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A case study on the united states finacial crisis

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            A case study on the united states finacial crisis

                                               Problem Definition

                                   Symptoms & causing factors

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            The United States of America is experiencing one of the worst financial meltdowns in her history after the great depression of 1930. The world will relive the climax of the financial crisis that was experienced in September 15, 2008 also dubbed as the Black Monday following the weekend collapse of legendary Wall Street firms, Lehman Brothers and Merrill Lynch and other firms showing signs of collapsing.

The financial crisis started way back in 2002 and has culminated into an economic meltdown that has put the world’s “anchor” currency, the dollar on the weighing scale. The dollar has declined in value compared to the European community currency, the Euro and the Japanese Yen. [Kenneth Jost, 2008]

            The dollar which has been the major currency used in virtually all international trading has caused the price of oil to escalate. Oil producing countries of the Middle East are considering increase the prices as the dollar continues on a down ward trend in bid to cover expenses.

            The crisis also has affected the US mortgage industry with many firms closing or seeking bailout by entering into mergers with other firms or even seeking help from the federal government. The federal government is turning to foreign investment corporations for financial assistance to boost its treasury and hence increasing the treasury debt. [Kenneth Jost, 2008]

            The prices of food have also not been spared as they have tremendously been increased. Investors are turning on the food industry to invest their surplus money as the financial sector is on a down ward trend. This has created much unrest in developing countries.

            Mortgage defaults are on the increase, current crisis has undermined the ability of Americans to secure good paying jobs, service their mortgage in good time, and even save. The mortgage firms have taken the initiative to repossess houses cars and other properties from owners who have failed to honor their part of the deal. Barbara Mantel, 2008]

            Cases of bankruptcy are on the increase as Americans are pilling too much credit card debt. Many Americans have opted for credit cards that are offered at competitive terms by over 6,000 credit card issuing companies.

            There is also the fact the lending firms are giving mortgages to people whose credit worthiness is subject of doubts and therefore can not afford to service the debts in good times as their income are far below their basic needs. The consumer debt is growing at an alarming rate, an average American possesses about four credit cards a phenomenon that has resulted into a debt explosion. [Kenneth Jost, 2008]

            Many Americans are spending the prime part of their income in servicing household debts which is chiefly comprised of home. Many Americans are nurturing dreams of owning their own homes. Student loans are becoming easier to access, thanks to new regulations by the congress that has made the acquisition of loans by students almost automatic.

            The financial crisis has culminated into mass lay-off of workers, for instance, the collapse of Wall Street financial institutions resulted into thousands of job losses. Other sectors of the economy have also suffered a lot and far many Americans are now unemployed living on credit cards and therefore making their credit worthiness worse and hence deepening the next recession. Many Americans have been declared bankrupt as a result of failure to honor their debts obligations. [Barbara Mantel, 2008]

            There is also the China challenge on the dominance of the US as a strong economic force in the globe, a phenomenon exhibited by the 2008 Beijing Olympics television display of her current economic might to millions of viewers. She is now the second largest global exporter after Germany and the third global importer after US and Germany.

            There is also looming problem that the foreign investment firms may begin to doubt the ability of the Americans to honor their debts and therefore use restrictive measures such as hiking the loans interest rates in bid to discourage borrowing, a move which may make borrowing more expensive and also plunging the dollar.

                                    Justification for problem definition

            The current financial crisis that has engulfed the world’s super power is wholly blamed on the backfiring of the credit and mortgage industry policies, which allowed the lending to virtually everybody, as a result the lending firms could not survive and therefore to close or even seek bailout from out sources. The financial crisis that was experienced at the Wall Street is a testimony to this argument, as the financial wizardry exhibited by credit lending firms chiefly occasioned by a system of government that did not have any regulatory controls or supervision from the federal government led to the collapse of major credit rating companies, private companies owned by banks that markets mortgage securities. The credit rating companies did not provide reliable ratings to the would-be purchasers to rely on in making decisions on whether to buy mortgage s or not.  [Kenneth Jost, 2008]

            Initially the Americans were known to be cash and carry customers, the economy comprised of three quarters peasant farmers. The majority Americans did not know of credit cards, they used to borrow from fellow farmers or merchants to buy very essential items such as seeds, equipments, and fertilizers. With the emergency of the industrial revolution, other means of getting credit emerged. However, this changed when industries started making commodities which were priced highly, hence making consumers unable to pay through cash. With the increase of the population and increase in poverty rates the demand for the use of credit cards grew tremendously. Many working class and middle class Americans have since been using credit cards to finance their necessities. Another factor to rapid transition from cash payments to credit card buying was occasioned by the state of competition that rose between banks and non-bank institutions that ventured into the issuing of credit cards. This resulted in lowering of interest rates thereby luring many Americans to opt for using credit cards for their shopping needs. The volume of household debts that comprises of home loans, car loans, and other types of debts have increased by large margin and hence it has killed the any form of saving or even investing as many Americans are forced to spend the biggest chunks of their income on the repayment of the debts.  [Barbara Mantel, 2008]

            The issue of employment also has contributed to the increased use of credit cards, Americans whose annual income is smaller than their annual expenses have opted for using of credit facilities to boost their consumer powers. Other incidences of laying-off has made Americans to resort to using credit facilities in order to sustain themselves as they look for other job opportunities or even service other urgent debts - using debts to pay debts.  [Barbara Mantel, 2008]

            Another phenomenon that resulted into increased consumer debts was the introduction of mortgage system. It is known that between 1890 and 1940 majority Americans were renters with only a small percentage of the population that owned houses. The election of Franklin Roosevelt as the president heralded the era of homeownership through a newly created Federal Housing Administration, a body that facilitated the easy access of mortgages to the populace. Many Americans “benefited” from this program which indiscriminately gave mortgages anybody without proper assessment of their credit worthiness’, a phenomenon that resulted in many citizens failing to service their mortgages in good time or even sought for other loans to service mortgages hence raising their debt volume and compounding the problems the more. [Barbara Mantel, 2008]

            The soaring college tuition fees have also caused too many students seeking for more loans to see them through their university and college education. These loans act negatively on the future lives of the students as they are forced to repay them when they first get jobs and therefore denying them a chance to start saving or even investing. The repayment of the loans also affect the social life of many ex-students, some postpone marriage until they are through with loan repayments an exercise that may take a long time to accomplish. [Barbara Mantel, 2008]

            The payday lender system off accessing credit facilities to willing customers has resulted to the credit giving crisis in the US. Americans can acquire as many loans as they are willing to pay since the payday lenders terms are competitive when compared to those of financial institutions. They are easy to acquire and therefore they are mostly popular with low income earners who opt for them to service other pressing debts given by banks. However, they come with huge price, they gather up to $15-$20 for very $100 borrowed for a duration of two weeks. The secret behind them is that they are not short term really as one can acquire a new loan to service another one; they target those who can not pay in good time so that they pay the handsome charges in future.  [Barbara Mantel, 2008]

            The plunging of the dollar against oil producing countries currencies has resulted to increased consumer spending especially on the buying of locally manufactured commodities. When the dollar decreases in value the oil prices always go up making the extra costs transferred to the consumer inform of taxes. The value of the dollar and that of oil have been depended on each other due to the fact that many oil exporting countries tie and value the oil prices in relation top dollars. The Middle East being the chief world oil source has considered hiking of the prices of the oil as the dollar continues to depreciate in value. This is a necessary move and justifiable as one of the ways to cater for expenses incurred in the extraction transportation of the oil to the final destinations. It should be noted that the dollar has been the unit of measure against oil and therefore any slight shake on the stability of the dollar should lead to adjustments of the oil prices. [Peter Behr, 2008]

            The dollar value versus the price of food has also contributed to the financial crisis that threatened many American citizens. Many citizens are finding it hard to put a balanced diet meal on the tables of their families without using credit facilities. In light of blurred future in financial investment sector many international investors are turning to the food industry to invest their capital. This has resulted to a situation whereby the price of food stuff has tremendously raised due to more money that is being dangled by the investors to entice framers to sell their produce at low prices which is resold to the consumer at exorbitant prices. [Peter Behr, 2008]

                                   Alternative course of action

            Following the ripples that were witnessed on the Black Monday the federal government through the concerned body, Federal Reserve under the chairmanship of Ben Barnanke embarked on a rescue mission dubbed the “Bail Out Plan” to save the demise of more Wall Street firms. Although economic ripples and downturns are inevitable in economic systems measures that seeks to limit the freedom of financial institutions in their activities of lending should be put in place. The nature of the economic crisis in the US is characterized by lack of regulatory controls in the financial market, a phenomenon that has caused individual firms to incur untold losses. The following are some of the measures that can salvage the current economic situation in the US.

            In order to instill discipline and sense in the US financial system the following key objectives should be accomplished;

elimination of unnecessary burden and cost;
consolidate supervision of the activities, capital adequacy, risk management, internal control, corporate governance and overall safety and soundness of all US  financial institutions;
improve supervisory cooperation, consistency and effectiveness;
promote a more unified, coherent and transparent rule making process;
support a shift towards more principles-based supervision and;
Provide more comprehensive supervision of the financial system as a whole.
NB: The Federal Reserve should be given the legal muscle in order to keep a close regulatory role on the financial system. The measures can be divided into short-term, intermediate-term, and optimal in order to address both short-term and long-term challenges of the much liberalized financial system and also to achieve the above mentioned goals. [Kenneth Jost, 2008]

Short-term:

·         Expand the membership of the presidential working group on financial markets a membership that will include the heads of all the leading banks regulatory agencies;

·         Create a federal mortgage commission that will help to establish uniformity in setting federal standards; Review Federal Reserve decision to allow borrowing by investment banks (non-depository institutions).  [Kenneth Jost, 2008]

Intermediate-term:

·         convert thrift (savings and loan) institutions to nationally chartered banks over a period of two years;

·          rationalize federal supervision on state-chartered banks;

·          create a mandatory federal charter, administered by the federal reserve, for payment and settlement systems that transfer funds between financial institutions and their customers;

·          merge securities and exchange commission (SEC) and commodity Futures Trading Commission (CFTC) eliminate special regulation of “investment advisors” in comparison to brokers and dealers and;

·         Establish an office of National Insurance within the treasury to administer optional federal chartering for insurance firms. [Kenneth Jost, 2008]

Optimal:

·         create three part “objectives-based” regulatory structure for financial sector focused on market stability, prudential financial regulation and business conduct regulation;

·         designate federal reserve as market stability regulator with authority to collect and disclose information from financial institutions, and in conjunction with other market regulators take corrective measures when necessary in order to facilitate a stable market;

·         create a new prudential financial regulation agency with authority to regulate all government insured financial institutions;

·          create a new conduct of business regulatory agency to regulate business conduct across all financial institutions;

·         Create a federal insurance guarantee corporation to provide insurance services for all institutions regulated by the prudential financial regulator and;

·         Designate SEC as corporate finance regulator for general issues related to corporate oversight in securities markets. [Kenneth Jost, 2008]

                                               Evaluation of alternatives [Kenneth Jost, 2008]

            The above alternatives have got both strong points and weak points depending on ones position in regards to the  whole thing, for instance a proposed regulation that restrict the freedom of the financial institutions will be vehemently opposed by proprietors of the institutions and vice versa.

            The first alternative of expanding the membership of the presidential working group that incorporates bank heads will make sure that, there is no friction between the federal government and the banks whenever it comes to matters of policy making. On a negative note the proposal will hardly be impacting because it fails to address the root cause of the problem.

            The creation of a federal mortgage commission will go along way in fixing terms and conditions of mortgage standards while on a negative side it will kill competitive spirit which leads to favorable terms for the consumers.

            The conversion of thrift (savings and loan) institutions into chartered banks will go along way into inducing sanity in the regulation of loan interests and savings terms and therefore abolish exploitation of consumers. On a negative side the conversion will lead to sluggishness in terms of service delivery as the nationalization will kill the spirit of competition.

              The rationalization of supervisory roles by the Federal Reserve will help to streamline the financial institutions by monitoring its progress and intervene incases of need. On a negative side it will affect the entire financial system as compared to other foreign financial systems.

            The creation of federal charter administered by the Federal Reserve for payment and settlement will help induce a sense of understanding and efficiency between financial institutions and financial institutions and their customers, however, it may cause unnecessary legal tussles when dissatisfied customers or financial institutions uses the leeway to default payment.

            Merging of the Securities and Exchange Commission and commodity futures trading commission will help reduce or even eliminate unnecessary hurdles placed by brokers and dealers. While on a negative note this will bring a lot of misunderstandings and undue tussles as the two bodies have got clearly definite independent roles.

            The establishment of an office of national insurance within the treasury will help to administer optional federal chartering for insurance firms, while negatively it will kill the competitive spirit within the insurance firms.

            The creation of three-part objective-based regulatory structure for financial sector will help to induce stability in the market while it will discourage innovations and the power of initiative.

            The designation of Federal Reserve as the sole market regulator will help disclose illegal secret deals that have been used by financial institutions to exploit citizens. The disclosure of information concerning financial institutions will act retrogressively in undermining the confidentiality rule that bars undue access to client information.

            The creation of a prudential financial regulation agency will make sure that the government insured financial institutions perform to the expected standards and within the set restrictions. Negatively it undermines the independency of such institutions and hence limits their overall performance.

            The creation of a new conduct of business regulatory agency will help to abolish cases of misconduct and also induce certainty among the financial business fraternity, however, this will not go down well with the nature of the financial system as is highly varied i.e. it incorporates commercial banks, investment banks, credit lenders, insurance firms etc.

            The proposed creation of a federal insurance guarantee corporation will help provide insurance services to all institutions regulated by prudential financial regulator whereas this is a noble cause it comes with some restrictions as it will mean that the insured firms will subscribe to the whims of the corporation.

            Finally the designation of SEC as corporate finance regulator for general issues will facilitate a close scrutiny on the trading at the securities market and hence create public trust. Negatively it may create feelings of dependency and may also lead to sentiments that points fingers to influencing of securities pricing. [Kenneth Jost, 2008]

                                   Recommendations

            The financial crisis that has engulfed the US has deep penetrating roots which need to be uprooted in order to tackle the problem squarely.  According to Travis Plunkett the legislative director at the consumer federation of America adopting any plan to rescue the situation is equivalent to telling the victims of hurricane Katrina who are stranded in the rooftops of their houses to hold on for another four years as you come up with a rescue plan! My recommendations are that the government should literary adopt a plan that will seek to protect home owners who were in the middle of paying their mortgage, or even are unable to continue paying the mortgages. Again a complete and a doable plan should be made in order to protect credit card owners against undue changes of payments terms. This is important because the genesis of the current credit system crisis emanated from the public failure to honor credit payments terms. The federal government should see to it that the mortgage firms do not repossess houses whose owners are unable to pay. The public should be sensitized on wise borrowing to avoid unnecessary borrowing and also be encouraged to develop saving habits. [Kenneth Jost, 2008]

                                   Follow up and Evaluation

            This study has unearthed the problems that are experienced by the Americans, the root causes of the problems are now a known truth, the solutions have also been proposed, and the only remaining part is the implementation. To determine whether the studies findings are doable the following methods will be used. It will involve scrutinizing the financial documents of institutions, interviewing of consumers, monitoring trends at the securities market, monitoring the consumer purchasing habits at various stores and many other methods. The process will take a period of three years as some programs will take time to be implemented.

                                               References:

Barbara Mantel, consumer debt, March 2, 2007. vol. 17, no. 9, pp. 193-216, accessed on December 7, 2008
Kenneth Jost, financial crisis, May 9, 2008, vol. 18, no. 18, pp. 409-432, accessed on December 7, 2008
Peter Behr, Troubled Dollar, October 2008, vol. 2, no.10, pp. 271-294, accessed on December 7, 2008

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