Every business has an aim to earn profit and maximize its size of business. For this purpose we make some policies and set some plans to achieve those objectives. But the curse of excessive profit carries dilemma and one of the major examples is current global financial crisis and we can also call credit crunch. Here I raise the question ‘What are Global financial crises?' In other words we can say Credit Crisis and its main causes: The global financial crisis, which started in mortgages (housing) and financial sector 10brewing for a while, really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. Commonly we heard about three types of financial crisis: - Currency crisis (Balance of payment crisis) - Banking crisis - Foreign debt crisis (sovereign
debt) Above of them the banking crisis was the major caused of 2007-08 financial crises Q: what is banking crisis and how it's affected to US economy? 14Financial crises can think various forms. I have to focus primarily on financial crises involving the banking sector and do so for some reasons. First, banks play an important role in the credit intermediation process in most countries, providing and generating financial support to companies14beyond the cash flow provided by their normal operations. Banks also normally serve as custodian of a significant portion of household saving. In many countries, for example, banks play a key role in channeling credit to firms particularly those firms not able to arrange the finance from assets markets or others sources and also hold considerable customer deposits. These financial crises also take a part to disturb the real economy of any country and its same happened with US.22There are no doubt many causes and many consequences like high intensity of market liquidity, low interest rates, low cost of capital, and very low yields on safe investments.
But one of the major causes was subprime mortgages in housing sector and it's completely demolishing the US economy in 2006-07.25It's a worldwide fiasco involving the terms we probably heard like: - Subprime Mortgages - Collateralized debt obligations - Frozen credit markets - Credit default swaps Subprime Mortgages: The 5subprime mortgage market lends money to people who don't meet the credit or documentation standards for ordinary mortgages. Since subprime borrowers often have credit problems or low incomes, there's a greater chance that they won't pay back their debts, making subprime mortgages inherently risky for lenders. To compensate for this added risk, banks and other lenders charge higher interest rates on subprime mortgages. (http://www.wikinvest.com/wiki/Subprime_mortgages) 5Source: Edward Gramlich, FRB, and Mara Lee, NPR5Subprime lending became popular in the U.S. in the mid-1990s, with outstanding debt increasing from $33 billion in 1993 to $332 billion in 2003. As of December 2007, there was an estimated $1.3 trillion in subprime mortgages outstanding. 20% of all mortgages originated in 2006 were considered to be subprime, a rate unthinkable just ten years ago.
Collateralized debt obligations: 6Collateralized debt obligations are simply collections of loans that are bundled together, usually by a bank or by a brokerage house, and sold to investors. The loans can range from short-term corporate business debts to home mortgages. The key is that the debts are grouped together and sold in slices, known as tranches, according to their expected level of risk. The safest levels, known as the senior tranches, carry the least risk of non-repayment and generally pay the lowest interest rates. The next levels, known as mezzanine debt, are riskier and carry a higher payout. The riskiest levels, known as equity debt, pay the highest periodic interest payments but also carry the highest risk of default.
(http://beginnersinvest.about.com/lw/Business-Finance/Personal-finance6/Collateralized-Debt-Obligations-CDOs-A-Complicated-Way-to-Spread-Risk.htm)24CDO's played an important role in the credit crunch because they meant when mortgage defaults rose, many banks around the world went bankrupt. Frozen credit markets:4The term frozen credit markets simply means credit is frozen or very hard to get, even for people or businesses with terrific credit histories. For consumers, that could mean denials on car loans, the lowering of credit-card spending limits or an inability to get a mortgage or open a home-equity line of credit. For small businesses, it could be the beginning of the end. Without available credit, some businesses won't be able to make payroll (which could mean layoffs), they won't have capital to stock their shelves and pay their suppliers. Credit is not a right. It's a privilege. You need to protect it," Adam Levin, chairman of credit.com and former New Jersey Consumer Affairs director, said yesterday. "In good times, it makes your life easier, and in bad times, it could prove to be your safety net." Now that the bad times are upon us, lenders are nervous and they're not as willing to lend as they once were -- even to previously approved customers. 7Credit default swaps: (CDS) are basically insurance policies against the default of a bond issuer many investors had used these securities to take a view on a particular credit event. The major bankruptcies that occurred in the fall of 2008 caught some investors in these contracts off guard; after all, a major CDS event had not occurred since Delphi in November 2005.7Credit default swaps have two sides to the trade: a buyer of protection and a seller of protection. The buyer of protection is insuring against the loss of principal in case of default by the bond issuer.
Therefore, credit default swaps are structured so that if the reference entity experiences a credit event, the buyer of protection receives payment from the seller of protection. FACTS AND FIGURES Below I will explain some important fact which I took from different sources, Its elaborate the whole picture about US economy when the things started to going wrong and how US administration was trying to recover from them. 2Between 2004 and 2006 US interest rates rose from 1% to 5.35%, triggering a slowdown in the US housing market. July-2007,23Federal Reserve chairman Ben Bernanke follows the news with a warning that the US sub-prime crisis could cost up to $100bn (£50bn) August-2007,21The European Central Bank pumps 95bn Euros (£63bn) into the banking market to try to improve liquidity. It adds further 108.7bn euros over the next few days. 1August-2007, The Fed cuts the rate at which it lends to banks by half of a percentage point to 5.75%, warning the credit crunch could be a risk to economic growth. 1September-2007, The US Federal Reserve cuts its main interest rate by half a percentage point to 4.75%. October-2007, 2Merrill Lynch's chief resigns after the investment bank unveils a $7.9bn exposure to bad debt. 1January-2008, The World Bank predicts that global economic growth will slow in 2008, as the credit crunch hits the richest nations. 1January-2008, A major bond insurer MBIA, announces a loss of $2.3bn - it's biggest to date for a three-month period blaming its exposure to the US sub-prime mortgage crisis. 1April-2008, The International Monetary Fund (IMF), which oversees the global economy, warns that potential losses from the credit crunch could reach $1 trillion and may be even higher. 1September-2008, Wall Street bank Lehman Brothers posts a loss of $3.9bn for the three months to August. 1Meanwhile, another US bank Merrill Lynch, also stung by the credit crunch, agrees to be taken over by Bank of America for $50bn. September-2008, The 16US Federal Reserve announces an $85bn rescue package for AIG, the country's biggest insurance company, to save it from bankruptcy. AIG gets the loan in return for an 80% stake in the firm. September-2008, In the largest bank failure yet in the United States, Washington Mutual, the giant mortgage lender, which assets had valued at $307bn, is closed down by regulators and sold to JPMorgan Chase. October-2008, The 2US House of Representatives passes a $700bn (£394bn) government plan to rescue the US financial sector. 9October-2008, Figures for US retail sales in September show a fall of 1.2%, the biggest monthly decline in more than three years, as hard-up consumers avoid the shops. The figures underscore fears that the wider US economy is now being hit by the financial crisis.
The Dow Jones index falls 733 points or 7.87% - its biggest percentage fall since 26 October 1987. November-2008, The US government announces a 1$20bn (£13.4bn) rescue plan for troubled banking giant Citigroup after its shares plunge by more than 60% in a week. December-2008, Bank of America announces 1up to 35,000 job losses over three years. 9February-2009, US President Barack Obama signs his $787bn (£548bn) economic stimulus plan into law, calling it "the most sweeping recovery package in our history".9March-2009, The US Federal Reserve says it will buy almost $1.2 trillion (£843bn) worth of debt to help boost lending and promote economic recovery. May-2009, One of the "big three" 2US carmakers, Chrysler, enters bankruptcy protection after pressure from the US government. The majority of its assets are to be sold to Fiat. June-2009, The 2world's largest carmaker, GM, enters bankruptcy protection after bondholders agree to a deal that means they lose 90% of their money. The US government loans the company an additional $50bn. July-2009,2US bank Goldman Sachs beats analysts' forecasts with a net profit of $3.44bn (£2.1bn) for April to June. It says it has set aside $6.65bn for pay and bonuses in the quarter. Several - but not all - other US banks subsequently announce big profits. However, analysts warn that the US banking crisis is not yet over. All these were the main realities of US financial crisis but there were some others factors as well and one of the most important factors was Iraq war.18Iraq war is a moral strategic disaster for the US. But what has not yet been fully recognized is that it has also been an economic disaster. To date, the government has spent more than $522 billion on the war, with another $70 billion already allocated for 2008-09 3The economic consequences of Iraq run even deeper than the squandered opportunities for vital public investments. Spending on Iraq is also a job killer. Every $1 billion spent on a combination of education, healthcare, energy conservation and infrastructure investments creates between 50 and 100 percent more jobs than the same money going to Iraq. Taking the 2007 Iraq budget of $138 billion, this means that upward of 1 million jobs were lost because the Bush Administration chose the Iraq sinkhole over public investment. Recognizing these costs of the Iraq War is even more crucial now that the economy is facing recession. While a recession is probably unavoidable, its length and severity will depend on the effectiveness of the government's stimulus initiatives. 3The federal fiscal deficit in 2007 was $244 billion. Shutting down the Iraq War and using the fiscal savings to cut the deficit would mean a 57 percent deficit reduction. On the other hand in 2007-08, US had to raise the rate of interest because of inflation. And because of that mortgage payment were more expensive for home owners, in addition those homeowners who taken the mortgages two years back now they faced massive amount of installments as their introductory period ended. Meanwhile they also faced lower disposable income because of other factors like health cost, growing food prices, high health care cost and increasing petrol prices etc. According to Manuela Badawy, 13The latest U.S. trade data are based on oil-import prices of less than $30 a barrel. With oil flirting with the $40 threshold, analysts say the negative effect of high energy prices on the trade has only just begun. Economists are not yet saying the U.S. economy is suffering from the higher oil prices.
But there is increasing agreement that strong Asian demand - mostly from China, as well as India - is putting upward pressure on prices. "Oil prices have jumped substantially, and that obviously raises the cost of imports, which offsets the gains from increased U.S. exports in manufacturing,"13said Philip Verleger, a veteran oil industry analyst and visiting fellow of international economics at the Council on Foreign Relations.15Although these trends were accurate, the price of oil was being affected by more than supply and demand. In fact, the data shows global demand was down and global supply was up. Oil consumption decreased from 86.66 million barrels per day (bpd) in Q4 2007 to 85.73 million bpd in Q1 2008. During this same time period, supply increased from 85.49 to 86.17 million bpd. According to the laws of supply and demand, prices should have decreased. Actions and Reforms: When US President Obama came in government and gave his first addressed to the 12congress, spoke in stark terms about deepening economic recession but assured to American nation that they will succeed. “We will reconstruct, we will make progress, and the United States of America will come out stronger than before,” the president declared. The President said that we need some bold actions required to get rid from financial crisis and also need to make long term programs like: Foreclosure Plan Re-consideration on Tax Policy Federal Deficit Withdraw From Both Wars Immediately Foreclosure Plan: First of all they need to implement a financial rescue package and 12emphasized the necessity of a home foreclosure plan to help responsible 11homeowners keep their homes, but it may be too little and too late for millions of others. Many of them 11have lost their homes during last two or three years and mostly are expected in future.
According to usatoday:27(http://www.usatoday.com/money/economy/housing/2009-02-18-is-foreclosure-plan-fair_N.htm) 11The Obama plan reaches out to those at risk of default, rather than just those already facing foreclosure, and it offers mortgage servicers — the firms that collect payments — financial incentives to modify loans. In addition, the Treasury Department said Wednesday it will commit up to $200 billion more to mortgage giants Fannie Mae and Freddie Mac to try to keep mortgage rates low. It pledged $200 billion — $100 billion apiece — to them last fall when the government took them over. Re-consideration on 12Tax Policy: On tax policy, Obama noted that only the “wealthiest two percent of Americans” earning above $250,000 will pay higher taxes and that those earning less will begin to see a higher paycheck beginning on April 1 as a result of the new “Make Work Pay” tax credit. He also said corporations that outsource their jobs overseas should not receive the same tax breaks as companies that keep their jobs in the United States. Federal Deficit: The US federal deficit getting high and high, but US administration taking steps to control and reduce the level, 26during the month, the government racked up $311 billion in outlays compared with $135 billion in receipts. 17From an economic point of view, Congress needs to pass a large scale jobs program that focuses on spending, that directly puts people to work.
Given the massive neglect of the public infrastructure over the last eight years, there is an enormous amount of productive work to be done - either by directly paying contractors or by funding a federal public works program. 20Withdraw From Both Wars immediately: US nation has never been able to pay for these wars except through massive debt or massive inflation. Immediate withdrawal would save at least a trillion dollars. And 19the Iraq adventure has seriously weakened the U.S. economy, whose woes now go far beyond loose mortgage lending. You can't spend $3 trillion- yes, $3 trillion on a failed war abroad and not feel the pain at home. Now time has come and US government should think about it specially the time of financial recession. US government can keep massive amount of funds and utilize those funds for push the economy and also inject those money in financial sector. Additionally, the government should create "corporate guarantee funds" to be managed by trusts, for different levels of economic activities, mainly small and medium enterprises, so as to cover the risks of starting new productive initiatives properly evaluated until the formation of their assets and the generation their cash flows, then the whole operation goes into the trust system while the credit is at risk. With this new or revitalizing existing initiatives, employment would be generated and thus the confidence regained but through a new system. Money instead of going to rescue bank bailout programs within a exhausted system would go through a healthy and transparent system trust guarantee funds banking type of credit lines with the intermediation of commercial banks to bust the economy restoring the payment capacity to a market plenty of new opportunities. Conclusion: The 10financial crisis is likely to weaken the condition of the US as the world's only superpower.
On the realistic level, the US is already prolonged militarily, in Afghanistan and Iraq, and is now stretched financially. On the philosophical level, it will be harder for it to dispute in favor of its free market ideas, if its own markets have distorted. In my opinion bail out not the right solution, its mean they inject money from treasury into banks and re-establish their ability to maintain what they have handled so bad throughout so many years. Here what should proceed is to be clear and this is probable only after recognizing the true extent of the disaster in each country largely in the US. What is required for the market to regain confidence? The only option is to give right to use to money in order to meet the people needs enlarged demand and this would only be viable with more income for persons no with credit cards. But as this does not seem to be possible at this time because of the mortgage crisis, what may be explored first is how to lesser the pressure to collect from them what they cannot afford, but not through the purchase of their debts by the Treasury that would pay the banks, as this is "more of the same, but through a careful study to transfer the debt titles from banks, to a “special trust” then the banks would become beneficiaries of the trusts and there will be no writing-off in their balance sheets. In the meantime, pending the recovery of the payment capacity of individuals and families, also can be set -in stages- special contracts for rental of occupied houses whose product enter to the trusts collection subordinated with special conditions and gradually to the banks according to a design to be agreed. US 8banks made loan to people that could not afford to pay back the loans. A few of those banks almost went bankrupt and had to be rescued by American taxpayers. 8It takes more dollars to buy the similar stuff you could have bought with a lesser amount of 8money ten or fifteen years ago. The fact that there is a limited amount of oil in America affects the economy too. That causes the price of oil to increase. The price oil affects the price of all you buy in the market because it takes gas or diesel to transport those products to the consumer. Overall, I would have to say that reckless spending and the endless war in Iraq have affected the U.S. economy the most.
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