The Economic Consequences of Mr. Bush - Assignment Example

The neo-liberalised economy accelerated the growth of the global housing markets especially, that of the American real e market. However the trend of enormous growth in the industry had a critical backfire in the recent months which resulted in a serious mortgage crisis. The International Monetary Fund has described America’s mortgage crisis as the largest financial shock since the Great Depression.The United States of America now has four separate bailouts underway, $800 billion for banks, $200 billion for Fannie Mae and Freddie Mac, $85 billion for the insurer AIG, and $25 billion for the U.S. auto industry. These figures add to more than $2.1 trillion (Roberts, 2008) The history and the cause This crisis was not a day’s product. The bilateral ties and increased international links amongst the nations developed after the Second World War encouraged more global trade. This caused a spurt in finance resulting in an abrupt increase in the number of financial institutions within America .It increased the amount of money in business resulting in an increase in the spending capacity of the public. But in reality this capacity was an induced one, with the ease in availability of loans. Lending became the backbone of American economics. Further, the trial for market advancement, led the financial institutions to the idea of multilevel lending process which later evolved as derivative markets. The market started to depend much on Real estate industry, Share market and other future marketing ventures. However American Public sector had a strong influence on the real estate market till the 1970s as Fannie Mae, a public sector owned company led the show till then. Fannie Mae was established to stimulate the real estate market as a trial in accordance with New deal of 1929 to boom the economy out of the 1929 crisis. They collected capital by the issue of debt papers, which was easily done with its reputation as a public sector company. Using this capital they purchased loans from primary loan lenders at a commercially feasible rate which in turn ensured the capital for further business to the primary loan lenders. The American government’s strategy to pump in more money into the market was put into practice, as through rule amendments Fannie Mae was allowed to work more as a private entity and another institution called Freddie Mac was introduced into the market. These companies introduced Mortgage Backed Security in 1981and 1971 respectively which is a securitised interest in a pool of mortgages (Riskglossary, 2008). Till 1995, these institutions held a responsible position as they lent only prime loans which involved lesser risks. However, thereon the financial institutions introduced high risk sub prime loans addressing a major American community who had no proven income sources. The risk was covered by an increase in the interest rates as compared to that of prime loans and the maintained value of the mortgaged assets. This trend was dangerously taken up by the primary financial institutions as well. This flow of money was defined to be economic growth of America. H. Minski had argued that the growth envisaged in the economy due the prevailing favorable conditions was only a temporary scenario (Pattanayak,2008).The policies of the U.S government also encouraged this business scenario as Alan Greenspan, former Federal Reserve chairman was reported to state during his official tenure that if businesses were to spend and hire more vigorously, they would need to be convinced that economic growth could be sustained beyond the short run (Greenspan,2003). Private institutions though tried to market Mortgage Backed Security; they failed miserably as it involved a package of risked loans and lacked the government support. It was in this situation that Collateral Debt Obligations were introduced by the private players. To assure the risk coverage of CDOs Credit Default Swap (CDS) was introduced by the insurance companies which were integrated with the CDO concept. It was assumed till this crisis that the American finance sector was safe under this CDS coverage. As a result of inflation there was a steady hike in the loan interest rates during 2006-07 financial year. This scenario adversely affected the repayment of the sub prime loans subsequently increasing the number of defaulters. The real crisis began when the mortgaged real estate asset’s value had a down lash as a result of increasing inflation and the confiscation efforts proved to be a failure as the asset value had fallen well below the principal amount. It was this crisis which led to the pauperism of Lehmann bros. The increase in the failed CDOs led to the downfall of AIG as they had to compensate huge amounts through CDSs. This crisis spread rapidly and devastated the dependents of Wall Street like another Katrina, the cyclone. The Signals of the crisis The economic indicators are often used by the analysts to assess the chances of recession and other trends in the national economy. One of these indicators, the Gross Domestic Product had however indicated growth in the US economy in the beginning of this year .The analysis by The National Bureau Economic Research on the economic trends had a different point of view. The National Bureau Economic Research uses monthly indicators from the national accounts against the variables of employment, industrial production, real sales and real income to determine the actual dates of economic cycles and this system thus becomes more inclusive of minute details than in the case of the GDP methodology which only considers GDP trends whose frequency is quarterly. This allows the freedom to declare recession without concurrent occurrence of GDP contraction, as happened in 1960 and 2001. (Generex F & Vachnon H,2008) As per this methodology recession in the American economy had been indicated to be begun in early 2008. This should be read together with the fact that GDP growth remained positive in the first months of the year 2008. The economists used the detailed analysis of the performance of four variables to correlate the possibility of the recession. However the amplitude of this recession has been estimated as much feeble as compared to the recessions which happened in the past. (Generex F & Vachnon H,2008) This economic prediction proved to be true as the real estate industry had an abrupt backlash late in this year. The indications further included the increase in the non performing loans. The problem was further aggregated as the real estate capital value decreased to unaffordable levels. The money flow almost turned standstill which aggregated the issue. The symptoms were much stronger as the National stock indexes recorded historic downfalls. The Problem The International Monitory Fund has warned that there is now a one-in-four chance of a full-blown global recession over the next 12 months (Steward,2008).The government’s intervention to substantiate and regulate this situation is inevitable. Joseph E. Stiglitz criticized that the repercussions of damage done to the American economy by the present government will be felt beyond the ages (Stiglitz, 2007). The government may try to stabilize the market by pumping in money and giving security to the institutions in crisis. But a more sustainable approach should be taken because a trial to masquerade the crisis by forced money flow may prolong the essential tragedy, but won’t solve the problem for ever. This statement could be read together by the fact that similar efforts by the government during the Dotcom bubble burst in 2000, 9/11 attack and the Iraq war couldn’t stop this crisis from happening. The finance flow is also not of good prospect as the mortgage defaults are on a rise and the spending tendency also have reduced to a considerable extend. To add to the economic crisis, the buying power of dollar has gone down tremendously eventually increasing the cost of living. Nobel laureate, Joseph E. Stiglitz, evaluates the economic effects of Bush’s presidency as ones which are harder to reverse, likely to be long lasting and more insidious than those of Herbert Hoover, whose policies aggravated the Great Depression. Generex F and Vachnon H (2008) have calculated a job loss counting up to 1,500,00 over the 260,000 layoffs which were already made, in case of a normal recession. The average job loss in case of the recessions in 1970 and 2001 was 1.9 percent which counted up to 1,755,000 jobs. However the job losses during the 2001 recession which was on a major count was not merely due to the national economic reasons but mainly fuelled due to the reasons that businesses adjusted to new technology, growth of productivity, global structure changes in the manufacturing sector and a wave of delocalization for an ever increasing slab of production towards emerging countries including China and India. (Generex & Vachnon,2008). The average drop on the industrial production during the previous recession periods was 7.7 percent. As on the date of the article by Generex F & Vachnon H (2008), the industrial production saw a drop of 0.4 percent which was expected to get larger. However the drop in the real sales had only been half of the average drop recorded in the last two recessions which accounted to 6.9 percent. The Measure of the impact on the real estate industry The economic indicators after a few months would start to give the exact damage that has been caused by the current crisis in the global economy, especially in the economy of the United States. The job losses, the stock index fall and the crisis in the fund supply chain has created measurable impacts in the economy. The sales of real estate property have been affected to a larger count. It would be interesting to analyse the sales figures of the housing properties in order to understand the measure of the impact caused by the current crisis. The industry had seen an enormous growth in the number of houses constructed in the last decade. The following figures would provide an analytic view of this trend. YEAR AVERAGE NUMBER OF HOUSES SOLD (Average) 2005 1,283,000 1990–1995( per year) 609,000 The unsustainable growth that happened in the last decade is quite evident from these figures. The Economagic (2008) has compared the sales of houses in The U.S from the year 1963 and their data is updated to the latest date. The abstracts from their data reveal the following figures. YEAR AVERAGE NUMBER OF HOUSES SOLD (Average) AVERAGE PRICE (Average of quarterly average price/house) 2005 1,283,000 236550 2006 1050000 243750 2007 776000 244950 2008 436000 (Till October) 231600 (Three Quarters) The downward trend the sale since last four years is confirmed by the above table and the graph shown below. However the average prices of the houses also showed similar trends in the current year. In general it is considered that the national production is highly affected by the demand for the products and services. So would be the dependence of the growth of the real estate industry on the market demand. The sources of demand can be the direct consumers, the government in terms of its spending capacity and also international trade and economic relations. However demand can cause a market performance impact with reference to the quantum of disposable income of the people. This is the actual disposable money which the customers can afford to spend and invest in the market after paying taxes. (Barnes, R 2008). This indicator very much depends on the salary or the income the citizens of the nation receive. However disposable income is directly related with other economic indicators and so is other indicators interlinked with each other. As the credit flow almost stopped as a result of the crisis the quantum of the disposable income available with the people reduced to a considerable extend. It is quite obvious that thus the spending capacity of the people would reduce causing a huge gap in the demand. Supply would directly depend on the market demand. In the case of real estate, supply would refer to the availability of more housing properties for sale in the market. With reference to the lower demand caused by the crisis, the supply in the real estate market which literally means its growth would be hindered to a considerable extend. Financial Regulations & other Remedial Measures An empowerment of the public sector entities should happen by the deliberate efforts of the U.S government. The government may take lessons from the sustainability of the national economies which were not affected by the crisis, still have Public financial Institutions on the rule. The neo-liberalistic approaches will have to be rethought. Resources like treasury regulations and policies are for obvious going to affect the American economic scenario. The crisis will lead to regulations in the leasing industry. This will substantially decrease the money flow in the economy. As a result industries and service sector would tend to implement stronger cost control methodologies even resulting in low production and unemployment. References Barnes, R 2008, ‘Economic Indicators: Overview’, Investopedia, viewed 08 December, 2008, < http://www.investopedia.com/university/releases/> Economagic, 2008, “Browse Housing Sales Data of the US Census Bureau”, The Economic Time Series Page, viewed 08 December, 2008, http://www.economagic.com/cenc25.htm#Price> Generex, F & Vachnon H, 2008 “Where Are We With The Us Recession”, Economic View Point 4:457-464 Greenspan A, 2003, “Remarks by Chairman Alan Greenspan”, Federal Reserve Board, viewed 08 December, 2008, “Mortgage based security”,2008, Risk glossary, Contingency analysis, viewed 08 December,2008, Pattanayak P, 2008, ‘The Crisis’, in Malayalam, Nair, J S , Thiruvanthapuram. Roberts P, 2008,“Does the bailout pass the smell test”, Economy in crisis, ,America’s economic report, viewed 08 December, < http://www.economyincrisis.org/> Sreward H, 2008,“IMF says US crisis is largest financial shock since Great Depression”, The Guardian, viewed 08 December, Stiglitz ,J “The Economic Consequences of Mr. Bush”, 2007, Vanity fair, viewed 08 December, Read More