Ben Bernanke and Sub-prime
Considering Ben Bernanke’s statements and economic forecast one year later, the downside has occurred. He mentioned the effect of consumer confidence and attitude about the possibility of inflation. Since that forecast was made attitudes across the board have shown no confidence in an economic upturn, or at least a belief that the economy is less than stable. The federal government has responded with the Economic Stimulus Package designed to increase consumer and business spending. The Stimulus Package will put actual dollars into the hands of consumers hoping to cause a real increase in consumer spending.
Bernanke stated that business capital expenditures should at least remain stable. However, an extra push was given in the form of additional tax writeoffs for large capital expenditures.
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In other words both consumer and business spending were leveling off or decreasing and needed a boost. Gas prices have remained unstable, rising and falling by nearly $1 per gallon in many areas. This constant fluctuation makes it difficult to assess the long term affect of gas prices on the economy. However, gas price fluctuations may not be as large of a downside as some other issues in the economy.
Consumers can shop long distance without using any gasoline. With the internet people can shop online eliminating to drive across town for a day of shopping. Employment and trade deficits continue to be of concern to economists, however these issues have been overshadowed by continuing developments and downturns in the housing and mortgage industries. The Downside At the time of the 2007 economic forecast, the housing market had already entered a slump. Bernanke stated that the subprime effect may be contained. However, that has not been the case.
The subprime debacle has remained in the headlines under many terms including: the housing crisis, the subprime mortgage mess, the foreclosure crisis, and the credit crisis. The housing crisis began after the price and sales boom in 2005. As housing prices began a rapid decline over one year, it became evident that the problem was due in part (if not in full) to the recent developments in the subprime mortgage market. Many subprime mortgages had adjustable rates which were unaffordable when the rate adjustment increased those monthly mortgage payments.
This was compounded by the fact that housing prices had begun a rapid decline. There was no way for homeowners to get out of those rising payments either by selling or refinancing. Homes no longer had the equity or value that they were expected to have. The Spillover and Its Affect The first spillover from the housing price decline was directly to the subprime mortgage market. Two years after the housing market meltdown, it has been discovered that the entire subprime market was the result of the collective genius of Wall Street investment firms.
Subprime mortgages had become a complex range of securities including bonds, hedge funds, mortgage-backed securities, collateralized debt obligations (CDOs) and other such terms that we now hear everyday on the news. Many have found that their personal investments – pensions, IRAs, as well as bank and corporate investments were heavily invested in subprime mortgages at least indirectly. What has resulted is a breakdown of the financial markets, both in the United States and internationally.
Daily news reports show that international investors and banks have been exposed to or involved in the U. S. subprime markets. Credit ratings on many investments have been lowered to the point of declaring some bank securities worthless. When banks have no collateral to borrow against, they have no funds to lend to their banking customers, even the ones with good credit. When investment houses get lower credit ratings, the value of a shareholder’s’s investments becomes worthless as well. As a result, the U. S.
dollar has lost footing against foreign currencies. This caused the government and the Federal Reserve to step in and literally change the way they put money into the economy. Until very recently, the Federal Reserve, the U. S. Central Bank, did not lend money to Wall Street investment firms. Realizing that the developments in the subprime market and the widespread use of subprime mortgages as investment vehicles, the Federal Reserve has come to understand that the subprime mortgage industry is at the very heart of our economy.
Changing key interest rates several times did not help, so the Fed had to put money into the area that is most likely to bring the economy into a recession. In other words, there has been a change in the banking and financial systems. Lending and borrowing fuel buying and selling, and saving and spending in the economy. Commercial deposit banks are no longer the primary source of capital to businesses and consumers, but investment banks are. To support this new source of business the Federal Reserve has begun lending to investment houses by the same means that it lends to banks – through short term loans.
Investment houses have also began offering smaller consumer based deposit and credit products such as money market deposit accounts and credit cards available at many major investment brokerages. Analysis and Conclusion The reason for the subprime spillover into other segments of the economy is because the economy and the way it operates is shifting. The U. S. economy, and the international economy may no longer be bank based. As governments begin to privatize certain operations, the way these organizations seek funding or capital becomes a private matter.
For example, when the Unites States government chartered private companies Fannie Mae and Freddie Mac to essentially operate the mortgage market, Fannie and Freddie raised capital on the U. S. financial markets as opposed to borrowing through banks. Right now the U. S. is at the downside of a bank based economy. What the upside will be is the complete shift to an investment based economy. As the Federal Reserve continues to support the investment houses, those will become our deposit institutions of the future. Once that shift is complete, the economy will stabilize and grow, even though it will be completely different.