As a result of globalization, the revolution in communication, the openness of the financial markets and other factors that make the world a small village, countries are interconnected. Since they influence each other, the impact might be either positive or negative.
A look at the American financial crisis: what’s next?
One of the most important reasons which led and might lead to financial crises in the future is the consumption habits of those who live on credit and above their means.
Another reason is the so-called “bubble effect” which occurred in the real estate mortgages. The U.S. banks gave housing loans to people who were not creditworthy, or were able to pay them back. Thus, a large group of people were not able to proceed with the mortgage payments. Many houses were taken away from their owners, about 1.3 million homes in 2007, up 79% from 2006.
This chain of events eventually made the largest banks declare bankruptcies worldwide.
What else led to the aggravation of the crisis of liquidity? What was the pin to pop this” bubble ” up?
Hedge and sovereign funds also contributed their share to the bubble burst. Sovereign funds are state-owned and they hold such financial assets as stocks, bonds, etc.
These funds also invested in structured (mortgage) products offered by the Wall Street banks since the major credit agencies such as Fitch, S&P and Moody’s put a triple A ranking (meaning the financial tools are of the highest quality and bear minimum or no risk for the buyer). In order to amplify their profits, hedge funds applied leverage — additional loans — which eventually lead to a higher volatility.
These activities have exacerbated the impact of the bubble effect in the financial crisis which was and still is going through the United States.
An economic convention states that when an imbalance occur in the free market, it resets itself back to equilibrium without any state intervention. But the U.S. financial crisis has showed that the market often fails to restore the balance by itself, let alone achieve any social justice or economic efficiency.
In my opinion, economic stability will be achieved only by combining the market mechanisms and the application of regulations, introduced by the government.
There are several views and scenarios when the United States’s economy will get back to an accelerated recovery:
1. The optimistic scenario
Individuals, investors and societies in general are concerned with the future of the economy and their jobs. But reassurance and emergency treatment programs could play a role to suit the size of the problem and solutions to come out of the crisis with minimal losses. A broader support for new entrepreneurs could re-ignite the economic growth in the U.S. And it would be about time because the share of young people starting businesses is at historic lows.
2. The pessimistic scenario
Many of us remember the Hollywood movie “Titanic” when the star of the film talks about her former fiance who was affected by the crisis of the great depression in 1929 and led to his suicide.
This is not a “movie” exaggeration , but in reality , the negative effects inflicted on investors, entrepreneurs and countries in this period, had led of some of them to commit suicide in despair and of a lot of them to bankruptcy. This crisis in the United States is believed to be worse than the crisis of the Great Depression in the early thirties of the last century.
Because of the interconnected economy, it also became complex. If the current state of the global economy is not going to be improved, the next economic downturn might be even worse than what we experienced 8 years ago.
3. The moderate scenario
This way the crisis is expected to continue for a few months or a year at the most predication, after that the US economy is supposed to recover and then the rest of the worlds economies. However, I think that the monetary stimuli are not enough: while the quantitative easing programs launched by the majority of the central banks worldwide prevented the world economies falling from the abyss, the real economy is barely improving.
There is another issue: can the US economy free itself from the chains that shackled it down, and catch up with the Chinese economy, for example? The time will tell soon enough.