The US economy is the world’s largest. Its GDP was approximated at $ 13. 8 trillion in the year 2007. It has a very high level of GDP per capita approximated at $46,000 in 2007. The economy has kept a stable overall GDP growth rate. This has been accompanied by low unemployment, high capital investment and research. This has mainly been funded by national and foreign investors. However, the US has faced one of the worst financial crises in its history. There was a sudden decrease in availability of credit and a proportional increase in the cost of the credit.
This has come to be commonly referred to as the credit crunch. The Cause In March 2007, economics analysts warned of a credit crunch in the US financial markets. Later in August, there was a general conclusion that the crunch had taken effect in the business sector. However, the consumers were still spared. A survey in September 2007 gave evidence that households had also stated to feel the crunch. One-third of mortgage loans were unable to close due to investors’ inability to purchase these loans (Rabel, 2002). This credit crunch had been in looming.
The government introduced measures and loose monetary policies caused a housing boom beginning in the year 2000. This was not sustainable. This was done through manipulating interest rates. When the rates were lowered to less than the normal market rate, borrowing money became cheap. Long-term projects that demanded a lot of capital that could be unprofitable suddenly turned to profitability. There was increased money supply and this is the root cause of the boom. It resulted in mal-investment and allocation of resources in low demand sectors.
This was shown by overbuilding real estate. On this realization, the builders resorted to drastic measures such having the prices lowered to make a quick return on their investment. This returned the economy back to balance, to a state of equality between demand and supply. This adjustment created a situation where affordable housing could be found without seeking mortgage products. This really hurt the real estate industry players. The government tries to keep the prices artificially high. The Government Action To solve this problem, the government took several measures.
Among them was a bailout of some of the concerned corporations that were considered too big and too essential to collapse. The government bailed out Fannie and Freddie and purchased AIG and the $700 billion scheme. The aim was to prevent liquidating of bad debts. Why it cannot work It is excessive government meddling in the private sector business that caused this financial crisis in the first place. A government solution is not possible. A bailout is an excessive economic intervention. By bailing out these corporations, the government is not giving markets a chance to adjust prices.
They can only lead to an increase in financial instability. Moreover, this action will end up encouraging a moral harzard. It has set precedence for financial institutions to engage in risky businesses because they are assured of a government bailout. This will lead to financial system instability in the future (Randazzo, 2008). The way forward To solve this crisis and prevent more in the future, government should not meddle in the market. Government intervention distorts the market and then reacts by imposing new regulatory laws that cause more distortions and the cycle continues.
The government must also decrease their expenditures and reduce regulations on banks and other financial institutions that could cause the financial sector to be rigid. Government bailouts, although have good intentions, have diminishing impact. The latest bailout in the United States for instance has in reality had the opposite of what was desired especially on stocks. This has shown that government bailouts are insignificant and unwarranted (Paul, 2008). The private sector also needs to be careful not to invest in very risky ventures that may subject it to a possible bailout.They need to run themselves competently and not rely on governments for security.
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