Bailouts the Current Recession Was Precipitated in Essay
- Length: 6 pages
- Sources: 7
- Subject: Economics
- Type: Essay
- Paper: #30742349
Excerpt from Essay :
The current recession was precipitated in large part by Wall Street, which fuelled an asset bubble in the housing market and repackaged bad loans as good ones. One of the initial consequences of the bursting of that bubble was that the banking system became unstable. This situation led to the first Wall Street bailout in September, 2008. This bailout was priced at $700 billion and was intended to stabilize the financial system, in effect stabilizing the economy (Stout, 2008). While the bailout has ultimately proven to cost less than $700 billion as the result of strong returns (Onaran & Leondis, 2010; Faler, 2010), the plan did not have the desired impact on the American economy at large. While the banking system was more or less stabilized, the GDP shrank and unemployment soared. These are the primary impacts on Main Street and they were not impacted by the Wall Street bailout. Today, we see the lingering effects of the bailout. On Wall Street, profits have been restored and bankers are once again earning handsome paychecks on the back of rising stock markets, but on Main Street the recession remains (Smith, 2010).
This paper will analyze the impact of both the Wall Street bailout and the ongoing recession on Main Street. The failure of the banking system to apply its bailout funds to support economic recovery on Main Street has resulted in some devastating effects to the American economy, and these will be explored from both an economic and sociological perspective.
The Wall Street Bailout
When the financial crisis broke, the Wall Street bailout was deemed a necessity by the Bush administration. In order to stabilize the financial system, $700 billion of bad debt was purchased by the federal government from the banks. The underlying theory was that by removing bad debt from banks' balance sheets, those banks would be able to continue lending and a credit crunch would be averted. The concept of the credit crunch is critical to understanding failure of the banks to help small town America. When it appeared that the banking system was in crisis, it was reasonable that banks, saddled with bad debts, needed to essentially horde money so that they could pay those debts. This situation would have resulted in a credit crunch, where troubled banks would simply be unwilling to lend their money. This would have had devastating consequences for the American economy, in particular as firms would then be unable to expand their businesses and many would not be able to secure ongoing financing for their operations. The federal government recognized the risk that a credit crunch would cause for the economy and took the drastic step of bailing out the banks in order to prevent it (Stout, 2008).
The problem is that the bailout, along with easy money from the Federal Reserve, did not result in avoiding a credit crunch. There are indications that the money the banks took from the government in exchange for their bad debts was not used to invest in the American economy. There is evidence that Wall Street was speculating in oil futures (Wallace, 2009), and it was also noted that the credit crunch persisted even though the banks no longer held their "toxic assets." Banks, free to lend knowing that their debts were covered by the federal government and having easy access to money, did not lend. The Treasury and Federal Reserve added another $800 billion to the effort, but again this did not spur lending (Goldman, 2008). Thus, economic contraction continued and unemployment continued to rise.
By the first quarter of 2009, the recovery in the banking system had already begun, with prominent investment banks recording record first quarter profits. The profit recovery masked underlying economic weakness, however, as millions of consumers were still defaulting on their mortgages and the commercial real estate market followed the residential housing market into recession (Dash, 2009).
That recession that was not supposed to happen did, despite hundreds of billions of dollars being poured into the banking system. The GDP declined from the third quarter of 2008 to the second quarter of 2009, and growth spurts have been intermittent since (BEA.gov, 2010). Unemployment has continued to increase, with the latest increase taking the figure to 9.8% in November 2010 (BLS.gov, 2010). These results point to a disconnect between the banking system as small town America. The banking system failed to restore credit market conditions following the Wall Street bailouts, and it has prospered since, while the recession in middle class America continues unabated.
This will continue to have profound economic impacts. Many of the unemployed have been so for a long time, and the longer they remain unemployed the less likely they are to find employment later. In effect, they become unemployable. This is especially true older workers, who often have trouble finding jobs. Structural unemployment creates a drag on the economy as these workers are not at full productivity, such that even after the recession is over, the economy remains subject to inefficiency. The long-term unemployed become a drag on their loved ones and on the taxpayers, and there is little that can be done to alleviate the situation.
Long-term structural unemployment is just one risk associated with the failure of the Wall Street bailouts to transfer to Main Street (The Economist, 2010). It contributes to social disorder, as resentment is created in many segments of the country. Anger levels rise and there is a backlash against the political establishment, as well as against Wall Street. In light of the number of Americans still struggling through the recession, and without significant prospects for a better future, this anger can translate into antisocial behavior.
An increase in the unemployable also has other social costs as well. These individuals become a permanent underclass, with their children also having difficulty gaining opportunity because they lack educational opportunities and are often viewed as second-class citizens. As poverty becomes entrenched, it becomes increasingly difficult to alleviate that poverty. This poverty is associated with many negative social outcomes, including declines in life expectancy, increases in crime, increases in disease and obesity and declines in quality of life.
There are also social costs with respect to mistrust. There has long been a cultural gap between Wall Street and Main Street, but that gap is heightened when the government spends money on Wall Street, with the intent of helping Main Street, only to see those efforts fail. The political system fails, as everyday Americans realize that there is little hope of gaining response from policy elite. It is interesting to note that the bailout -- TARP -- will cost much less than the $700 billion that was earmarked for it, but there is no talk in Washington of taking those savings and pumping them into the Main Street economy. The choices of the politicians speak to their priorities. For small town Americans, this highlights the gulf between them and the ruling classes, damaging their faith in the democratic political system.
The troubles are widespread, but there are still some areas that are harder hit than others. Small towns, rural areas and areas in the so-called Rustbelt have suffered the most, and it is in these areas where the social effects of the failure of the Wall Street bailout will be felt for years. The people in these areas contributed little to the cause of the recession, but they are suffering the bulk of the cost. The inequity is unlikely to have a positive resolution. One of the outcomes that has been seen already is that populist anger over the political response to the recession has resulted in political turnover in Congress, especially in the areas that have been hardest hit by the recession.
In addition, the costs have not been distributed equally among race. As with most recessions, the social costs have been distributed unequally among minority classes, which in turn can be expected to spur further disenfranchisement among those groups, as their role in the economy is continually downplayed. It is unlikely that disenfranchised groups will respond well knowing that the bailout response from the government has completely failed them in terms of delivering a better economic outcome. Those communities are also among the least equipped to deal with such problems, so the failure of the Wall Street bailout will only exacerbate existing social problems in minority communities.
The Wall Street bailout was intended to help not just Wall Street but Main Street as well. The monies in the bailout were supposed to pass through the banks to the everyday small town American. That has not happened, as banks invested that money elsewhere, allowing the recession in America to drag on. With high unemployment and low GDP growth, the situation promises to have several negative social consequences.
Long-term unemployment increases and perpetuates poverty and is associated with a large number of adverse social incomes. The wealth divide between Wall Street and small town America grows, and reduces the nation's…