Economics Crisis as an Inevitable Essay

  • Length: 13 pages
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  • Subject: Economics
  • Type: Essay
  • Paper: #43936576

Excerpt from Essay :



The U.S. is a property owning civilization and a number of the people wanted land and housing. Americans however scarcely ever create savings. "The country itself lives on other countries' savings by issuing bonds to finance its excessive consumption. The current crisis began with cheap housing loans offered by banks. Banks provided loans but instead of holding the loan in their books, they packaged them into collateralized debt obligations (CDOs) and sold them to other agencies. These agencies passed them on to others and spread them globally as assets" (the Current Economic Crisis, its causes, its impact and possible alternatives, 2009).

Interest rates were lowered and housing loans went up with construction activities leading to land prices increasing. The real estate was booming, generating employment and incomes. But as the rate of interest on housing loans came down, banks started to compete to get more business. Because of low interest rates, it was probable to borrow more from the same monthly payment to pay the old loan and still have some left as extra for a vacation or to buy something else. Some went for a second house as an investment. The problem started when housing loans came to be at rates below the prime rates of banks, known as sub-prime lending. Banks thought that land prices would continue to go up and did not bother to examine economic credentials of borrowers and their capability to pay back. "The scenario was known as ninja loans - no income, no job no assets" (the Current Economic Crisis, its causes, its impact and possible alternatives, 2009).

Lack of appropriate information to borrowers and slow rising of interest created trouble for some borrowers to close the mortgages. Defaults appeared and questioned the sustainability of the real estate and housing boom in 2007. In the middle of 2007, the bubble began to burst when information came out that mortgage hedge funds with two institutions were in trouble. "The problem spread to CDO's linked to subprime mortgages which in turn had its impact on some investment banks. At the end of 2007, well-known financial institutions like Citigroup, Merrill Lynch, Lehman Brothers, UBS, and the Bank of America had to announce major write downs. The crash came in the middle of 2008 with Lehman brothers going bankrupt. Lehman brothers were outside the banking system (shadow banking) and could not get support from the Federal Reserve Bank of the U.S. The American Investment Group (AIG), the giant insurance firm operating globally also went under" (the Current Economic Crisis, its causes, its impact and possible alternatives, 2009). Attempts were made to fix the situation through mergers and buyouts but the situation did not become stable. With this came fear spreading to the stock market which is the altar of free market capitalism. The credit squeeze and layoffs affected many households, predominantly those relying in credit cards. Because spending went down, it led to deflation which turned into recession (Steinberg, 2008).

3. What has been the response of governments to the political economic crisis?

The political leaders who once thought that one could spend and borrow their way to affluence now seem to distinguish that indeed something is very wrong. Yet they still do not view the big picture and have instead paid attention to individual elements of the problem without taking a holistic approach (the Economic Crisis and the U.S. Policy Response: Just Right, Too Little or Too Much, 2011). "Their reaction to the economic mess was to pass bailout bills worth over $700 billion, provide insolvent banks with taxpayer cash, guarantee bad debts, and purchase toxic assets. These responses have channeled most of the resources mentioned to our financial institutions in order to increase their liquidity" (Avizius, 2009).

The first problem with taking this approach is that the government is handing money directly to the very same people who caused the problem to begin with. These people are vermin on the system. They do not create anything. They do not generate any wealth. They just maneuver the money that the producers in the economy have managed to save or invest and skim a percentage off the top for themselves (the Economic Crisis and the U.S. Policy Response: Just Right, Too Little or Too Much, 2011). This leads to what is known as a moral hazard. While it may not have been the perfect answer, it would have been a better to give every American taxpayer a check with the stipulation that it must be used to pay down debt, or if the taxpayer had no debt they could put the money into a bank and hold it there for 1 year and after that the money would be theirs, to do with as they please (Avizius, 2009). This would have offered an immediate shot of cash to the banks, allowing the people who would in the end have to pay the bill to have at least reaped some of the benefits. This advance would have served to prevent some foreclosure on homes as well. This approach would have given money to the banks that made cautious decisions and allowed those that were totally insolvent to fail. The responsible banks could have picked up the slack of the ones that failed.

The second problem with the bailout approach was that the people who were in charge of put into practice the program, were themselves complicit in making the mess, and failing to foresee and inform the nation of the problems that are now being seen. "Secretary Paulson was the CEO of Goldman Sachs for 8 years before becoming Treasury Secretary. He was in charge of the largest Wall Street firm that wrote these questionable financial instruments and then made even more money by betting against these very same instruments once he knew the market was going to collapse. Paulson left the scene with an estimated personal net worth of $700 million. Timothy Geithner was president of the Federal Reserve Bank of New York and also failed to predict and warn the nation of the impending disaster. He played a major role in the $30 billion bailout to prevent the bankruptcy of Bear Stearns. He also played a major role in the bailouts to investment banks. Now these same people who failed to see the warning signs of this crisis were placed in charge of trying to fix it and are distributing $100's of billions of borrowed money to their friends on Wall St." (Avizius, 2009).

The third problem with government's response was the fact that the funds were distributed and the public was not told to whom (Sylvester, 2008). The only thing that we do know is that only those companies deemed too big to fail had money given to them with few strings attached. This can be seen as a sort of reverse Darwinism where the weak survive because of government intercession, leaving the accountable and strong to fend for themselves in this atmosphere that favors the big and weak providing them with competitive advantages as a consequence of government interference (Avizius, 2009). This continues to be a system where profits are kept by the elite, but losses are publicly financed by the taxpayer standing the entire capitalist system on its head. This is corporate welfare at its absolute worst (Steinberg, 2008).

The fourth problem has to do with how the bailout money was used. It created companies that used the money to get even bigger and fatter than they were before. One of the problems was that bank lending had frozen and the goal was to get banks to start lending again. Yet, most of the money was going to all of the too big to fail companies. Common sense would tell anyone that any company that is too big to fail is a mortal threat to the economic well being and national security of the United States. These companies should be broken down into smaller pieces in order to reduce this threat. Instead we have again another vicious result that these banks and financial houses are using the funds extorted from the taxpayer to obtain and merge with other banks to become even bigger and fatter than their current too big to fail size. "This is not a sustainable model and is what got us into this mess to begin with. If we had smaller banks and financial houses, this economic mess would be significantly easier to manage" (Avizius, 2009).

The fifth problem with the bailout is its focus on trying to get things moving by having the banks start lending again so the consumer starts spending again in order to continue what was an unsustainable model to begin with. The banks are now doing what they should have done in the first place and that is to be careful who they lend to. The…

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