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US CRISIS 2008 & 2011

US CRISIS 2008 & 2011 

  • The largest economy of the world went through two major crises in the recent time and the worst since the great depression 1929-33. The crisis of 2008 was a “financial sector crisis,” the genesis which was sowed in the inverted financial system, highly over leveraged, as an inverted pyramid.
  • The mechanism of the overleveraging was through complex financial derivative products (products deriving value from an underlying financial assets) which had excessive risk.
  • Globalization of the financial system had happened even earlier to the economic globalization, resulting in a broad global financial architecture covering banks, investment banks, pension and insurance funds, housing finance companies, hedge funds all finely inter meshed with each other difficult to differentiate the financial products and the holders of such products.
  • These products were traded “over the counter,” outside the stock exchanges resulting in their being unregulated or any kind of supervision on their trading.
  • It was also driven by consumption led growth especially through housing loans making it relatively easy for people to get mortgage backed loans which were then sliced and diced as multiple risky derivative products. In 2008 the total outstanding of mortgage loans was around USD 15 trillion, more than the GDP of US and the financial derivatives market was of over USD 600 trillion.                                                                                US CRISIS 2008 & 2011
  • A default in the mortgaged loans brought down the financial system, resulting in an overnight shut down of around 140 banks, financial institutions, crashed the stock market resulting in the crisis also known as the “Global meltdown” and also as “subprime crisis.”
  • The US crisis of 2011 was a “fiscal crisis,” arising out of reckless fiscal spending over the past decade with deficit to GDP climbing to double digit in less than a decade.
  • This was due to compulsions of the US of mounting expenditure of social security and the crisis of 2008 only making matters worse, in terms of recession and also rising unemployment of one of the highest in the history of US, requiring increased spending besides monetary easing.
  • At the same time, taxes were never reviewed with tax rates virtually unchanged and on the contrary, as a response to the crisis in 2008, tax rates were lowered for boosting consumption in an attempt to revive growth.
  • The fiscal crisis occurred when the US hit the ceiling of the overall level of debt of USD 16.4 trillion, which meant that deficit could not be sustained through increased borrowing as done in the past. Further with fears of breaching the cap, there also arose the likelihood of a default at bonds due for payment could not be done through more borrowing, unless the cap was raised.
  • This resulted in the first ever down grade of the US rating by Standard & Poor in 2010. The Senate realizing the gravity of the problem passed a resolution of suspending the cap but with strict austerity measures in government spending and roll back of tax concessions given effective December 2012, resulting in a “fiscal cliff,” of the relative inability of the government to reduce spending and also raise taxes, in the wake of the growing unemployment rates and marginal growth of the US economy.
  • The US govt has to cut expenditure by USD 1.2 trillion over a 9 year period beginning December 2012.
  • In view of the fiscal cliff, US congress has further extended suspension of the debt ceiling till May 19, 2013. The fiscal crisis of the US has not been resolved but only postponed and the fiscal cliff would resurface in May 2013.                                                                        US CRISIS 2008 & 2011


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