Oct 8, 2020 in Political

Political Economy Analysis - 2008 Financial Crisis and Beyond

Abstract

This paper will analyze the cause of economic meltdown in USA in 2008 and beyond. It explains what went wrong and what could have been done to avoid the crises and it identifies its main contributors. It also looks at political contribution to this meltdown through the policies that were in place. It further looks at how the crisis affected individual citizens and how they were dealing with it. How the government involved itself in solving the meltdown is an issue that is analyzed deeply. Besides the paper entails the finding of the commission that was formed in 2009 by the government to address the issue. It finally looks at different theoretical frameworks, their application during the economic meltdown period and their relevance in today's economy.
 
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Economic meltdown is an issue that occurs for years due to a series of decisions and actions made in the wrong direction. Some implemented measures may provide a solution for a short time. However, later, they backfire, causing more problems. The situation in the USA that almost cost the country its economy was one of such meltdowns. Even though they eventually found a solution, Americans and financial institutions had already suffered and had made huge losses. Some organizations collapsed, while others had been disposed of through acquisitions by more stable corporations. Other countries that had financial links with the USA also suffered as the crisis had spread to more countries. This paper aims at looking at the primary causes of the economic meltdown, discuss how it affected the companies and households, and provide the solutions employed in tackling it.

1. The Problem Identified inside the Meltdown

The problem established in the meltdown was the collapse of the housing bubble accelerated by the fact that interest rates were low; credits were easily accessed and available, while mortgage rates were adjustable. The home costs had gone up in early 2006 and rapidly decreased in mid-2006 (Aikins, 2009). The decline of home prices made most buyers lose the ability to refinance their loans, which led to the increase in foreclosure rates between 2006 and 2007 (The Financial Crisis Inquiry Commission, 2011). That contributed to most Americans losing their homes, savings, and jobs and increased the risk of collapse of the economy and financial institutions. Financial institutions, which had direct links to mortgages and which had borrowed significant amounts against them, incurred enormous losses that were further increased by synthetic securities. These led to the massive crisis by lending companies and mortgage finances.

2. Financial Meltdown as Related to the Topic of Political Economy

2a. Financial Meltdown as a Political and Public Issue

The above-mentioned meltdown was a political issue because the government had to intervene to prevent the economy and financial institutions from collapsing. The crisis began spreading all over the world, and the investors had started backing away, which contributed to the meltdown in various ways, for example, in tax policy that exempted houses from cost gain. Citizens expected the government to come up with a solution or a plan that would save the situation. Consequently, to some point, the government had come up with the financial bailout to the collapsing financial institutions (Dobratz, Waldner, & Buzzell, 2011). The meltdown could not occur had the government initiated a policy to reduce the securitization of loans by the banks as they borrowed more loans to lend to the securities.

Furthermore, the meltdown was a public issue because when people foresaw the problem ahead, they stopped borrowing and some even considered taking their money back. That compelled some banks to give loans regardless of higher risks to be able to compete. With little deposits and no security details, some banks collapsed quite quickly. Even the banks with larger deposits had to turn to the government for the bailout to get more money to lend in an attempt to restore customers confidence, but this strategy failed (Dobratz, Waldner, & Buzzell, 2011). The bailout did not help because people, who relied on credit, could no longer access them quickly; hence, they also felt a pinch of the bank losses.

2b. Financial Meltdown as a Cause of Personal Problems for Individual Citizens

The crisis haunted financial institutions, consumers, and house owners. Since some of these establishments had closed down, many Americans lost their jobs, which led to higher rates of unemployment in the country. Most families reduced their spending yearly since they saw the need to reduce the debts. Those who were still employed opted to retire at a later age of above 62 (Aikins, 2009). The labor force contribution by men between the age of 62 and 64 rose between 2003 and 2006, which showed how willing these people were to work so that they could service their loans and mortgages (The Financial Crisis Inquiry Commission, 2011).

Those who retired and had their retirement savings said that their value had reduced by 30 % (Aikins, 2009). That was not a good thing, as they had not expected to strain financially after retiring. Therefore, they had saved money, especially investing in stock markets. The value of shares on stock markets also declined tremendously, and that compelled the stockowners to sell their shares at throwaway price to avoid more losses. Some relocated the retirement balances from the stocks. The stain was even more significant as their house value had dropped with a bigger margin (The Financial Crisis Inquiry Commission, 2011).

2c. Government Involvement in the Issue

After the crisis, the government could not simply observe the sinking of financial institutions and the economy. It gave bailouts to the corporations to revive them, although the strategy did not help at first (Aikins, 2009). Thus, in AIG bailout, federal officials assumed the control of mortgages by providing funds to keep them in operation for longer time. However, the government had failed to look at the risks and terms of this company. The company offered high-risk loans with minimal security, and later, they would be difficult to recover. It had also invested an enormous amount into mortgage-related assets, and their value went down. The company still negotiated for a larger rescue package with easier terms. There was also troubled asset relief program that planned to use funds to buy troubled mortgages. Therefore, $700 billion were channeled to the program to recapitalize the banks and other financial institutions (Aikins, 2009).

Another bailout was commercial paper funding limited that aimed at liquidity on a short-range financing market. It bought out unsecured and asset-backed papers for three months. The program operated until 2010 when it was closed down (Aikins, 2009). The key constraint the government had faced while addressing the issue was the opposition from legislators. Most lawmakers felt that the government had spent significant resources in resolving the meltdown crisis; hence, they had failed to pass important financial bills proposed by the federal government with the aim of offering sustainable solutions.

2d. Application of Theoretical Framework in the Analysis of the Crisis

  • Pluralist theory. As much as the government was busy making decisions, the key consideration was the size and importance of the company in contribution to the economy (Dobratz, Waldner, & Buzzell, 2011). Only large, influential companies were bailed out. Due to their size, they were not expected to fail after bailing out, and their plan of getting out of trouble was not examined in a proper way. They further securitized the mortgage companies and individuals with the aim of making more money. The perspective is applicable in the current economy where the government considers the economic influence of a firm before offering any help.
  • Rational choices theory. The president of the Federal Bank and the members had to make intelligent decisions regarding the companies intended for bailout. At some point, the president had to go against the suggestions of the members as he also looked at international interests (Dobratz, Waldner, & Buzzell, 2011). Moreover, the decisions were not to bail out some companies as well, as it could not have been possible to help all of them. The application of rational choices theory today can assist in solving economic issues like dumping by imposing trade quarters.
  • Elite theory. International companies were the greatest beneficiaries. Thus, some of them, such as AIG, received bailing more than others after the first attempt had failed, as they had not considered the risks involved (Aikins, 2009). This became possible because they could produce their products in the country with cheap labor and transport them to different countries. However, this act has led to robbing Americans of a chance to work in these companies since the US workforce expensive. China is the country's biggest threat as it has driven the world economy in the recent past, with most Americans getting jobs in China.
  • Institutionalists theory. The crises arose from institutionalization where big companies aimed at making great profit and ignoring the medium and low-class institutions. Thus, they came up with the rules that could not fit these small organizations. Securitization failed the big corporates, as the compensation system lacked a proper link to the risk management (Dobratz, Waldner, & Buzzell, 2011). The driving force of any countrys economy is the numerous small businesses as compared to the big firms, and once they are negatively affected, the countrys economy will decline.

Why Pluralist Theory is Better when Analyzing the Situation than Other Theories

Pluralist theory is best suited to explain the American fiscal collapse as compared to other perspectives because every business activity is under the control of the government decisions that lean on elite institutions (Dobratz, Waldner, & Buzzell, 2011). For example, the decision to bail out some companies focused on the size of the organization and its contribution to the economy. The perspective is applicable in the current economic situations, whereby the government accepts free market that has an unhealthy competition to local industries.

Conclusion

All the causes of the meltdown in the US financial sector were human made, and no natural cause was to blame. That means that the crisis could have been avoided with proper planning or contained early enough as soon as initial signs had been detected. The steps taken by the government were beneficial because finally, the crisis ended. Furthermore, the government formed a commission in 2009 to look at the real cause of the crisis. The report has been beneficial since it guides in solving the problem at hand, and it helps to provide tips for avoiding a crisis of similar nature in the future. Theoretical perspectives also played a significant role in understanding the fiscal collapse; hence, it is important to use them while addressing the current economic challenges. Furthermore, there is a need to have a comprehensive legislation so that it could help in regulating various sectors of the economy like the real estate, stock markets, and banking institutions.
 
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