Economics Essays - A Recession in America

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A Recession in America

In macroeconomics, a Recession is decline in the Gross Domestic Product (GDP), or negative real economic growth, for two or more successive quarters of a year. A recession may involve decline in coincident measures of overall economic activity such as employment, investment, and corporate profits. Recessions may be associated with falling prices (deflation), or sharply rising prices (inflation).

A severe and ugly U.S. recession is inevitable. Over the past year, there have been warnings of a worsening housing recession, a severe credit crunch and financial meltdown, high oil prices, unemployment, and a saving-less and debt-burdened consumers being on the ropes causing an economy wide recession. Higher oil prices have put a squeeze on households. Low unemployment and solid wage growth have been a big reason for consumer’s resilience thus far. The Fed Funds rate will be down to 4% by January and below 3% by the end of 2008.

By early next year, output and jobs could be shrinking. The main cause is the imploding housing market. With house prices lower and credit conditions tighter as a result of the subprime crisis, households can no longer borrow against capital gains to support their spending. Unemployed individuals are unable to earn money to meet financial obligations. Failure to pay mortgage payments or to pay rent may lead to homelessness through foreclosure or eviction. The loss of health insurance benefits that comes with unemployment increases susceptibility to malnutrition, illness, mental stress, and loss of self-esteem, which may lead to depression. Recession or not, America faces a tricky and rough road ahead.

Some of the leading analysis on Wall Street (David Rosenberg of Merril Lynch and Jan Hatzius of Goldman Sachs) are talking about a US recession and a credit crunch reducing lending by $2 trillion. Richard Berner ( a most sophisticated economist and analyst) has written a piece titled “The Perfect Storm of the US Consumer”. Berner states, “Serious pressures are mounting on the US consumer on five fronts: Job growth is slowing, surging energy and food quotes are draining purchasing power, adjustable rate mortgages are resetting, lending standards are tightening, and housing wealth will likely decline. Do these dark clouds finally and ominously herald the perfect consumer storm?”

So at this point the debate is less and less on whether we are going to have a recession that looks inevitable; but it is rather moving towards a debate on how deep, protracted and severe such a recession will be. But the financial and real risks are much more severe than those of a mild recession. We could see a generalized run on some banks, broker dealers go bankrupt, a collapse of the ABCP market, and defaults and losses in subprime, near prime and prime mortgages.

Some economists found high correlations between governments spending as a percentage of GDP to unemployment from 1981 to the present using data from the Bureau of Labor Statistics. There is considerable debate among economists as the causes of unemployment. Unemployment can be the result of: insufficient effective demand for goods and service in the economy (cyclical unemployment), inefficiencies, inherent in labor markets (structural unemployment), or minimum wage laws, taxes, and other regulations that may discourage the hiring of workers (classical unemployment).

The rise in oil prices is due to a strong demand in emerging economics, which have accounted for as much as four-fifths of the total increase in oil consumption in the

past five years. In past American recessions the oil price usually fell. This will hurt the finances of Western consumers, and also the jobs of central bankers, by combining inflationary pressure with economic slowdown. Global crude oil prices rose more than $10 dollars during October. If current levels are maintained, it would represent a drag on annualized household income of approximately on percentage point.

The economic housing bubble began in 2001, especially in California, Florida, New York, the suburbs of Chicago and Detroit in the Midwest, the BosWash megalopolis, and the Southwest markets. It reached its peak in 2005-2006, and has been deflating and accelerating since. In 2006-2007, homeowners’ foreclosure rates increased. U.S. homeowners were unable to pay their mortgages caused a crisis in the subprime, Alt-A, CDO, CDX, mortgage, credit, hedge fund, and foreign bank markets. The U.S. Treasury Secretary called the bursting housing bubble “the most significant risk to our economy”.

The housing bubble is an economic bubble that occurs in local or global real estate markets that is characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. The housing bubble in the U.S. was caused by historically low interest rates, poor lending standards, and a mania for purchasing houses.

The impact of booming home valuations on the U.S. economy since the 2001-2002 recession was an important factor in the recovery of the Great Depression because a large component of consumer spending came from the related refinancing boom, which simultaneously allowed people to reduce their monthly mortgage payments with lower interest rates and withdraw equity from their homes as values increased.

Former U.S. Fed Chairman Alan Greenspan said, “we had a bubble in housing” and also said in the wake of the subprime mortgage and credit crisis in 2007, “I really didn’t get it until very late in 2005 and 2006”. The mortgage and credit crisis was caused by a large number of homeowners unable to pay the mortgage as their home values declined. Freddie Mac CEO and Richard Syron concluded, “We had a bubble,” and concurred with Yale economist Robert Shiller’s warning that home prices appear overvalued and that the correction could last years with trillions of dollars of home value being lost. President Bush said of the U.S. housing boom in early 2006: “If houses get too expensive, people will stop buying them…Economies should cycle”.

I can see the severe and credit crunch of Americans daily. People depend on each other to make a living. When people lose their jobs, many others suffer. Not only these men/women and their families hurt, but also the businesses. People have less money and can only afford the necessities. Banks hurt because borrowing money is limited. Sales are hard to make, so it’s much harder for the businessman. Even the people who have money do not want to invest. The marketing housing is terrible. The oil prices are ridiculous. People can barley make ends meet. Consumer confidence in the U.S. economy has already fallen. It cannot be long before consumer spending stumbles, which in turn would hurt business’ profits and investments. These bad conditions spread over the entire economy of the country. Hopefully, by now some of the people in these powerful and political offices will start thinking about these serious and dangerous systemic financial crisis that could emerge in the next year and what to do to prepare for it. Americans need assistance, and we need it now!