Causes Background Of The Current Economic Essay Example Pdf - Free Essay Example

Background United States is currently going through the rampant financial crisis and economic depression, manifested by failures in financial institutions substantially and the collapse of stock market increasing the intense market instability. With the increase in the real estate and property bubble and the flexible rate mortgages (FRM), the housing prices rose gradually. The banks began to increasingly lend out more loans to potential home owners encouraging the home owners to take on significantly high loans paying back with the interest rates. This didnt last for long as the interest rates began to rise in mid 2007 and the housing price started to drop significantly in 2006 leading into 2007. Large number of people went from tenants to homeowners due to the increase in subprime lending and homeownership rate in U.S considerably increased in large margin. This resulted to increase in house prices with unsustainable supply relative to rents which were going down (Timothy.2008). The refin ancing became more difficult in many states like California resulting to a rise of the number of foreclosed homes. Certainly many subprime borrowers had difficulty making their mortgage payments when the rise in housing prices stopped in 2006. In mid 2007, many mortgage lenders become bankrupt due the excesses of the subprime mortgage market gaining the crisis proportions. Failure to take effective action by the financial authorities and the Federal Reserve triggered surprising mayhem throughout the international financial system affecting the global financial markets (Fred, 2009). Causes of financial crisis According to Timothy (2008), the origins of the financial crisis occurred as a result of number of forces on which some were the product of market forces while others were product of market failures. Liquidity insufficiency in the U.S banking system was a main cause of the financial and economic crisis in United States which has currently led to collapse of financial insti tutions, banks, and downturn in global stock markets. The incentives created by policy and regulation both market-based and regulatory reasons also contribute to the crisis leading to a substantial financial rumble on international scale. The short term interest rates which were reduced led to the decline in inflation rates, and subsequent deflation slowing down the growth of the economy. Central banks policy rates regulations led to the deflation risks with high rate of international savings than perceived in the real investment opportunities. The investors became more confident as the rumble continued in the comparative solidity of macro, economic and financial conditions of the country with financial instruments. This aspect increased the credit risk and widely exposed the financial institutions to the risk of a less compassionate world. More weaknesses and vulnerable continues inhibit to the financial system as the interaction of these forces increase. The assumptions made by the financial institution also exposed them to major risks with the proliferation of credit risk transfer instruments driven uninterrupted liquidity. According to the Stock market investors (2011), the housing bubble in the U. S.A housing market suffered a great loss contributing to the collapse of key businesses and declines in the economic activities in many areas. The huge mortgages and unprincipled lenders led to the collapse of the highly developed real estate and property bubble making it unsustainable in the market. The increasing demand and consumption of financial assets with unsustainable supply mainly led to the collapse of the markets on which many places failed to essentially provide such financial assets. Effect to the current economic crisis The financial crisis affected the confidence in many banks and other financial institutions with the stock market experiencing systemic weakness throughout the entire financial sectors. This was accompanied by the dropping of the share prices for large, small, and investment banks losing a third of their value. The capital from consumers experienced continuous depletion due to the continuous foreclosure scourge eroding the financial power of the banks and other financial institutions experienced in many banks today. The actions taken by the banking institutions had considerable negative effects on the performance and liquidity of market as the market contributors and participants have taken measures in reduction of the reduce further loss exposure. Banks and other financial institutions are experiencing different types of liquidity and funding challenges as they have engaged in funding a wide range of different reliant liquidity and credit commitments The extensive negative effects of securitization and syndication markets has reduced the financial institutions accessibility to liquidity and their capability to control their assets and finances off the balance sheets (Fred, 2009). The liquidity of the financial conditions has further eroded as the market value of many securities declines, and investors unwillingness to finance more risky assets. This has led to cautious in strongest institutions, building up extensive platform of liquidity, reducing the leverage and bringing down the funding for the institutions leveraged counterparties. Measured and counterparty financial risks and ambiguity on the value of the market has increased with many hedges performing poorly. The coherent measures taken by the financial and other banking institutions in reduction of future losses exposure and risks have negatively affected the market functioning, increasing the liquidity implications for a large number of financial institutions and banks. The financial and banking institutions in United States such as investment banks , regulated banks and hedge funds should increasingly play an important role in ensuring the economical recovery. These institutions play a major role in provision o f credit to the country economy and have taken considerable debt and credit burdens from the investors. The Chairman of the United States Federal Reserve Board should bail out major banks and financial institutions in the country initiating economic incentive programs and enhancing important additional financial commitments in effort of enhancing the economic growth. Crisis Resolution In economic crisis resolution dynamic policy measures should be intensified and reinforced in the financial markets in an effort to downside risks. This can accelerate the growth for an economy with significant regulation in housing and other real estate transactions. This includes the monetary policy, liquidity provision. Macroeconomic and supervisory policies need to be enhanced in containing the risks. Monetary policy and liquidity instruments should be used proactively in dealing with the critical risk potential for the damage in financial markets. Provision of liquidity should be used to mit igate this risk in sequence of processes in reduction of the intensified risks at market liquidity environment. This involves the adjustment process in credit markets with substantial flexibility adjustment of these particular liquidity tools dimensions. Encouraging the financial restoration in the countries financial structures and systems implementations as expectations of the future change encourages new equity capital increase preventing the capital ratios from falling mainly on events, such as asset sales or cheap lending, that might intensify the credit crisis. Fiscal stimulus plays an important role in reduction of the downside risks to growth. This policy structure, macroeconomic stimulus, liquidity support and the targeted support for housing reduces the level of the risks bringing long term returns and growth rates parallel to the economys long term prospective. The long term regulatory reforms of the U.S. financial structure and methods should be simplified and impleme nted in balancing the capital and the market infrastructure in an effort to stabilizing economic forces in reaction to future financial market.