While a number of government officials still would like to avoid using the seemingly taboo “R” word (recession) in referring to the state of the US economy, a number of factors would otherwise indicate that in fact, it has been in that condition for almost a year now, without showing any signs of letting up.
Plummeting stocks, rising unemployment, investment houses, once thought to be bastions of high finance,closing shop one after another, and a general feeling of alarm among the American people only support the inescapable fact that indeed, the US is facing an economic crisis such that has not been known since the Great Depression in the 1930’s.
While banks struggle to find ways of coping with the sudden surge in the mortgage foreclosures by coming up with tighter credit measures, consumers and businesses on the other hand, find themselves in the position of having their source of funds cut off because of these new regulations.
The federal government, in turn, responded to this abysmal turn of events by coming up with a much needed but hastily designed $700M bailout plan. It should have left the financial world in a much more stable state, yet in the end, did little to curb market jitters that have spread even to the European and Asian markets.
From Boom to Doom
The origins of this credit crunch are attributed to the housing bubble, which came about when in 2001, lowered loan interest rates which meant cheaper mortgage payments, subsequently led to a higher demand for housing and higher valuation of homes.
When the increase in the values of houses reached a peak in early 2005, the levels with which they had arrived at were no longer sustainable; and in the middle of 2006, home prices eventually went down fast, leaving a considerable number of homeowners with negative equity, or a mortgage debt higher than the actual value of the property.
So while the housing boom paved the way for many Americans to acquire properties, this also led to the eventual housing slump, which is at the very bottom of the current crisis.
When hundred of billions worth of mortgage-related investments went awry, the pieces just fell apart one by one.
The very first indication of some trouble in the market was in June 2007 with the collapse of hedge funds owned by Bear Stearns, which had put up some serious investment in the subprime market. In March of 2008, the Federal Reserve served as an intermediary to prevent a Bear Stearns bankruptcyby assuming $30 billion in liabilities and brokering its sale to JP Morgan Chase.
By this time however, more banks had learned that many of their mortgage-backed investments were doing poorly as the rate of prime mortgages going to default rapidly increased.
Things came to a head much faster in the third quarter of this year with the dramatic fall of prices of Fannie Mae and Freddie Mac, government supported mortgage finance companies. On Sept. 7, 2008, the Treasury finally announced its takeover of the two entities.
Shortly thereafter on Sept. 12, talks of the government stepping in and taking over investment house Lehman Brothers, emerged but unfortunately did not materialize, causing the financial-services firm to file for bankruptcy on Sept. 15, by far the largest bankruptcy filing in the history of the US.
This brought shock waves not only to Wall Street but also to the global banking industry; waves that were felt even more in the next few days.
Merrill Lynch sold itself to Bank of America® for roughly $50 billion to stave off a similar fate to that of Lehman. Sept. 16 saw the Federal Reserve propose an $85 billion bailout plan and take control of beleaguered insurance giant American International Group (AIG). And still, on Sept. 26, in what was undoubtedly the largest bank failure in American history, Washington Mutual succumbed to a $1.9 billion takeover package offered by JP Morgan.
The Government (Not Quite) to the Rescue
In an attempt to stop the stock market bleeding, the federal government came up with a $700 billion bailout plan which was meant to restore confidence in the markets and get credit moving again.
Even with President Bush imploring the passage of the bill, however, the House initially rejected the proposal, a move that sent stocks nose-diving even further on Sept. 29. The plan had to go through a series of amendments and compromises before it was passed in the Senate and Congress on Oct, 1 and Oct. 3 respectively.
The Bush administration is already putting in some $250 billion into banks for increased capitalization in exchange for partial ownership. Part of the bailout money is also intended to buy bad mortgages and other toxic debt held by financial institutions.
As the prospect of a severe global recession loomed even nearer, gains as those achieved in the early days shortly after the passage of the bailout package, were impossible to sustain. On Oct. 15, Ben S. Bernanke, the Federal Reserve chairman, categorically stated that even with the government’s intervention, there would be no quick economic turnaround as what was hoped for. As a result, the Dow plunged 733 points.
How are the Americans Dealing with the Crisis?
Manufacturing, Consumer Spending Dismally Low
According to the US Commerce Department, retail spending dropped at the fastest rate in three years last September, and Federal Reserve revealed as well that all 12 of its regional banks reported a slowdown of manufacturing and consumer spending.
Automotive companies from Asia to Europe to the US said sales for the month of October were the weakest in about 20 years as economic woes escalated and consumer credit tightened. In the US in particular, the numbers are depressing: vehicle sales for General Motors went down 45%, Ford Motors 30%, and Toyota Motors 23%.
Earlier, General Motors Co had indicated that after posting a huge third quarter loss ($2.5 billion), and if the state of the economy continues as is; it would run out of cash next year. Similarly, Ford Motors Co lost $129 million and made known its intention of cutting off more jobs.
Because of the reduced retail spending, factory activity subsequently contracted sharply in October, falling to its lowest point in 26 years. Evidence of this can be seen in the fact that Circuit City Inc, a consumer electronics manufacturer and retailer, announced that it would be closing 155 branches and laying-off employees as liquidity problems deepened.
The decrease in spending also means companies face the likelihood of continued high expenses even as demand for their product lines weakens.
No Christmas Shopping
Retailers, from the luxury chains to the major retailing stores, report a drastic collapse of sales, again a clear indication that consumers of all income levels were tightening the proverbial belts.
Even with the onset of the holidays, sales sharply fell compared to the same time last year, giving rise to the growing possibility that this could be one of the weakest Christmas seasons in decades. Even with stores discounting by as much as 30 to 40%, something unheard of previously during the holiday seasons, consumers still are not biting.
While sales drops off about 5 to 10% may not sound so devastating, it would be well worthy to note that store chains have fixed costs, and declines in the sales that large can spell a big difference in the profits, especially when factoring in the big discounts being given that many of these businesses can ill afford. An unhealthy bottom line would make banks think twice about offering any financing.
Because of these developments, financial analysts are anticipating a fresh wave of bankruptcies after the holidays, this time among the store chains.
Unemployment Rate Soars
Latest reports now disclose that another 240,000 jobs were lost last October pegging the unemployment rate at a 14-year high. The jobless rate consistently increased month after month since early of this year, spiking up to an alarming 6.5% just last month.
Not only are businesses cutting down on capital spending with the uncertainty of the market right now, but they are also laying-off employees by the hundreds too. Economic troubles have so far paved the way for the loss 1.2 million jobs since the beginning of the year. Even more distressing is the reality that more than half the job losses have been in the last three months.
The prognosis is definitely not good. Analysts are predicting unemployment to rise to as high as 8% by mid 2009.
According to Stuart G. Hoffman, chief economist of Pittsburgh’s PNC Financial Services Group, “The economy is slipping deeper into a recessionary sinkhole that is getting broader. The layoffs are getting larger, and coming faster. We’re likely to see at least another six months of more jobs reports like this.”
The Obama Administration
“To the victor go the spoils.”
And definitely, spoils would be an appropriate term for the severely besieged economy that President-elect Obama has been given the job, just days ago, to put back on its feet. Aside from the distinction of being the first black president in US history, the newly elected president also faces the uncommon position of taking over a country so deep in economic strife.
Speaking at a news conference Friday, his first after the election, Obama gave his word that his top priority would be help the more than a million Americans struggling to cope with lost jobs, fast-dwindling savings, and foreclosed homes, and strengthening the economy in the long term. In the same breath however, the person so profoundly associated with the promised and much-needed change warned against hopes of easy and painless solutions.
“It is not going to be easy for us to dig ourselves out of the hole that we are in,” he said, reiterating that there is still a great deal of work to be done before the economy’s state can be totally our danger. And then he added that he was confident that the country could do it.
Even while acknowledging that he will be president only on Jan. 20 of next year, incoming president Obama already has his top priorities set, starting with an economic stimulus package that would extend benefits to the jobless, extend food aid to the poor, send out Medicaid funds to needing states, and spend tens of billions of dollars on projects on public works.
The plan is slated to be deliberated on in a special session of Congress this month, but if for some reason it does not get approved during this time, Obama vowed that “it will be the first thing I get done as president of the United States.”