Reinvestment Act of 2009 in which a further $787 billion was granted by the Congress to facilitate the economy. However, unlike the previous aid that was purely intended for the troubled assets category only, this aid was provided to support on general basis to the most of the areas of the economy. The major sectors that were intended for this financial aid were unemployment, infrastructure and alternative energy resources. The overall help was provided to create more job opportunities, increasing business investments and stimulating the stagnant consumer spending (Katkov, 2011). 3. Increase in Money Supply by Fed Not only this fiscal measure taken by the US government to combat with the recession by providing around $1.5 trillion, the monetary policy was also modified to provide more liquidity to the banks and other financial institutions so that the chances of their defaults can be minimized. Federal Reserve took a major step by purchasing the securities amounting to around $2.25 trillion from the banks and increasing the money supply due to the likelihood of defaults made by student loan owners, credit card holders and automotive loans (Katkov, 2011). Signs of Recovery The above three measures provided a lot of stability to the US financial crisis such that the depressing position of the economy went came to its end by the end of the 2nd quarter of 2009. Following are the results that can be observed which shows by and larger the positive progress of the economy after the above financial assistances. Real GDP started to cruise up once again as it has not experienced any downfall since 3rd quarter of 2009. The double digit unemployment rate of 10.0% fell to single digit rate of 9.7% by the end of 2010. Most of the new jobs were created at the government sector however private sector still remained a bit reluctant in opening their doors to the new comers. The unemployment benefits available to 1.5 million American who lost their jobs in this crisis was extended to around 99 weeks which became the most helpful measure to decrease the problems of unemployed people. The other major assistance that was provided by the Federal Government in this regard was to provide more funds to the state and municipal level by allowing them to make expenditure not only for the infrastructure and necessary jobs, but also to pay interests on the municipal bonds issued by those local governments (Katkov, 2011). Intended Actions to be taken for Recovery from Recession Many Americans feel that the economy will never get recovered. The rate of unemployment is increasing and for those, who are employed, amount of salary is falling down. The big reason behind this fact is that the U.S economy relies heavily on consumer spending. It produces around two-third of its total output from consumer spendings. Now when consumers do not have jobs, or if they have, then the salary is decreasing, consumers have taken hands off from spending (Reuters, 2011). Non-spending of consumer due to low level of income or unemployment has raised serious economic issues in economy of America. In this regard, President Obama has initiated to take some actions in order to boost employment which will ultimately kick start the economy. As the major driver which fuels up the economy of America, is consumption pattern of its citizen and when consumption pattern will get better, the entire economy is expected to get in a stable position (Reuters, 2011). Obama’s recent speech in Parliament of America has highlighted his keen interest in combating with unemployment and bringing out the country out of recession. He has huge concern about people losing their jobs and getting unemployed. After the great recession of 2007, every country is striving hard to keep itself in a safer position economically. America too has started trying to be the one. 1. Obama’s Economic Recovery Plan Obama in his speech has restricted in giving outsourcing work. He said that 70 lac Americans have already lost their jobs. By doing so, we can save the other 20 lac American from losing job, who are expected to lose their job in near future. Now, out of every 10 Americans, 1 is unemployed. Apart from this restriction of outsourcing, the bill also focuses on proposing the plan to providing loan of $3000 to small industries. Obama has also planned to create more employment opportunities in the near future. 2. Doubling Forex Exchange Obama has also decided to double the forex exchange. Currently, there are not any definite plans for doing so, yet the plan has been proposed. This needs to be done so that when dollar jumps up, United States will get benefited because of the countries doing dollar transactions with United States. 3. Remaining as Super Power Obama in the same speech has said that America will remain in the position of ‘Super Power no.1’.But for that, it is essential for U.S to keep itself off the aim of attacking other countries. In past, America has spent a hefty amount on fighting against war and terror. In this regard, Mr. Obama has stated that if requires, and then he will withdraw the forces off from Afghanistan. This step, if implemented will prove to be a good one for America. 4. Other Contradictions Despite of the fact that Obama’s decision seems right in managing with unemployment, this decision possesses another outlook as well. America has always been urging other countries for economic liberalization and globalization of trade. Just by the persistence of America, this phenomenon has come into existence. It has impacted many countries. Now, restriction on free trading is also going to be imposed by American Government which will hamper the economic condition of other countries. Conclusion In order to prevent more adverse effects of economic crisis, the government needs to implement a prudent and sound macroeconomic policy. This package of prudent fiscal policy will stimulate the spending pattern of small economic agent as well as household. The increased level of spending will trigger the slowing and stagnant economic activities. These stimulations in economic activities will increase demand pattern in economy of U.S. The increased level of demand will induce the producers to start production and thus liquidity will start circulating in the market. Financial institutions and commercial banks will also revive their activities. This process is based upon multiplier effect and therefore the income of both the economic agent and household will boost. Unlike the strategies of bail out which will deepen the effects of economic crisis (World Bank, 2009). Works Cited 2008 Financial Crisis & Global Recession, n.d.. The U.S Financial Crisis. [Online] Available at: http://2008financialcrisis.umwblogs.org/the-recession/ [Accessed 25 April 2012]. Katkov, A., 2011. THE GREAT RECESSION OF 2008-2009 AND GOVERNMENT’S ROLE.. Proceedings of ASBBS, 18(1), pp. 898-906. Reuters, 2011. For Americans, recovery feels like recession: study. [Online] Available at: http://www.reuters.com/article/2011/10/10/us-usa-economy-incomes-idUSTRE79951Q20111010 [Accessed 25 April 2012]. World Bank, 2009. Global economic prospects, commodities at the cross road., Washington D.C: Princeton University Press. Read More