Financial Meltdown

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Financial Meltdown

Introduction

The United States’ financial crisis has been one of the most fundamental issues in the history of the world. Needless to say, quite a lot of literature has been written with the aim of explaining why the crisis occurred, its effects, as well as possible ways of eliminating or alleviating the crisis.

In the paper, “The U.S. Economic Crisis: Root Causes and the Road to Recovery”, Brown and Lundblad acknowledge that the root of the financial crisis went beyond the housing bust. They acknowledge that the consumption of the United States went beyond the country’s production, in which case it was financed by borrowing from abroad (Brown and Lundblad, 5). Brown and Lundblad acknowledge that the United States economy would be unlikely recover until the long-run imbalances have been rectified. They predict that structural unemployment will be higher in the short term and decrease after adjustments in the skilled labor force. In addition, they underline the importance of increased levels of real and financial investment in the economy so as to reestablish the economic pillars for sustainable and long-term growth. Financial bailouts should remain in place so as to thaw the credit markets (Brown and Lundblad). However, the financial system has to be cleaned up, and the quality of oversight and regulation improved. The two authors note, however, that there will be a substantial cost as consumption has to be reduced, and taxes raised so as to enhance the balance in the United States economy.

However, Banas Derek blames the banks and other financial institutions for the financial crisis. In his YouTube video, Banas states that mortgage-backed securities looked more attractive that they, in fact, were, simply because they paid higher percentages of incomes compared to other AAA investments ( HYPERLINK “http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu” http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu). In essence, their demand increased to which banks established more mortgage CDOs that had even worse ratings, which were still sold as AAA. The banks, with time started betting that the payout of the CDOs would cease. In addition, they started buying the Credit Default Swaps that would pay out once the CDO’s collapsed. The CDSs were not regulated, in which case there was no money for payout this led to the drop of the total value of CDOs from $180 billion to $20 billion ( HYPERLINK “http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu” http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu). The collapse of all mortgage CDOs meant a debt of $62.2 trillion since it is possible for an individual to acquire an unlimited number of CDSs. The debt then dropped to $38 trillion within a year. In essence, Derek blames the financial crisis on banks as they were selling insurance that had no principle to pay off once the mortgage CDO collapsed ( HYPERLINK “http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu” http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu).

Sachs, nevertheless, offers some strategies that would be used to combat the crisis. He concurs with Derek that the crisis emanated from the fact that investment and commercial banks lent trillions of dollars in loans that the borrowers were ill-equipped to repay (Sachs, 2). Sachs outline the key threats to the United States’ economy, which include declining consumer spending on autos and housing leading to a recession, reduced lending by the banking sector. In addition, homeowners will default on consumer loans and mortgage payments, while short term loans will be threatened and possibly suspended. He explains that any policy should not aim at preventing a recession as it has too many imbalances (Sachs, 8). Instead, it should aim at preventing a deep recession or outright collapse. This would be attained in two actions. First, the Federal Reserve Board should supply short-term loans so as to sustain the interbank lending, smooth functioning of the money market funds, as well as the commercial paper market (Sachs, 9). It should also ease the terms of repayment for existing mortgage holders so as to reduce foreclosures and defaulters. In addition, it should support expansionary fiscal and monetary policies abroad so as to offset the consumer spending in US by increasing consumption in other countries.

Works cited

Banas, Derek. US Financial Crisis. YouTube, 2011, viewed on 22nd October 2012 from HYPERLINK “http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu” http://www.youtube.com/watch?v=S3AXHQcXYMk&feature=relmfu

Brown, Gregory W. and Lundblad, Christian. The U.S. Economic Crisis: Root Causes and the Road to Recovery. The Journal of Accountancy, 2009. Retrieved 22nd October 2012 from HYPERLINK “http://www.journalofaccountancy.com/Issues/2009/Oct/20091781” http://www.journalofaccountancy.com/Issues/2009/Oct/20091781

Sachs, Jeffrey D. How to Fix the U.S. Financial Crisis: Policies can avert disaster only if they interrupt the cascading threats to the U.S. economy. Scientific American, 2008. Retrieved 22nd October 2012 from HYPERLINK “http://www.scientificamerican.com/article.cfm?id=fixing-financial-crisis” http://www.scientificamerican.com/article.cfm?id=fixing-financial-crisis