Financial Crisis

Topics: United States housing bubble, Economic bubble, Dot-com bubble Pages: 5 (1716 words) Published: April 3, 2013
Dean Baker on the Crisis

This podcast focuses on the financial collapse of 2007-2008 and the subsequent recession that followed. The financial collapse was largely due to the housing boom and its subsequent bust in 2007, but has deeper economic causes stemming from the dot com boom and bust of the late 1990’s and early 2000’s. The podcast also touches upon and evaluates recovery efforts from the federal government, such as the Troubled Asset Relief Program, bailouts in the financial sectors, and federal stimulus spending.

The origins of the housing bubble can be traced back to the decades following the 1950’s. A few structural shifts began to change the economy. Among these are globalization, the strengthening of the U.S. dollar, lower transaction costs due to technological innovation, and the weakening power of unions. Throughout the latter half of the twentieth century, the U.S. economy experienced a naturally growing GDP. This provided more disposable income and relative wage increases, which facilitated higher consumption and investment. In the nineties, innovations in telecommunications, technology, and the Internet led to more investment in the technology industry and lowered transaction costs. Low interest rates coupled with large investments led to the dot com bubble. However, in 2000 this speculative bubble burst, as the Federal Reserve raised interest rates and the economy began to slow. Investors began to question the safety of investing in the high tech sector, and began to move funds to investments which were deemed safer, such as housing. Recovery from the dot com bubble was slow. To elicit recovery and growth, the Federal Reserve lowered interest rates to encourage investment. Spurred by these lower rates, people began to invest in housing. Following the recovery in 2003, housing became an extremely lucrative field in which to invest. This is evident in phenomena such as “no-look” bid on houses, 300% returns, and house “flippers”, who would buy a house on debt and shortly thereafter sell it for a gain. Related industries, such as the financial sector and the construction industry, also began to see large returns because of the housing boom. The financial sector, attracted by large returns in the housing market, began to give out risky mortgages. The booming housing market began to alarm the Federal Reserve, who was wary of such radical growth. However, the Fed was content to let the bubble run its course, and thus kept interest rates low.

The housing bubble finally burst in 2007, which had drastic affects on the economy. The construction industry slowed as new housing starts plummeted. Consumer spending fell by $1.2 trillion, while savings rates grew. This meant less money was being put back into the economy. Many homeowners defaulted on risky mortgages. This left financial institutions such as Bear Stearns, Lehman Brothers, Goldman Sachs, Merrill Lynch, and Morgan Stanley with large amounts of bad debt in the form of mortgage-backed securities that would never be repaid. This led the federal government to give bailouts of these large financial firms, or risk a catastrophic economic downturn. The government instituted the Troubled Asset Relief Program (TARP), which bought assets and equity from financial institutions that were burdened with bad debt. This program saved the U.S. economy from a full-blown meltdown, but the TARP left the leaders of these financial firms in charge and cost the American taxpayer billions. The housing burst still had a significant effect on the economy. The Federal Reserve responded half-hearted to the financial crisis. Possible options for the Fed are to increase inflation slightly or target nominal GDP. However, the Federal Reserve is not totally independent from the industries that it regulates. Many of the voting members are selected from the private sector and are prone to act in their sectors interests. This means less accountability to Congress....
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