The Macro and Fiscal Policies in Macroeconomics - Research Paper Example

Macroeconomics Abstract This research paper explores the macro and fiscal policies that can be introduced along with government regulation policies to the current American mortgage market in order to prevent another market crash. I use three important areas, the Financial Market, the Policy sector, and bank regulations sector in pursuit of policy changes or resolutions that could help avoid future market failure or limit the exposure at most. This paper considers Canadian economic market, which is heavily regulated to find solutions to the housing market in the United States. In addition, the paper relies on publications of Turkish/American Economist Nouriel Roubini one of the few people to have predicted the 2008 financial crisis. The research concentrates on macro-economic variables such as government laws, taxes, macro policies, fiscal policies, mortgage rates, average income of the average American, inflation, and interest rates. Each variable has some form of correlation in understanding why Americans keep mortgage rates based on inflation and interest rates, as well as factoring the average income of the American. This paper suggests that consumer credit should determine Government regulation on bank mortgages and issuing securities. If one cannot pay of their mortgage within the given period they should not be given, the loan as it would jeopardizes the bank’s future and potential assets. Alternatively, banks could change the amortization period to ensure consumers meet their payments. The research paper finds that fiscal and macro policies were effective and helped stimulate the economy by increasing government spending. I recommend further research on the effective policies that could help expedite the recovery period without having to lower the interest rates close to a liquidity trap. Motivation After researching numerous topics within the field of economics, I was intrigued by the 2008 financial Market. In pursuit of education career in improving and understanding policy making strategies within the Macro and Fiscal sector, I decided to do extensive research on this topic to gain knowledge on various perspectives and biases on the reasons for the crash, and measures taken to resolve them. “To Big to fail”, by Andrew Ross Sorkin and the famous blockbuster, “Margin Call” helped paint a picture to what actually happened with Lehman Brothers. The selling of bad debt to the world in the form of layered Mortgage Back Securities to clear their books caused the entire market to crash along with other problems. I feel that the magnitude of this crash could have been limited, if not avoided, had the government regulated banks; banks kept proper regulation on mortgages, and assessed the housing bubble thoroughly. Introduction Over the past years, the United States government has learned from its mistakes and loopholes within the mortgage market. Macro-economic interventions such as regulation of government taxes imposed on citizens, use of quantitative easing, a macro policy of buying and selling bonds in open market to inject money in the economy has helped jump start the economy. The cost of the economies revival was at the expense of banks giving out mortgage loans to individuals with poor credit. With the help of deregulation and historical trends of the housing prices, financial analysts felt no harm in giving loans to individuals as long as house prices were rising, the default risk would be zero. Soon the mortgages went underwater, since the price of an individual’s house was lower than the mortgage payment and forced homeowners to default on the loans. Empirical Framework This research paper focuses on the 2008 Financial Market Crash with an aim of understanding in details the policy-making strategies within Macro and Fiscal sector. Furthermore, the paper explores in details the causes of the crash and the measures employed since then to solve the crash. The paper analyses data with aim of elucidating both fiscal and macro policies. These policies can be applied along with Government regulation policies to a mortgage crisis in order to prevent similar market crash. This paper considers the selling of bad debts to the world in the form of layered Mortgage Back Securities to explain books as the Main cause of the crash of the market among others. Additionally, the paper explores the role of the Government in regulating banks and the role of the banks in regulation of mortgages. I put focus on three areas namely: financial market, macro-policy sector, and bank regulations in order to gain insights into the market crash and formulate corresponding policy changes. The paper also highlights the resolutions to avoid future market failures or limit the occurrence of the failure. According to Farmer (2012), house bubble is a financial problem that occurred in the U.S due to fall in the price of houses and borrowers refraining from paying the mortgages due to the decreased values of the properties. The housing bubble started in the year 1991. At that period, the house index stood at 17% but by the year 2008, it had declined to 6%. This contributed adverse effects on the U.S financial stock market. The net price of property shares by the investors declined from one dollar to 0.97 cents. From 1991 to 2005, the demand for the houses had doubled from 264 billion dollars to 586 billion dollars. Many economists have claimed that the bubble started in the year 2006 the demand grew up to five point one percent that is approximately 123.8 billion dollars. However, after the end of the bubble period in three years the demand had fallen back to 351.3 billion which was last witnessed in the year 1995 (Farmer, 2012). Subprime mortgages that started in the year 1999 played a great role in the collapse of the market (Cooper, 2010). They are offers of mortgages to consumers who have little earnings or savings as compared to the amount of their savings. Federal Mortgage Association with an aim of ensuring everybody owned a home carried out the initiative. However, these mortgages were high-risk loans hence there were hefty terms and conditions attached to them. They accrued high interests and variable payments. The American Government In the year 2002 increased the credit they were giving to the Mortgages Company up to three trillion dollars. The company used to buy the mortgages from the lenders with an aim of making profits when the consumers pay. However, there was a rise in default cases, which led to a threat of collapse of the companies. The type of mortgages they offered was referred to as Adjustable-rate mortgages as opposed to the normal Fixed-rate Mortgages. The terms for this type of Mortgage required the borrower to pay a lower amount initially, but the amount payable increased in the subsequent months. Between the 1999 and 2005, the mortgages were risk-free since the borrowers would sell their homes with a profit in case they feared the increasing payments on the mortgages (Bates, 2012). However, many economists viewed this as a disaster waiting to happen in case the property value of the American Market declined. Data Analysis & Discussion House crash of 2008 and mortgage data According to an excerpt by Bates (2012), house crash of 2008 is a period where the stock market value declined to an approximate value of 30% in relation to its total value. It is one of the most difficult times in the American history of the stock market. The 2008-2009 Financial Crisis Data 2007 Q4-2009Q2 Output -4.99% Consumption -3.86 Investment -42.2% Hours -9.52% Wages 6.94% MPL ⇑ Source: Federal Reserve Bank of St. Louis FRED system Housing prices appreciated steadily from late 1990’s to mid-2000. The appreciation in house prices was highest between 2004 and 2006 at more than 10%. During this period, home ownership rose to a record high of 68.6% in 2007. At this point, it was unclear whether the prices would be sustainable. The major cause of the subprime mortgage market collapse was the defaulting by the homeowners. A large number of the homeowners had defaulted due to the increasing payments, but the prices of buying a home were decreasing. The only way that the homeowners could have moved out of the problem was either by paying the increasing payments or by selling their homes. However, their homes were worth less than the mortgages prices. Despite the entire ordeal, financial market remained stable and kept on increasing until October of 2007, notably, Dow Jones Industrial Average (DJIA) attaining a high of 14,164 on October 9, 2007 (Farmer, 2013). Sadly, by December 2008 the turmoil had started taking its roots. The economy of U.S was now in a recession. In July 2008, the DJIA had recorded the worst decline in a record of two years of below 11,000. On Sunday September 7, 2008, the financial market had declined to approximately 20 % since October 2007 when it was at its peak (Farmer, 2013, p. 45). The Government withheld the Fannie Mae and Faddie Mac Company due to the heavy losses they had recorded because of the collapse of the Subprime mortgage market. On September 14, Lehman Brothers Company that had heavily invested in the Subprime Mortgage Market collapsed. Additionally, it recorded the highest ever witness bankruptcy in U.S. The collapse implicated a deduction of the net asset share value from one dollar to ninety-seven dollars. In the end, the Dow valued approximately 10,000 something that has never been seen since 2004 (Hudomiet et al., 2011). Most of the Government policies over the years are the ones to blame for this turmoil. The Clinton and Bush Government had introduced policies on home ownership and credit transfer leading to the housing bubble (Glaeser & Nathanson, 2014). The three policies that the Government reviewed and amended are Community Reinvestment Act, the affordable housing, and the Government-sponsored enterprises. According to an article by Spiegel (2011), he claims that these policies were vague and misguided; tax laws further amplified the problems. Government taxed the property and mortgages and this lead to an increase in the interests that homeowners were to pay. Bank regulatory policies also contributed significantly to the financial crisis of 2008 (Jurgilas & Lansing, 2013). Conclusion From the research, it is evident that the events that caused 2008 financial crisis are because of irrational thinking and abandoning rational thinking (Münnix et al., 2012) Further to that, it is undisputable fact that the measures put in place by the American Government were meant to benefit all the citizens equally including the poor. However, to some point in time the Government lost its focus and this lead to a financial crisis. Considerably, as the prices of homes accelerated, lenders who had been accredited by the Government devised more tricks to keep the prices afloat never minding on the dire consequences of their practices. Putting into consideration the unprecedented growth of the subprime mortgage market and the consequences of the investments the financial turmoil of the year 2008 was not a deliberate occurrence but it was unforeseeable. My findings from this research had shown that the financial crisis was controllable and solvable before the consequences escalated. Had the Government regulated banks, and banks regulated the mortgages the crisis would not have occurred in the first place. Recommendation In order to prevent such a financial turmoil in the future new regulations of the financial system are not much important. However, the Legislature should consider amending the U.S housing policies since it is the cause of the problem (Shiller, 2012). Additionally, there should be regulations and checks on greedy investment bankers, incompetent agents, and homeowners who do not put into consideration future market shifts and mortgage brokers. Additionally, there is need for a new type of mortgage-backed security. At the moment, investors have no liability if any issue arises concerning the underlying loans backing the bonds because mortgages come with full guarantee of respective agencies. An introduction of new securities would change this. This would entail giving bond buyers the risk of partial loss in the event that a loan went bad. These would bring a trade-off between higher interest rates and risk of partial loss. Furthermore, introducing a market-determined price on the risk would be easier for both parties to alter risk-management patterns to reflect realistic estimates of the value of risk investors want to transfer. References Bates, D. S. (2012). US stock market crash risk, 1926–2010. Journal of Financial Economics, 105(2), 229-259. Cooper, G. (2010). The origin of financial crises: central banks, credit bubbles and the efficient market fallacy. Harriman House Limited. Farmer, R. (2013). The Stock Market Crash Really Did Cause the Great Recession (No. w19391). National Bureau of Economic Research. Farmer, R. E. (2012). The stock market crash of 2008 caused the Great Recession: Theory and evidence. Journal of Economic Dynamics and Control, 36(5), 693-707. Glaeser, E. L., & Nathanson, C. G. (2014). Housing bubbles (No. w20426). National Bureau of Economic Research. Hudomiet, P., Kézdi, G., & Willis, R. J. (2011). Stock market crash and expectations of American households. Journal of Applied Econometrics, 26(3), 393-415. Jurgilas, M., & Lansing, K. J. (2013). Housing bubbles and expected returns to homeownership: Lessons and policy implications. Available at SSRN 2209719. Münnix, M. C., Shimada, T., Schäfer, R., Leyvraz, F., Seligman, T. H., Guhr, T., & Stanley, H. E. (2012). Identifying states of a financial market. Scientific reports, 2. Shiller, R. J. (2012). The subprime solution: How today's global financial crisis happened, and what to do about it. Princeton University Press. Spiegel, M. (2011). The academic analysis of the 2008 financial crisis: round 1. Review of financial studies, 24(6), 1773-1781. Read More