Massive Financial Disaster essay
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The United States of America is considered to have the strongest economy in the whole world as compared to other developed countries like Europe, Spain, Germany and Japan. The great recession in the United States of America in 2007 to the year 2009 caused heavy changes in the unemployment rates, the inflation rates, low output, poverty and drastic changes in the GDP of the country since it caused the economic system of the country to be at a very great pressure. Before the great recession, the US was fairing very well with a GDP growth rate of about 25-30 percent per annum. However, during the time of the recession, the growth rate was seen to plummet until the government had to intervene by the use of monetary and fiscal policies through the Federal Reserve.
The main purpose of this paper is to analyze the current economic condition of the United States of America. This is because the consumer spending, rates of unemployment and the stagnation in the real estate market are the causes of the troubles which faced the US economic situation which was a vicious cycle. The economy started recovering in 2010 fiscal year. During the U.S. economic recession, the production function was affected. The production function is the relationship which exists between the outputs and inputs of the country where the productivity deviation is the disturbances which are either positive or negative in the relationship and could also include factors like capital inputs, measured inputs and labor. This economic recession in the US brought about more negative effects in the US economy between the years of 2007-2009.
The great recession originated from the bursting housing boom in the country which caused a great impact in many countries across the world. The housing bubble started to burst in 2006 when the interest rates increases at a very fast rate which further led to the reduction in the house prices and the blacks, the Latino, and the working class people especially the white families in the United States begun taking on large and huge mortgages. The financial system then got to be fragile since many factors like the credit card defaults or the commercial loans themselves triggered the financial crisis. Many people were reported to have defaulted their loans which led to the decline in the total value of the assets which was the houses, and most of the institutions which held those security assets were in a threat of collapsing and bankruptcy. There was also the deregulation of the banks which was supposed to advice the banks on the lending practices.
This made it a global crisis because of the negative effects that it attributed to the world since it just begun as a sub-prime segment in the US housing market and was reported to be a mutated recession which was full blown in 2008 and it greatly affected all the countries of the world. The developing countries were the hardest hit by this global recession with the developed countries in the European Union and other countries like Japan going into a recession by the year 2008 which showed that the whole world was in a recession since the World War II around the years of 2002-2007 which were the years when the boom happened in the United States of America.
Due to the recession, it caused the government of the United States to operate in a deficit which showed that the US government debt was drastically increasing to a point that the ceiling of the debt was reached in the year 2011. This debt ceiling brought about heated debates in the government on how the government was going to tackle this government deficit so as to be able to reduce the government debt. By the year 2001, the government debt in the US was about $6 trillion, $14 trillion in the year 2011.
Government spending helps in the generation of private sector income and public spending would further affect the economy’s aggregate income and the distribution of the income would be determined by the direction of the spending. The increase in the spending by the federal slowed down all the pressures which were due to the pressures which limited the deficit size. In the 2007 fiscal year, the Federal spending was estimated to be at 0.7%, government spending was at 2.2%, and the State spending was also expected to grow by 3% in the fiscal year of 2007.
In 2008, the U.S. economic growth rate was at 0% and in 2009 it declined by a 2.6% which showed a down ward movement in the economic growth of the country. The economy started recovering in 2010 and it did so by recovering at a 2.5% per annum. The decline in the GDP led to the drop in the tax revenues which resulted in a deficit in the 2007 fiscal year which was estimated to be about $370 billion. It increased to $460 in the 2008 fiscal year as shown in Graph 7. The U.S. financial crisis hit the labor market and created very large disparities which were regional and they affected many different segments of the US economy. Throughout the whole of the recession period, not only got the richer to be richer, but also the poorer got to be poorer. The population was increasing at a very fast rate and the number of people who were willing to work at the prevailing wages was more than the jobs that were in the market which made many people who are able to work jobless. This increased the rates of unemployment in the country since the population ratio was very high as shown in Graph 1.
The unemployment rates in the number of workers in the United States as shown in Graphs 5 and 6 increased at a very high rate due to the recession since the household incomes were below standards and it varied from one household to the other where the high income workers were better off than the low-income workers who in this case were the hardest hit by the crisis since they suffered an unemployment rate of about 30%, while the other group of low income earners only suffered about 20% of this rate. This showed that the low income earners were disadvantaged by this economic recession which hit the country.
In the fourth quarter of 2009, the unemployment rates fell because the levels of household incomes improved quite a bit where the workers faced 4% and 3% rates of unemployment which was also termed to be a full employment equivalent. The main reason why there was a very high unemployment rate in the US is that it experienced a labor market turnover which was sluggish and there was also a problem of the adequate supply of jobs which symbolized an increase in the unemployable labor. The amount of frictional jobs increased during the global recession in the US since it took the residents a lot of time to be able to find and secure a full time job and employment (Graph 2).
Inflation in a country can cause both positive and negative impacts in the economy. The great recession in the US caused inflation which is the continued increase in the general prices of the most essential commodities where the residents of the United States had to pay more for the essential commodities that they consumed and the unit of currency that they possessed could buy only a few services and goods as compared to the time before the recession. The purchasing power of the consumers was greatly eroded and this price inflation is measured by the use of the inflation rate which is normally annualized by the percentage of the CPI (consumer Price Index) over time.
The increase in the unemployment rate (Graph 4), led to a downward pressure on the real wages growth which further helped in the increase of the inflation rates. In the global recession in the United States in 2007 led to the increase in the supply of housing which pressured the rents downwards and the components which were accounted for by the rentals which showed that it was between 30%-35% of the CPI (Consumer Price Index) and a 40%-45% core index which showed that due to the slow rate of the rental, inflation would impact the overall price index.
Inflation led to the fluctuations of the exchange rates which made the country perform very poorly in the international market. This is because the domestic currency was losing value at a very fast rate, which showed that the country was importing more that it was exporting. The prices of commodities like crude oil was also affected where an increase in demand for crude oil will raise the price and lead to an increase in the quantity supplied. According to Graph 11, an increase in supply will lower the price of crude oil and increase the quantity demanded. An increase in supply is shown by the rightward shift of the original aggregate supply 1 curve to aggregate supply 2 curve and the immediate effect of this increase in surplus is at the ruling price p 2. This surplus will force the price downwards leading to an increase in quantity demanded. An increase in the price shows that there will be a fall in supply which would also lead to a decrease in the quantity demanded.
The variables that would affect the position of the supply curve to shift to the right are: a decrease in the price of other commodities making it possible to produce a commodity with unchanged price, a decrease in one or more factors of production used in the production of the commodity, an improvement in technology and an increase in a government subsidy for a commodity. According to the law of supply, the higher the price is, the larger the quantity supplied. The variables that would affect the position of the supply curve to shift to the left are: an increase in the price of other commodities making it less profitable to produce, an increase in the production costs, an increase in indirect taxes which represent an increase in the costs of supplying a commodity.
Equilibrium in demand and supply occurs when the quantity demanded equals quantity supplied. A stable equilibrium is said to exist when economic forces tend to push the market towards the equilibrium. The market or aggregate supply of a commodity is the alternative amounts of the commodity supplied per period of time at various prices by all the producers of the commodity in the market. It depends on all the factors that determine the individual producers supply and additionally on the number of producers in the market.
Economists of today still think that there is a direct relationship between the price level change and the money supply like the issue of inflation which explains the relationship. Other economists still think that a supply of money which is in excess in the economy could lead to a large increase in the prices of the commodities which explains the fact that the central banks in an economy have to put in monetary policies so as to be able to control the amount of the currency that is in circulation so as to avoid the large increase in the prices of the essential commodities which would also protect the local currency from losing value in the international market.
The government of the United States was quick enough to respond to the financial crisis that it was suffering from between the period of 2007-2009 by the use of fiscal and monetary policies. These policies were used so as to be able to stimulate the macroeconomic effects of the government of the US this included the effects that it had on the real GDP, unemployment and job availability for the inhabitants of the US and inflation. If the government had not intervened in advance, the great recession would not have come to an abrupt end and the unemployment rates, the inflation rates would have got up at a very fast rate which could have greatly affected the low income workers of the country. This is because they would have ended up paying a lot of money for the most essential goods and services which they could still not afford at that time.
During the recession, the Fed was forced to intervene so as to be able to control the inflation rate which was increasing at a very fast rate so as to be able to sustain it through the use of monetary policies like the OMO (Open Market Operations), MRRR (Minimum required Reserve Ratio) and the Discount rate so as to be able to control the amount of money in supply. An increase in the money supply shows that there would be a lot of money in circulation which shows that the Fed has to mop up the excess liquidity so as to protect the domestic currency from depreciation and loosing value in the international market. It can do so by either purchasing or selling of bonds so as to be able to control the money supply. If the money supply is too much in the economy, it could also lead to inflation which affects the general performance of the country in the international market due to the fluctuations in the exchange rates.
With a reduction in the demand for money by the Fed intervention, the IS curve would shift downwards. This puts down the downward pressure on the interest rates of the country which is normally set by the world international markets. This downward pressure would further bring about an outward capital outflow causing the domestic currency of the US to fall as shown in the Graph 3 and 8. The United States operated in a trade deficit during the whole period of the recession since it was importing more that it was exporting.
The AIG’S liquidity crisis was reported to have emerged at exactly almost the same time that the Lehman Brothers securities collapsed which was exactly a week after Freddie Mac was placed in conservatorship. This was a backdrop which was a recognition of threat to the financial stability which was forced by the failure which was disorderly and more complex as compared to the one of the previous year where the Board of Directors with the treasury Department’s full support decided to intervene so as to try and prevent the AIG bankruptcy on 16th of September, 2008.
AIG is one of the largest financial and insurance services company throughout the world and by the time it informed the Federal Reserve and the Treasury that it was experiencing liquidity problems which were very severe, it was a one trillion company at that time. AIG has penetrated its market in over 140 countries throughout the world with more than 80 million corporate and individual customers globally. In the United States alone, AIG has more than 40 million customers including individual, commercial, and institutional customers.
AIG was the largest health insurer and life insurer and was second largest casualty and property insurer in the U.S. it has more than 85 million life insurance policies and is the largest issuer of all the fixed annuities in the U.S. it is one of the largest retirement services provider to most of the schools, non-profit healthcare groups, and universities with more that 7 million people holding retirement accounts with AIG. In the derivatives markets, AIG had been a major participant through its business unit Financial products (AIG FP) and an unregulated subsidiary. The AIG FP had engaged in most of the financial transactions with a large number of customers which was made up of both international and international customers and it also included the U.S. pension plans, the municipalities and the stable value funds.
The reason as to why the U.S. government decided to bail out AIG and not the Lehman Brothers was that the bankruptcy of AIG under any economic condition in 2008 would have led to very severe consequences to the U.S. financial system and economy. That was the main reason as to why the government of the U.S. decided to bail out the AIG company and let the Lehman Brother to declare bankruptcy instead. If the AIG company had failed at that time, it would have meant that there would have been many losses which could have been suffered by the investment banks and many global commercial banks which could have led to the financial system collapse. The U.S. policyholders would still suffer a great deal since they would have been left facing a great deal of uncertainties about their claims and rights.
Despite the fact that the Federal Reserve loaned out money to AIG, it still continued to face liquidity problems where most of these liquidity pressures came out of the total AIG’s losses which were incurred from the RMBS (residential backed securities) in which it had invested before the crisis as being a part of lending program securities. In the late 2008, the New York Fed was authorized by the board of governors to also fund the Maiden Lane II which after the funding was able to purchase the RMBS at the current market value which enabled the AIG to unwind all its lending transactions securities where it was able to repay its loan of about 37.8 billion.
The central banks like the Federal Reserve control the amount of money that is in circulation through the use of monetary policies. This amount of money that is in circulation is often termed as the liquidity of the currency in the economy which is usually the mutual funds in the money market, cash and credit. The most commonly used part of the liquidity that is controlled by the central bank is the credit which includes bonds, agreements to repay, mortgages and loans. If the amount of money that is in circulation is not controlled, it could lead to serious high levels of the economy since the local currency would depreciate in the international market which could make the country import more products that the economy is exporting.
In conclusion, the 2007-2008 global financial crisis had many causes which were directly connected to the US capitalist economy which was the initial point where the crisis begun. The presence of a low profit rate and economic inequalities which were very large led to the capital flow increase in the financial sector which further increased the U.S. workers credit that were experiencing declining real incomes since the early 1970s. it was the new financial innovations which led to the floating exchange rates and the financial deregulation in the United States of America which enabled the debt to be transferred to all the new financial products by passing the risk to a chain of buyers. There was the availability of money and the lending was relatively cheap which increases the investment levels and the risk was further spread to the global financial markets through securitization. The bursting housing bubble caused many financial institutions to collapse and the government and the Fed Reserve were forced to bail out some of them like the AIG Company.
According the US President, if the government and policy makers didn’t intervene and do something very quickly so as to be able to eliminate the inflationary gap, it shows that the price expectations would then adjust which explained the shift in the SRAS curve from SRAS1 to SRAS2 which would further lead to a price increase and a wage increase (Graph 9). During the economic recession in the U.S., it was a fact that if the banks or government hadn't made the moves that they did, then the United States would have been in the biggest Economic Crisis since the Great Depression in the early 1900's. The fact that the end result of the entire crises ended in just a single digit number of banks and the U.S. dollar not falling too low for global financial trading, is proof that the decision making during this time was the right and only move to make for potential success for economic rehabilitation for the United States.