The current financial and economic situation Essay Example for Free

The current financial and economic situation Essay During my analysis of the current financial and economic situation, I uncovered how the effects of the situation are still being revealed. It is imperative to recognize that the situation is complex in nature and that is why we must comprehend how this dire situation came to be. We must also comprehend why we are seeing the consequences unfold, the various impacts of the financial bailout, and lastly how we might fix the situation. My research paper shall discuss in depth the effects of our ‘financial crunch’ on financial markets, such as on banks, credit unions, the stock market, the mortgage industry, and retail sectors. Because these key aspects of our culture have been negatively affected by the credit crunch, the middle class is feeling doubts about their capability to overcome this new harsh financial sphere that now exists. This paper shall carefully examine how the financial crunch has affected these individuals and thus the retail and sales industry. It shall also look at some top financial companies which require the bailout money in order to survive; for instance, Lehman Brothers, Bears Stearns, and AIG. Furthermore, we shall correlate how individuals unwittingly began to rely on credit as a means to obtain more expensive items that might otherwise be outside of their price range. In fact, we shall see that people began living beyond their means due to relying on credit versus cash purchases and this has lead to the financial mess that we are in today (http://www. economist. com/opinion/displayStory. cfm? source=hptextfeaturestory_id=11885697). In addition, I shall pin point key aspects of the financial bailout that were proposed to aid individuals in returning to their safe spending habits and thus aiding the financial retail markets. Our government is seeking to rectify the situation via the financial bailout and such governmental driven policies might in fact be essential for the development of new successful businesses and our infrastructure. The paper will need to distinguish if such policies and procedures can positively or adversely impact the financial and credit crunch situation that we find ourselves in. Towards the conclusion of the research paper, I will attempt to suggest how perhaps in hindsight we could have warded off this recession at an earlier time. My suggestions will holistically analyze how vital it is to see the â€Å"big picture† as a long term development and not simply focus on the short-term details of our dilemma. My in-depth analysis includes ‘re-valuing’ the American dollar, holding our politicians responsible for how they are spending or investing our tax dollars, absolutely educating people in how to stop relying on their credit cards for purchases, considering organic produce, and how â€Å"turning green† in the long run will be beneficial for everyone. Look more: problem and solution essay Our failure to tackle the beginning signs of the recession has indeed played a negative role in where our financial perspective lies today. Hopefully, the federal financial bailout that we find ourselves in having to come to terms will can help us learn from this experience and prevent it from occurring once again in the future. For these reasons the bailout became a pressing necessity (http://www. usnews. com/blogs/the-home-front/2008/10/3/5-reasons-the-house-passed-the-bailout-bill. html) What led to Our Current Financial Problems? The bottom line: It was the misuse of our money, risky endeavors of the mortgage and banking industry, and individuals turning to credit for the chance to procure non-essentials without paying upfront. Honestly, the true origins of this financial problem were due to being more careless with other people’s money than we are with our own money. This predicament was entirely supported by credit card companies and the mortgage industry seeking to make an easy buck. These entities were satisfied in granting high credit lines to individuals who they knew via trend and marketing analysis would be unable to pay their bills on time. This led to those corporations receiving millions based upon late fee charges and finance charges. As our public began to depend more and more on credit cards, they found themselves unable to surmount the incredible amount of debt that they had created (Velshi 16-18). Now with this situation, these individuals began to declare bankruptcy because they were unable to pay their bills and wanted the collection agencies to stop badgering them. This act was not something the credit card companies, banking industry, or mortgage companies had the foresight on how to handle. http://www. economist. com/finance/displayStory. cfm? source=hptextfeaturestory_id=11 885272 We saw that as prices rose, including oil prices, people were under pressure to meet their basic necessity payments, and began to make minimum payments on their credit debts. The fallout reflected in their credit ratings and scores dropping due to outstanding debts and responsibilities. This financial distress was seen early on by economists who were ignored businesses such as banking giants and mortgage entrepreneurs were busy making bucket loads of money. This was also shown in the economic bubble perspective, that consumer spending was slowing down because they were seeing their home values decreasing. The public had become used to the real estate market booming and decided to refinance their homes to lower their monthly mortgage payments. By doing this, they drew the equity out of their homes at the same time and spent this money in the retail industry. The retail industry saw such actions becoming common place and developed more lines of credit opportunities to compel people to get further and further into debt. The retail industry focused on charging late charges and finance charges to draw money out of people in this vicious cycle. The subprime mortgage industry and banking industries were similarly practicing unethical procedures. They used lax lending standards so they could make the most money as the home valued at higher levels and their return customers spent more to refinance to lower rates. When the introductory interest rates reverted back to the regular interest rates, individuals were faced with the impasse of either making their higher mortgage payments or trying to refinance on a home which they now owned more than it was worth. Such individuals were also weighed down with other debts, such as student loans, car loans, rising oil prices, increased costs in the retail sector, and the increase in the cost of living in 2001, which made it difficult to make timely payments. In the United States, we saw that home sales and prices fell sharply in March of 2007. Americans were also seeing high unemployment and the foreclosures began on homes. Overwhelming debt led to this severe economic situation and the recession that people were seeing. The stimulus and bailout is expected to help people face these problems. (http://money. cnn. com/2009/02/17/news/economy/obama_stimulus_meas_success/index. htm) For people overextended in their vicious debts, they now faced financial pitfalls as they had to select between making payments to debt collection agencies versus providing food for their families (http://news. bbc. co. uk/1/hi/business/7523234. stm). The Aug 7, 2008 article, â€Å"Home Truths: A housing slump helped cause the credit crisis. But its effect on spending may have been exaggerated† the Economist illustrates that when the housing bubble burst, new homeowners were suddenly faced with the opportunity to purchase homes at much lower prices. This made it more affordable for young Americans to obtain homes at lower prices if they could qualify through the banks. This article shows that for current homeowners and landlords, this difficult economic situation leads to them cutting back on their spending in order to overcome this â€Å"loss of wealth. † (http://www. economist. com/finance/displayStory. cfm? source=hptextfeaturestory_id=11885272) As this housing and mortgage bubble has burst it has also cracked the illusion that debt was the answer to obtaining more material items. We arrived at this recession because of lax loaning practices and standards. We can see that the financial sector cared about making money versus the right decisions about who to lend money to or even how much money should be lent. This is why the financial bailout has arrived. Historically we have seen that past causes of a recession can be either external or internal in nature. For instance, internal causes include high interest rates, high taxes, high spending, mistakes by the fed to curtail financial concerns, corporate fraud, and investor reluctance to invest. On an external front, some past causes of a recession include global stock market falls such as in Asia or Europe, wars, and other such financial mayhem in the world. Overall, opinions are often divided as economists tend to disagree about when and if we are in a recession but currently they all agree that our economy is in bad shape and it has been for some time. While they hesitate to say what has toppled our economy and caused stagnation, they are certain that a variety of facts has led to our current financial predicament. Both the internal as well as external causes have resulted in a global domino affect around the globes financial and retail spectrum. The best reference we have for this situation is the Great Depression were economists saw a sharp decline in international trade . During the Great Depression large businesses were unstable and the governement via the New Deal was charged with the task of limiting how much power businesses had and giving more power to labor unions. Regulations were put into place which increased the amount of taxes paid by large corporates which generated revenue for the government and helped the government lower trade tariffs which had caused international markets to sell less. As people decided to save more in the face of those economic hardships they wound up actually saving less because businesses saw retail expenditures drop. They then decided to balance out there budgets they needed to layoff workers. As the article, â€Å"Causes of the Great Depression Political Perspectves on Causes and Cures†, states, â€Å" The increased savings (reduced spending) †¦. contributed to price deflation, perpetuating the Great Depression†¦. Businesses, cut back on investment spending because they were pessimistic about the future†¦. (led to) less investment, fewer jobs, less consumption and even less reason for business to invest. † http://www. experiencefestival. com/a/Causes_of_the_Great_Depression_-_Political_Perspectves_on_Causes_and_Cures/id/4905687 Role of the Financial Bailout for Lehman Brothers, Bears Stearns, and AIG Lehman Brothers: The nation’s 4th largest investment bank, Lehman Brothers, made poor investment decisions in its real estate holdings. Lehman Brothers, was one of the first investment banks granted the rights to borrow emergency money from Fed as a loan like commercial banks are allowed to. The true issue that arose with Lehman Brothers was that it was a insolvency risk (http://www. moneyweek. com/investments/stock-markets/what-went-wrong-at-lehman-brothers-03809. aspx). They had a large number of loans related to real estate and because such assets depreciated in value with the real estate market bubble burst, the face value of such properties was marked as a financial loss (Muolo 42-43, 143-144). When the company attempted to sell itself to Bank of America and Barclays, they were faced with their potential bidders requesting government support because they didn’t know the true scope of Lehman Brother’s financial losses. The Treasury department refused to grant this support, and both banks walked away from negotiations. After this occurred, Lehman was forced into filing for bankruptcy. (http://cbs5. com/business/lehman. brothers. crisis. 2. 816615. html) http://cbs5. com/national/lehman. brothers. shares. 2. 814040. html http://www. moneyweek. com/investments/stock-markets/what-went-wrong-at-lehman-brothers-03809. aspx Bears Stearns: Unlike Lehman Brothers, Bears Stearns was unable to get banks to lend money to them. As investors lacked confidence that the company could repay the prior loans granted to it, the reputation of this 5th largest investment bank faltered. The final element that led to its demise was that investors believed that the bank would be unable to adhere to the prior complex agreements that it had with the many other financial institutions that it did business with. Because such financial relationships with other banks was precarious and if the bank failed, those relationships could send a ripple effect through the economy the Federal Reserve was forced to agree to support JPMorgan Chase’s decision to purchase Lehman Brothers (http://www. usatoday. com/money/industries/banking/2008-03-17-bear-stearns-bailout_N. htm). The Federal Reserve agreed to â€Å" fund $30 billion of Bear Stearns assets that would be difficult to sell quickly, raising the possibility that taxpayers could be on the hook for part of the bailout†¦. As far as Wall Street securities houses go, Bear Stearns wasnt too big to fail, says Steve East, chief economist for FBR Capital Markets. (FBMC) It was too interconnected to fail. This collapse was the direct result of the bursting housing bubble. Society saw that home prices rose and fewer people could afford to purchase, so lending banks created new types of mortgages to qualify people who would not have qualified otherwise for the traditional 30 year fixed mortgage. These subprime mortgages allowed banks and brokers to charge fees for the closings which gave them substantial profits but no risk once the loans were sold to Wall Street. Investors, such as Bears Stearns, purchased these bulk complex securities packages and remained profitable on the interest generated from these packages. But when the housing market started to crash, borrowers became unable to refinance and select to default on their mortgages. With more defaults piling up, companies like Bears Stears were left with assets which were reflecting as devaluation. AIG The situation with AIG (American International Group) is a precarious one. As of Sept 16, 2008 this globally based company underwent a liquidity crisis due to its credit rating being downgraded; thus, AIG was forced to post collateral promises with its trading counter parties. When the company sold its CDS to meet collateralized debt obligations it endured a sharp decline in their value. The Federal Reserve was then forced to financially prop up the company so it did not collapse; which would have caused financial ruin for the global economy as other companies would have also collapsed. The Fed then created $85 billion in a secured credit facility for AIG, and took over 80% of AIG equity stake (Velshi 18). This bailout was by far the largest U. S. government bailout of a private company, but it was smaller than the bailout of Fannie Mae and Freddie Mac which occurred earlier in Sept 2008. After this occurred, the share prices of AIG fell more than 95% in value to $1. 25 from its prior $70. 13 per share. Investors found that AIG valued the types of securities that it held at Alt-A and its sub-prime mortgage backed securities at 1. 7 to 2 times more than the rates used by Lehman Brothers, the largest bankruptcy in U. S. history. The following month on Oct 9, 2008 the company forced to borrow an additional $37. 8 billion as a second secured asset credit facility initialized by the Federal Reserve (http://money. cnn. com/2008/09/17/news/companies/aig_explainer/index. htm? postversion=2008091715). The defaults for the next months were increasing steadily which shows that the company itself was facing a big collapse. Then on Nov 10, 2008 the U. S. Treasury heralded that it would be acquiring $40 billion in newly issued AIG senior preferred stock, under the power of the Emergency Economic Stabilization Acts Troubled Asset Relief Program. Federal officials indicated that its $40 billion investment in AIG would enable the government to decrease the total risk exposure to AIG to $112 billion from $152 billion (http://news. yahoo. com/s/ap/20090302/ap_on_bi_ge/aig_rescue). During this financial bailout mayhem, the public learned that AIG executives squandered bailout money at an exquisite California resort. This â€Å"vacation† using bailout money cost $444,000 and included spa activities, festivities, and golf retreats. In addition, these executives also used $86,000 on a hunting trip to England; this with the Fed giving them additional loans of $37. 8 billion! They also used $343,000 on trip to Phoenix Arizona for an exotic resort there. So when does this bailout money end! Attempting to sell their assets, AIG has been unsuccessful in paying off its government loans. With the global economy taking hits in insurance businesses, AIG is being protected by the Fed from falling into bankruptcy. This financial support by the government has lead to the Fed writing off some of its loans as losses and further devaluing the U. S. dollar. Recently as of March 2, 2009 AIG reported a 4th quarter loss of $61. 7 billion dollars for the last three months of 2008. This loss impacted Europe and Asian trading markets as well. Financial Problems and How the Financial Bailout is Hoping to Address Each Point: Effects Both Here at Home and Abroad †¢ Problem: increase in unemployment as companies downsize Bailout Solution: $39 billion will be spent on health insurance for the unemployed who can use this money to pay for cobra coverage or Medicaid. In addition $43 billion will be spent to enable them to increase their unemployment benefits and receive job training for new positions. †¢ Problem: credit tightening and lending standards inflexible Bailout Solution: rescinding the requirement that a $7,500 first-time homebuyer tax credit be paid back over time, and giving loans to companies and new procedures to ensure that lending continues so that student loans, car loans, etc†¦would be easier to obtain (http://www. washingtonpost. com/wp-dyn/content/graphic/2009/02/01/GR2009020100154. html). In addition, changes to how mortgages were granted occurred http://useconomy. about. com/od/criticalssues/a/govt_bailout. htm) †¢ Problem: retail industries closing as public demand decreases, and infrastructure concerns Bailout Solution: $31 billion: Construction and repair of federal buildings and other public infrastructure along with water projects and mass transit projects. For retail industries and small businesses the government will double the amount they can write off for capital investments and vital business related purchase. (http://www. glennbeck. com/content/articles/article/198/20639/) †¢ Problem: decrease in global expansion efforts and trade between countries which affects emerging economies which depend upon the U. S. and U. K. for big and small purchases and exports in order to continue growth and expansion Bailout Solution: n/a. If the U. S. economy can get back on track this would coincide with other countries being less impacted by our poor financial situation. †¢ Problem: failure of the mortgage and real estate industries due to being unable to aid individuals with in refinancing or making new purchases because banks are refusing to lend money Bailout Solution: aid to struggling home owners, but not listed in bailout bill †¢ Problem: growth projections declining from 4. 9% in 2007 to 4. 0% in 2008 Bailout Solution: $275 billion in tax relief ($1,000 tax cut for families, $500 tax cut for individuals through SS payroll deductions) along with $20 billion spent to increase the food stamp benefit over 13% so as to help ease the rising food costs. †¢ Problem: inflation increases in oil, commodities, and food prices and energy issues Bailout Solution: $32 billion is destined for funding a smart electricity grid in order to reduce waste, and $16 billion is geared for research and development on energy related work, energy tax cuts, and credits (http://www. washingtonpost. com/wp-dyn/content/graphic/2009/02/01/GR2009020100154. html). †¢ Problem: individuals recognizing that the federal and state governments are over extended in war funding and not tending to our financial crisis in a timely or appropriate manner Bailout Solution: efforts to bring troops home, but not listed in bailout situation †¢ Problem: value of the American dollar and reputation has turned drastically negative Bailout Solution: n/a. Efforts to fix our tarnished reputation but the American dollar is devaluing even more due to the bailout. †¢ Problem: Freddie Mac, Fannie Mae, Bear Stearns, and IndyBank also being key examples of financial companies which all required immediate aid from the federal government in order to collapse (http://www. imf. org/external/np/speeches/2008/032108. htm) Bailout solution: Continued support of such institutions to ensure that they do not fail How Should We Fix the Regulation? As voting citizens, we must should insist that the government account for its spending habits and they must be made responsible for spending more than it can obtain via revenue. For companies like AIG which receive bailout money and spent it frivolously on expensive resorts they must be held responsible and the board of directors held accountable or given jail time. The cost of war has also been unaccounted for, so our new regulations need to decrease the amount of spending on that front. As the bailout takes our hard earned money it needs to be used on improving transportation, education, medical requirements, and even social security. Poor lending standards and practices must be better regulated for those seeking to get good refinance rates or purchase new homes, cars, or even student loans. As we are seeing a sharp rise in unemployment and off-shoring of jobs, it is improper that businesses which hire individuals in the United States are forced to pay unemployment taxes; whereas, companies which elect to outsource their labor force are not required to pay these same taxes. This means such companies have more money in revenue due to the fact that they are paying their employees less overseas and adding to the unemployment that we see here at home. This action is counterproductive because from a financial perspective organizations might save more money by outsourcing and not having to pay the additional taxes, but it also means that unemployment will continue to rise in the face of such activity. A fair technique would be to increase the taxes on companies with large profits, and grant a fair marginal credit to companies which employ workers in the United States. This activity would put money back in the hands of American workers who can then turn around and use their paychecks in the economy and ease the financial crunch. This would also allow them to learn how to manage debt more practically and not take the equity out of their homes to pay debt off. I suggest that we better educate ourselves in managing our finances and saving versus running ourselves into the ground in insurmountable debt. References: Amadeo, Kimberly (2009). What Exactly is the Bank Bailout Bill. 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Lynch (3/15/2008). USA Today. Red flags in Bear Stearns collapse. Retrieved on March 1, 2009 from http://www. usatoday. com/money/industries/banking/2008-03-17-bear-stearns- bailout_N. htm