The current global economic crisis stems from the troubled US financial system which acts as a center for many business interactions. The impact spread across the globe as many nations had linkages with the US which is the world’s superpower. The prices of assets started to decline and there were difficulties accessing credit triggering contraction in the global liquidity. (Frenkel R and Rapetti M, 2009). Less money was in circulation which precipitated reduced demand for goods and services. Companies had to lay off workers with the reduced demand for their outputs as a way of cutting costs and maintaining profitability levels.
Increased uncertainties in the financial markets also had a role to play in the economic downturn as it influences people’s ability to invest and without investment economic growth cannot be realized. The IMF argued that the current global financial crisis was the worst to be experienced in a span of six decades. (Frenkel R and Rapetti M, 2009). The term ‘credit crunch’ or ‘credit crisis’ has been coined to explain the source of the prevailing financial turmoil. It refers to a situation where availability of credit to both individuals as well as business is reduced.
High interest rates are attached to loans available making them unappealing. The credit crunch could stem from lax lending policies, reduced house prices as well as low interest rates. (Budworth D, 2008). The credit crunch has immense effects on those businesses with a higher risk for bad debts although the negative effects eventually spreads to other sectors of the economy. The recent credit crunch in the US can be blamed for laxity in the lending procedures in the early 2000s when the housing sector thrived. (Budworth D, 2008). On seeing that the US economy was headed for a recession the economic Stimulus act of 2008 was enacted.
It aimed at boosting economic activity through tax rebates as well as other tax incentives. An economic stimulus refers to the measures adopted to stir up an economy and could be inform of ensuring availability of finances in an economy to boost people’s purchasing power. As the board of governors of FED chairman, Ben Bernanke noted the economic success story in the US took a reverse direction in summer 2007. The financial markets started to experiencing strains precipitating tight conditions that negatively affected businesses and individuals alike. (www. federalreserve.
gov). The GDP growth rates started to decline, the unemployment rates shot and generally the production declined. Bernanke noted that the prevailing condition could be blamed by the continued contractions in the housing sector. The house prices had risen after several years of economic boom in the US triggering the construction of more houses however this changed course in 2007 when the house prices started to decline significantly. Initially, there was ease in the accessibility to credit due to laxity in the lending institutions especially in the ‘sub prime market’.
The demand for houses shot to unimaginable levels precipitating the construction of more houses but as more strict measures were embraced in the credit market it was more difficult to access credit and demand for houses declined. (www. federalreserve. gov). Lower house prices worsened the performance of securities that were backed by mortgages and credit on mortgage became scarce. Reduced demand triggered excessive inventories on homes that had not been sold and the construction of more houses had to be halted.
Unemployment had to reduce in this sector as well as on other related sectors and eventually the negative effects would be felt by many. Global rise in fuel prices also had a role to play in as far as influencing of the US economic performance was concerned. It could be blamed for the declining consumer spending as well as erosion of wages. To reverse this condition the US government introduced a ‘fiscal stimulus package’. Tight conditions were to be embraced and they had an impact on both the individuals as well as businesses.
The investor’s confidence levels dwindled as turmoil’s persisted in the mortgage sector. The lax lending standards saw many financial institutions suffer credit losses which threatened their very own existence. Among the approaches embraced was the Term Auction Facility where credit was to be made available to the potential buyers using the auction method. This was however not very effective as a huge damage had been registered. (www. federalreserve. gov). To resolve the problem the former US president Bush adopted a tax rebate amounting to $150 billion with the aim of kick starting the economy.
However, this was viewed as just a drop in the ocean as the economy had severely deteriorated and there was need to adopt strategies to assist the financial as well as the housing industries to prevent their closure. (CNN, 2008). To the former US president, the bailout plan was more of a necessity rather than a requirement ‘as the entire economy was in danger’. The collapse of various financial firms which bore its roots to the sub prime mortgages had immense effects on the entire economy. To Bush, the 700 billion US dollars bailout was aimed at stabilizing the financial companies to enable them continue lending.
The government was to purchase troubled assets especially those backed by mortgage securities. Government bailouts are deemed proper as the government is ‘the only institution patient enough to buy assets at the current low prices and hold them until the prices have returned to normal. (CNN, 2008). The severity of the financial turmoil was also confirmed by FED chairman who argued that the current crisis was the worst the US has ever experienced since the Second World War. He also favored the bailout approach to responding to the economic situation.
Despite their varied political affiliations, different law makers came together to resolve their economic problem. (CNN, 2008). Bailouts by the federal government is not anything new in the US as noted by the Pro Publica Inc. Bailouts have been applied from as early as 1970 when Penn Central sought for government intervention before signing for bankruptcy. It purported that it played a vital role in as far as the nation’s security was concerned. (Pro Publica Inc, 2009). The government responded to their request and soon loans were available to people and the ownership changed to have more government control.
Through the government intervention the company remained in operation for some time before being privatized. Over the years, bailouts have yielded positive as well as negative effects. The Lockheed Bailout of 1971 is one of the successful bailout in the US. The fear that there would be a massive loss of jobs in California saw the government bailing out Lockheed a move that saw it earn over 100 million dollars in the form of loan fess in addition to having the company repay all her loans in a span of six years. (Pro Publica Inc, 2009). There was also the 1974 Franklin National Bank bailout that was not as successful as the Lockheed had been.
The poor governance and business practices where many in the management were associated with corruption could be blamed for the poor performance of the company. After sometime the government sold the Franklin’s assets at about $5. 1billion. The 1975 New York City bailout yielded positive effects as all the loans, their premiums and fees were repaid. The 1980 Chrysler bailout also saw the government earn over $660 million. Other bailouts included the Continental Illinois National Bank and Trust company, the savings and loan as well as the 2001 Airline bailout that was granted after the terrorist attack. (Pro Publica Inc, 2009).