The United States has not been spared from the great recession that has hit many nations across the world. The U.S. economic crisis has been attributed greatly to the current debt crisis, which is considered as the worst financial crisis since the Great Depression in the 1930s (Moseley 1). Easy credit conditions had been generated in the U.S. by large foreign funds inflows along with low interest rates (Folbre 1). This condition encouraged housing construction debt financed consumption. With loans of various types easily available, institutions and investors around the world started investing in the U.S. housing construction.
Causes of the U.S. Economic Crisis
The preliminary cause was the expansion of the housing bubble. The global housing bubble disintegration hit its highest point in 2006 in the U.S., thus lowering the values of securities tied to real estate and as a result, damaging financial institutions globally. The price of a typical American house had increased by 124% on average between 1997 and 2006 (Moseley 1). The appreciating prices and lower interest rates triggered an increase in mortgage though income generating projects, which were not able to grow at the same rate. The speculative bubble was difficult to sustain by 2003 and by 2008, the decline in the average U.S. housing prices was over 20% (Folbre 1).
This decline in housing prices led to great losses being reported by the major financial institutions that had borrowed and invested heavily in the U.S. Investors’ confidence was damaged, thus impacting stock markets greatly. The strength of banking institutions was eroded, credits tightened and international trade declined. In addition, large losses in securities were reported in the late 2008 and early 2009 (Folbre 1).
Other factors other than the housing and credit bubbles, growth contributed to the increased financial inflation. Lowering of interest rates in the U.S. from 2000 to 2003, from 6.5 % to 1 % provided simple credit conditions leading to incresed borrowing (Moseley 1). The U.S. was experiencing a high and rising current account deficit, which pressurized lowering of interest rates as the U.S. required borrowing money from outside countries (Solomon 4). The situation created a demand of different types of financial assets, the rising of their prices and reduced interest rates.
The easy credit conditions allowed borrowers with weak credit histories with a greater risk of defaulting to increase. This sub-prime lending has been viewed as one of the causes of the debt crisis. Mortgage frauds have been confirmed and predatory lending has also been viewed as causes of this financial crisis (Moseley 1). Further, it has been argued that the regulatory framework was not able to keep up with the pace of financial advancements. Some laws were bypassed and their enforcement weakened in parts of the financial system.
As the housing bubble expanded, the U.S. households and financial institutions became increasingly indebted as a result of over-leverage contributing to its collapse. The use of adjustable rate mortgage, mortgage backed securities, credit default swaps, collateralized debt obligations and other complicated, modern financial innovations were expanding, thus becoming leading causes of the debt crisis (Folbre 1). Market participants failed to precisely evaluate the risks associated with the financial innovations like the MBS and CDOs. They were not able to assess its impacts to the economy and the overall financial system. This resulted into great losses with many banks left with very little funds to continue with their operations (Moseley 1).
Solutions for the U.S. Economic Crises
The United States is recovering from the great recession that it has been going through in the recent past. The financial system as well as its growth has stabilized. Though, the economy is recovering, the process has been slower than any other in the past. Unemployment remains high even as the economy struggles to add jobs (Solomon, 5). Support from the fiscal stimulus and the turn in the inventory cycle is reduucing, thus leading to slow growth.
The long term implications of structural changes are very significant in the recovery of the economy. Growth and employment resulting from proper credit markets will contribute to the much appreciated economic recovery. Long-run imbalances in this sector needs to be rectified for the economy to enjoy a healthy economy (Solomon, 2). Unemployment trends needs to be reverted to drive sustainable growth in future.
The U.S. requires a long term plan for higher levels of financial and real investment to rebuild the economic foundation for sustainable long term growth. The savings rate must increase significantly to start generating sufficient wealth to cater for financial needs in future. Real investments will improve infrastructure, thus generating wealth required to support the future needs of retirees. The U.S. economy needs to invest in health care infrastructure and manufacturing sectors that will meet future global and the U.S. economic needs (Solomon, 5).
The Role of Policy
Improving the quality of regulation and oversight and the clean-up of the financial system is a necessity. A greater balance on the economy needs to be facilitated, spanning the household, government and external sectors. However, greater taxation rates and lower spending will be required once the economy has stabilized. Job training, federal support for unemployment benefits and investment tax credits are allowed (Solomon, 4).
The entire restructuring process will come at substantial cost to everyone. To improve the standards of living, elevated levels of investments and technological advancements are required. The U.S. needs to invest in innovative technology, education and job training in order to achieve long-run sustainable economic growth (Moseley 1).