The Business Cycle and the American Economy Essay

The Business Cycle and the American Economy Essay

The Business Cycle and the American Economy Essay

The Global Financial Crisis Sample Essay

Information introduction

The Global Financial Crisis (GFC), was a period of global economic recession between mid-2007 and early 2009. It was characterized by the collapse or near collapse of major financial companies. The crisis, also known as the subprime mortgage crisis was a result of excessive risk taking behavior by financial institutions. Between 2000 and 20201, the Federal Reserve bank slashed the federal funds rate from 6.5 percent to 1.75 percent, leaving financial companies such as banks and other lenders with too much money (Grant & Wilson, 2012). As a result, the institutions encouraged prime and subprime customers to take credit. However, the share of credit issued to subprime customers was significantly higher prime customers since the interest on such loans was much higher than for the prime customers despite their high risk of defaulting. Due to the laws of demand and supply, high demand of houses led to higher prices, thus many took loans to flip houses. By 2006, there was an oversupply of houses and prices crashed. Many borrowers failed to repay their loans due to unsold housing inventory, forcing major financial institutions to file for bankruptcy.

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Theoretical questions

Demand and supply is a law that states that the prices of goods and services are determined by the forces of demand and supply. When the demand is high, the prices increase whereas the prices drop when the demand fall. It also states that prices increase when the supply is low whereas they drop when the supply is high. The theory of demand and supply can be used to describe the events that took place during the financial crisis of 2007-2009. Demand for houses is significantly higher than the supply. However, as the supply of houses increased due to availability of financing, it was expected that the prices of houses would start to fall. Nevertheless, the reverse happened in the United States as the prices increased as the supply increased, indicating that the increase was not sustainable. Any economist would have predicted that the supply would eventually surpass the demand and the prices would eventually clash.

The events also formed a strong argument against the Laissez-faire economy. When the government allowed the financial system to self-regulate, the market showed inability to operate effectively, leading to a recession. As such, the government was forced to intervene in the market through bailouts and regulations.

Normative Questions

Most Affected

American households were the most affected by the financial crisis. Shortly after the burst of the housing burble, there was a sudden decline in consumption of goods and services, leading to the failure of a significant number of businesses. For instance, automotive companies like General Motors had to file for bankruptcy. Failing businesses led to mass layoffs by companies. Unemployment rose to above 5%, leading to higher defaulting of loans by the subprime customers (Junankar, 2011). As a result, many were evicted from their houses and their possessions such as automobiles repossessed by the lenders. When the bubble collapsed, most households that purchased houses during the boom found themselves with mortgages that were far above the value of their properties. The most affected were younger employees, between 20 and 30 years since they were the most affected by unemployment and loan defaulting. Life was therefore hard for American households.

Role of the Government

The government played a key role in the starting and the continuity of financial crisis. As noted before, FED’s sharp decrease of interest rates was reckless. It led to the increase in money supply for banks that consequently led to the lowering of the cost of borrowing. Between 2000 and 2001, the interest rate had dropped from 6.5 percent to 1.75 percent. The government to detect and stop the buildup of the bubble. FED did not notice the unsustainable growth in the housing market and predict the effect that the growth would have on the financial sector when the supply finally outpaced the demand for new units. Lastly, the FED failed to regulate the practices of commercial banks. They let banks to increase their subprime loans beyond the sustainable limits, thus increasing the risk of bankruptcy.

Response of the Government

Although the government was too late to stop the financial crisis, the United States implemented policies that minimized the impact of the crisis. The efforts included stabilizing the financial sector and the manufacturing sector through bailouts and assisting them to merge. The financial sector was on the brinks of total collapse when a large number of borrowers could not repay their loans. However, through government bailouts, the companies managed to remain in business. Bailout to the manufacturing sector, on the other hand, aimed to maintain demand. The recession created a shock in the market, thus fewer people preferred to spend money on large expenditures like vehicles. There was also loss of trust with financial institutions, hence fewer consumers were willing to take loans. However, the bailouts allowed manufacturers to give buyers favorable payment options, allowing a resumption in demand.

The US government also implemented new laws to prevent a similar crisis. Among them was the Dodd-Frank Act that became law in 2010 (Hossain & Kryzanowski, 2019). Firstly, banks and other financial companies were required to increase the size of their reserves to allow them to deal with potential future slumps. The FED also required large banks with assets of more than $50 billion to undergo an annual “stress test” to determine if they were in a position to survive a financial crisis. Other policies included the establishment of the Financial Stability Oversight Council (FSOC) to monitor risks in the financial sector, and the Consumer Financial Protection Bureau (CFPB) to shield consumers from being lured by banks into taking large mortgages that they could not repay.

Proposed Policy

The most affected part of the population were people between the ages of 20 and 30 who suffered from the effects of sudden economic decline. They lost their jobs and defaulted on their payments. Poor credit scores also meant that they were not considered in the government financed loan restructuring programs. As such, policies must be implemented to caution workers of sectors that are highly sensitive to changes in income levels such as automobile manufacturing and the construction industry. New laws must be enacted to compel employers to establish a fund that would protect the employees from a sudden loss of employment caused by a financial crisis. The fund should be able to sustain at least two years of the employee’s income. As such, in the event of a shock, the employees would be cushioned from the severity of the crisis. The fund would be similar to other policies created by the Dodd-Frank Act to protect institutions.

References

Grant, W., & Wilson, G. K. (2012). Consequences of the Global Financial Crisis (p. 287). Oxford University Press.

Hossain, A. T., & Kryzanowski, L. (2019). Global financial crisis after ten years: A review of the causes and regulatory reactions. Managerial Finance.

Junankar, P. N. (2011). The global economic crisis: Long-term unemployment in the OECD.

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Please use Economic concept and theories with factual information and researched statistical data to support your essay. E.g Comparative cost advantage, Opportunity costs, Production efficiency, Demand and Supply.

Please describe and analyze a particular time period in the Economic history of America ( please support with factual and statistical data for description accuracy. E g The great recession, The fast development of Industrialization at the end of 19th and beginning of the 20th century.

Please discuss the pre- industrial era, evolution, and the event that led to the era which hastened it like the technology advancement.

The essay is in 3 sections; Information introduction

Theoretical questions

Normative questions. All of which screenshots has been uploaded.

Please put in your best. I thank you greatly.