As I have continued to watch the fallout from the subprime mortgage fiasco stemming from this summer, I have delved further into the implications and history of such massive loss generating trades on Wall Street.
A recent Wall Street Journal article illustrated the magnitude of the problems resulting from the troubled subprime mortgages and the need for the federal government to intervene. As hedge funds have blown up, senior Wall Street professionals been fired, and wealthy investors lost billions of dollars, the average citizen will most likely endure the greatest hardship of all.
An estimated two million citizens who purchased adjustable rate mortgages expect to see interest rates jump in the distant future. In other words, a significant proportion of homeowners – at least 2 million in fact – will face significantly larger mortgage payments within the next two years. In fact, interest rates on as much as $362 billion in subprime home mortgages are expected to rise in the coming year, according to Banc of America Securities.
To prevent home foreclosures stemming from these increased mortgage payments, the Bush administration is leaning on Congress. Treasury Secretary Henry Paulson is pushing for legislation that would change the financing terms of these troubled subprime mortgages “and support a new White House proposal to use tax-exempt bonds to refinance troubled subprime mortgages” (Phillips). Additionally, Mr. Paulson believes that the administration will be aided by private industry that will place a freeze on adjustable rate mortgages sometime this upcoming week. The thinking goes that both actions when combined should sufficiently respond to the subprime problems aggressively enough and bring stability to the markets.
Imy opinion, the strength of the Fed’s suggested response to the subprime problem remains unclear. Programs already exist that would significantly decrease the cost of loans to a large portion of homeowners with subprime adjustable rate mortgages. The president of the Federal Reserve Bank of Boston actually believes that this option should be available to half of the subprime ARM market according to a recent speech. The need for this option to be exercised is all the more prescient upon repeatedly reading how home owners were “duped” into borrowing at potentially exorbitant costs that they would be unable to meet in the future. For example, “In an interview, Mr. Rosengren said some borrowers with relatively good credit may have been steered into a subprime loan because it was more profitable for the lender. Other borrowers ‘who might have been considered prime based on their credit score’ wound up in subprime loans because they didn't have adequate funds for a down payment, didn't wish to document their income or assets or wanted to buy a home that was more expensive than they could have qualified for” (Phillips).
However, the Treasury is officially calling for a freeze on interest rates in the mortgage industry that would affect lenders and investors in mortgage-backed securities. Hopefully Mr. Paulson’s proposal achieves its most moral goal of preventing further home foreclosures in addition to bringing calm to the markets. However, the notion that such a “bail out” of lenders, borrowers, and investors alike orchestrated by the Fed suggests “moral hazard.” As the Wall Street Journal defined this term recently in August 2007, “moral hazard is an old economic concept with its roots in the insurance business. The idea goes like this: If you protect someone too well against an unwanted outcome, that person may behave recklessly” (Browning).
The recent possibility of moral hazard strongly stirs in my memory the history of Long Term Capital Management, the private investment partnership that was once the envy of Wall Street. This obscure arbitrage fund borrowed nearly $100 billion in assets from Wall Street’s most respected investment banks and institutions throughout the 1990s. The fund participated in trading derivative contracts often intertwined in fact with mortgage securities and making astronomical bets on borrowed money was its jeu de guerre.
However, Long Term Capital Management, just like several recent and highly respected, risk management funds nearly collapsed bringing down with it nearly $1 trillion worth of exposure to a variety of markets (Lowenstein 206 – 210). To prevent LTCM’s default, the Federal Reserve invited the heads of every major Wall Street bank such as Bear Stearns, Merrill Lynch, Morgan Stanley Dean Witter, and Goldman Sachs. They were brought together to stop the panic that led to exuberant and highly irrational selling off all types of securities on the market – even the most historically risk free Treasury bills, for example. While LTCM did not default, the parternship was eventually dissolved and all of the fund’s investments were stripped by its institutional investors – the aforementioned investment banks.
The federal government was instrumental in forcing these companies to cooperate with each other and effectively “bailed out” LTCM to prevent further battering of the markets. Indeed, you can bet that many intelligent individuals cried foul and said the risk of moral hazard was too high to rescue LTCM at the time. However, the Fed believed that the cost of failing to do so would be greater than saving the fund.
I find it so interesting that again the federal government is devising plans to stop another market (this time the subprime mortgage market) from naturally correcting itself. To allow the market to do so would simply be unfettered free market competition, laissez-faire as it should be. Indeed, investors in the future would more carefully scrutinize making such risky bets as they did with subprime mortgages, collateralized debt obligations (cdo’s) and other related instruments. However, as history has proved time and again, the Fed has appeared ready and willing to bail Wall Street out such as during the recent financial crises in Mexico, Thailand, South Korea, and Russia (where a bailout was attempted).
Works Cited
Lowenstein, Roger. "When Genius Failed: The Rise and Fall of Long Term Capital Management." 2000. 21 Nov 2007.
Showing posts with label Public Square. Show all posts
Showing posts with label Public Square. Show all posts
Monday, December 3, 2007
Sunday, November 25, 2007
Time For Change?
As the U.S. Federal Reserve lowered interest rates by a quarter percentage point this week, a number of countries in the Middle East followed suit. Specifically, countries such as Saudi Arabia, the United Arab Emirates, Qatar, Kuwait and Bahrain adhered to the Fed’s decision, because their currencies are pegged to the dollar. This is undoubtedly the case for most of the Persian Gulf nations that are now facing severe inflation. “The combination of soaring oil prices and the tumbling dollar is distorting their economies and fuelling inflation,” according to the latest print edition of the Economist.
These concerns over inflation in all of the oil-rich states suggest that central banks should in fact be raising, not lowering rates. However, “monetary policy in the Persian Gulf states must mirror U.S. moves to avoid pressures from capital drifting to the currency with the most favorable interest rates” (Critchlow) .Consequently, economists believe that with enough pressure the Gulf states may soon break free from the dollar.
In fact, in September Saudi Arabia decided not to lower interest rates in tandem with the U.S. Federal Reserve (Gaffen). One only has to look so far to notice that the entire Gulf region is diversifying away from the dollar. This phenomenon is particularly true, because of the increasing number of oil exports at extraordinary prices. Further, with plenty of money flowing into these states’ coffers, pegging their currency to a depreciating currency is becoming less and less attractive.
Thus, the question arises: Should the region’s economies continue to tie their currency to the greenback? The original purpose for doing so was due to the financial immaturity of these states and lack of monetary experience. Determining the right interest rates to most optimally match a country’s savings with investments is tricky due to a typical central bank’s contrary goals of fighting inflation while creating economic growth.
The fact of the matter is that due to the Gulf Arabs soaring oil revenues, “their real exchange rates ought to rise” (“The dollar | Time to break free”). The peg to the dollar prevents this and as the value of the dollar falls, inflation has become a larger problem. Today, the U.S. inflation rate hovers around 4 to 5 percent on average since the economies two recessions during the 1980s. However, “some smaller Gulf economies now have inflation rates of around 10%” (“The dollar | Time to break free).
In my opinion, there are two ways to respond to the problem. The first is for the Persian Gulf states to abandon their peg to the dollar and instead move to a currency basket as Kuwait has already done. A basket of securities may include the dollar in addition to the euro, yen, and other strong currencies. Thus, the inflationary pressure exerted by the dollar would be alleviated.
A second option is to all together abandon ties to any currency. This is the optimal solution that requires a strong central bank that would allow its exchange rate to float as well developed countries already do so. However, “These countries have no history of independent monetary policy and few institutions to conduct it” (“The dollar | Time to break free).
Nonetheless, the Gulf states currently have their hands tied behind their backs and are effectively linked to the dollar. Should history provide any glimpse into the future, this certainly will not change overnight.
These concerns over inflation in all of the oil-rich states suggest that central banks should in fact be raising, not lowering rates. However, “monetary policy in the Persian Gulf states must mirror U.S. moves to avoid pressures from capital drifting to the currency with the most favorable interest rates” (Critchlow) .Consequently, economists believe that with enough pressure the Gulf states may soon break free from the dollar.
In fact, in September Saudi Arabia decided not to lower interest rates in tandem with the U.S. Federal Reserve (Gaffen). One only has to look so far to notice that the entire Gulf region is diversifying away from the dollar. This phenomenon is particularly true, because of the increasing number of oil exports at extraordinary prices. Further, with plenty of money flowing into these states’ coffers, pegging their currency to a depreciating currency is becoming less and less attractive.
Thus, the question arises: Should the region’s economies continue to tie their currency to the greenback? The original purpose for doing so was due to the financial immaturity of these states and lack of monetary experience. Determining the right interest rates to most optimally match a country’s savings with investments is tricky due to a typical central bank’s contrary goals of fighting inflation while creating economic growth.
The fact of the matter is that due to the Gulf Arabs soaring oil revenues, “their real exchange rates ought to rise” (“The dollar | Time to break free”). The peg to the dollar prevents this and as the value of the dollar falls, inflation has become a larger problem. Today, the U.S. inflation rate hovers around 4 to 5 percent on average since the economies two recessions during the 1980s. However, “some smaller Gulf economies now have inflation rates of around 10%” (“The dollar | Time to break free).
In my opinion, there are two ways to respond to the problem. The first is for the Persian Gulf states to abandon their peg to the dollar and instead move to a currency basket as Kuwait has already done. A basket of securities may include the dollar in addition to the euro, yen, and other strong currencies. Thus, the inflationary pressure exerted by the dollar would be alleviated.
A second option is to all together abandon ties to any currency. This is the optimal solution that requires a strong central bank that would allow its exchange rate to float as well developed countries already do so. However, “These countries have no history of independent monetary policy and few institutions to conduct it” (“The dollar | Time to break free).
Nonetheless, the Gulf states currently have their hands tied behind their backs and are effectively linked to the dollar. Should history provide any glimpse into the future, this certainly will not change overnight.
Sunday, November 18, 2007
The Envy of Wall Street
While billions are lost during the ongoing credit crisis, one firm stands alone and continues to make bets that thus far have paid off hugely. This Wall Street investment bank and it's chief financial officer identified the risks associated with packaging and selling mortgage related securities before anyone else. If anyone had to take a guess, I'm sure they would pick Goldman Sachs and they would be right. According to the following New York Times article, their CFO David A. Viniar late last year called a “mortgage risk” meeting in his meticulous 30th-floor office in Lower Manhattan.
I can only imagine the envy every other Wall Street CEO has for Lloyd C. Blankfein, Goldman's chief executive.
I found this article particularly interesting, because it shows the type of individualistic, go it alone attitude that characterizes one of the world's most successful companies. This success has carried on into all walks of life both inside and outside the business world.
In case you didn't hear, last week two Goldman managing directors helped bring Alex Rodriguez back to the Yankees. Also, "John A. Thain, a former Goldman co-president, accepted the top position at Merrill Lynch, while a fellow Goldman alumnus, Duncan L. Niederauer, took Mr. Thain’s job running the New York Stock Exchange. Robert E. Rubin, a former Goldman head, is the new chairman of Citigroup. In Washington, another former chief, Henry M. Paulson Jr., is the Treasury secretary, having been recruited by Joshua B. Bolten, the White House chief of staff and yet another former Goldman executive. The heads of the Canadian and Italian central banks are Goldman alumni. The World Bank president, Robert B. Zoellick, is another. Jon S. Corzine, once a co-chairman, is the governor of New Jersey. And in academia, Robert S. Kaplan, a former vice chairman, has just been picked as the interim head of Harvard University’s $35 billion endowment."
The power of this company throughout the world is simply mind numbing to me.
At that point, the holdings of Goldman’s mortgage desk were down somewhat, but the notoriously nervous Mr. Viniar was worried about bigger problems. After reviewing the full portfolio with other executives, his message was clear: the bank should reduce its stockpile of mortgages and mortgage-related securities and buy expensive insurance as protection against further losses, a person briefed on the meeting said.
With its mix of swagger and contrary thinking, it was just the kind of bet that has long defined Goldman’s hard-nosed, go-it-alone style.
Most of the firm’s competitors, meanwhile, with the exception of the more specialized Lehman Brothers, appeared to barrel headlong into the mortgage markets. They kept packaging and trading complex securities for high fees without protecting themselves against the positions they were buying.
Even Goldman, which saw the problems coming, continued to package risky mortgages to sell to investors. Some of those investors took losses on those securities, while Goldman’s hedges were profitable.
When the credit markets seized up in late July, Goldman was in the enviable position of having offloaded the toxic products that Merrill Lynch, Citigroup, UBS, Bear Stearns and Morgan Stanley, among others, had kept buying.
“If you look at their profitability through a period of intense credit and mortgage market turmoil,” said Guy Moszkowski, an analyst at Merrill Lynch who covers the investment banks, “you’d have to give them an A-plus.”
This contrast in performance has been hard for competitors to swallow. The bank that seems to have a hand in so many deals and products and regions made more money in the boom and, at least so far, has managed to keep making money through the bust.
In turn, Goldman’s stock has significantly outperformed its peers.
I can only imagine the envy every other Wall Street CEO has for Lloyd C. Blankfein, Goldman's chief executive.
I found this article particularly interesting, because it shows the type of individualistic, go it alone attitude that characterizes one of the world's most successful companies. This success has carried on into all walks of life both inside and outside the business world.
In case you didn't hear, last week two Goldman managing directors helped bring Alex Rodriguez back to the Yankees. Also, "John A. Thain, a former Goldman co-president, accepted the top position at Merrill Lynch, while a fellow Goldman alumnus, Duncan L. Niederauer, took Mr. Thain’s job running the New York Stock Exchange. Robert E. Rubin, a former Goldman head, is the new chairman of Citigroup. In Washington, another former chief, Henry M. Paulson Jr., is the Treasury secretary, having been recruited by Joshua B. Bolten, the White House chief of staff and yet another former Goldman executive. The heads of the Canadian and Italian central banks are Goldman alumni. The World Bank president, Robert B. Zoellick, is another. Jon S. Corzine, once a co-chairman, is the governor of New Jersey. And in academia, Robert S. Kaplan, a former vice chairman, has just been picked as the interim head of Harvard University’s $35 billion endowment."
For all its success on Wall Street, it is Goldman’s global reach and political heft that inspire a mix of envy and admiration. In the race for president, Goldman Sachs executives are the top contributors to Barack Obama and Mitt Romney, and the second highest contributor to Hillary Rodham Clinton.
All of which has made Goldman a favorite of conspiracy theorists, columnists and bloggers who see the firm as a Wall Street version of the Trilateral Commission.
“Goldman Sachs has as much influence now that the old J. P. Morgan had between 1895 and 1930,” said Charles R. Geisst, a Wall Street historian at Manhattan College. “But, like Morgan, they could be victimized by their own success.”
The power of this company throughout the world is simply mind numbing to me.
Thursday, November 15, 2007
Globalization and Protectionism
Although the recent free-trade deal with Peru passed by the Democrat-controlled Congress is a step in the right direction, the United States has a lot more work to accomplish. This symbolically important step is supposed to be a sign of fewer barriers to trade in the future. As such, “George Bush's administration hopes other bilateral deals will follow, as a new bipartisan consensus on trade develops” according to a recent article in the Economist (“Economic focus | Buying off the Oposition”).
However, this is unlikely to happen. This is despite the fact that global trade is a confirmation of the time-tested theory by Adam Smith in 1776: “Individuals trading freely with one another following their own self-interest leads to a growing, stable economy” (Greenspan). This model of optimal market efficiency occurs only when its fundamental requirements are at work. Specifically, people must be free to act in their self-interest, unfettered by economic policy. An example of such a mistaken policy includes any government action or regulation that limits international trade.
Unfortunately, America is leaning towards just such a shift in opinion. The Peru negotiation appears to be an irregular, one time event. First of all, the Democratic presidential candidates “want to ‘revisit’ existing trade deals and are against an agreement with South Korea, the biggest negotiated by the Bush team” (“Economic focus | Buying off the Oposition”). A number of economists even believe that the Peru vote will be used as a playing card by Congress to prove their independency from a one sided viewpoint.
Secondly, recent surveys indicate that the American public is also becoming more fearful of globalization and free-trade. According to an opinion poll conducted by the Pew Research Centre, “the share of Americans who believe that trade is good for their country has plunged from 78% in 2002 to 59%, the lowest proportion among the 47 countries included in the survey” (“Economic focus | Buying off the Oposition”). What’s interesting is that this bias towards trade skepticism is equally shared by both Democrats and Republicans, according to the article.
Indeed, the idea that U.S. economic policy is becoming more protectionist is hard to ignore. Barriers to both trade and foreign direct investment are increasing in number. For example, “the chances of congressional renewal of President Bush's trade promotion authority, which is set to expire this summer, are grim. The 109th Congress introduced 27 pieces of anti-China trade legislation; the 110th introduced over a dozen in just its first three months. In late March, the Bush administration levied new tariffs on Chinese exports of high-gloss paper -- reversing a 20-year precedent of not accusing nonmarket economies of illegal export subsidies” (Slaughter).
Additionally, one only needs to read the newspaper occasionally to see the number of thwarted attempts by foreign companies proceeding with mergers or acquisitions of U.S. companies. “In 2005, the Chinese energy company CNOOC tried to purchase U.S.-headquartered Unocal. The subsequent political storm was so intense that CNOOC withdrew its bid. A similar controversy erupted in 2006 over the purchase of operations at six U.S. ports by Dubai-based Dubai Ports World, eventually causing the company to sell the assets” (Slaughter).
Matthew Slaughter, a former member of Mr Bush's Council of Economic Advisers and now a professor at Dartmouth College, believes that this shift in U.S. policy reflects an American public that is becoming more protectionist due to “stagnant or falling incomes” (Slaughter). While globalization may or may not be the cause of this stagnation, people think it is. According to Slaughter, “public support for engagement with the world economy is strongly linked to labor-market performance, and for most workers labor-market performance has been poor.”
These thoughts are alarming because of the enormous benefits that global trade poses to the U.S. economy. Thus, the following question must be answered: How should U.S. think tanks and public intellectuals respond to the idea that global trade benefits Americans less than their trading partners?
Should the notion that lower income is a result of free trade be believed, incomes must rise to prevent further barriers to trade. Mainstream, well respected economists such as Greenspan in his recent book, The Age of Turbulence, suggest the need for greater investment in education and assistance to shift workers from old industries to new industries as a means to combat this drop income.
However, “significant payoffs from educational investment will take decades to be realized, and trade adjustment assistance is too small and too narrowly targeted on specific industries to have much effect” according to Slaughter. I won’t even attempt to conceptualize a solution to this problem. I will merely offer the opinion of someone much more educated than myself. Slaughter believes that the best way to combat the recent rise in protectionism is to redistribute income throughout U.S. society. This may be accomplished in several ways. The tax system may be overhauled as to more heavily levy taxes upon the wealthy and cut taxes for the poor. Slaughter classifies this idea as a “New Deal for globalization,” echoing thoughts of Franklin D. Roosevelt’s series of programs and initiatives that responded to the Great Depression.
Whatever course of action the U.S. embarks upon should undoubtedly be met with strong resistance at the moment. The magnitude of all of these ideas is by no means small and will require a great deal of time to implement. Nonetheless, any solution must strongly explain to the American people the many benefits of a global economy.
Works Cited
Greenspan, Alan. "The Age of Turbulence." New York: Penguin Group, 2007.
However, this is unlikely to happen. This is despite the fact that global trade is a confirmation of the time-tested theory by Adam Smith in 1776: “Individuals trading freely with one another following their own self-interest leads to a growing, stable economy” (Greenspan). This model of optimal market efficiency occurs only when its fundamental requirements are at work. Specifically, people must be free to act in their self-interest, unfettered by economic policy. An example of such a mistaken policy includes any government action or regulation that limits international trade.
Unfortunately, America is leaning towards just such a shift in opinion. The Peru negotiation appears to be an irregular, one time event. First of all, the Democratic presidential candidates “want to ‘revisit’ existing trade deals and are against an agreement with South Korea, the biggest negotiated by the Bush team” (“Economic focus | Buying off the Oposition”). A number of economists even believe that the Peru vote will be used as a playing card by Congress to prove their independency from a one sided viewpoint.
Secondly, recent surveys indicate that the American public is also becoming more fearful of globalization and free-trade. According to an opinion poll conducted by the Pew Research Centre, “the share of Americans who believe that trade is good for their country has plunged from 78% in 2002 to 59%, the lowest proportion among the 47 countries included in the survey” (“Economic focus | Buying off the Oposition”). What’s interesting is that this bias towards trade skepticism is equally shared by both Democrats and Republicans, according to the article.
Indeed, the idea that U.S. economic policy is becoming more protectionist is hard to ignore. Barriers to both trade and foreign direct investment are increasing in number. For example, “the chances of congressional renewal of President Bush's trade promotion authority, which is set to expire this summer, are grim. The 109th Congress introduced 27 pieces of anti-China trade legislation; the 110th introduced over a dozen in just its first three months. In late March, the Bush administration levied new tariffs on Chinese exports of high-gloss paper -- reversing a 20-year precedent of not accusing nonmarket economies of illegal export subsidies” (Slaughter).
Additionally, one only needs to read the newspaper occasionally to see the number of thwarted attempts by foreign companies proceeding with mergers or acquisitions of U.S. companies. “In 2005, the Chinese energy company CNOOC tried to purchase U.S.-headquartered Unocal. The subsequent political storm was so intense that CNOOC withdrew its bid. A similar controversy erupted in 2006 over the purchase of operations at six U.S. ports by Dubai-based Dubai Ports World, eventually causing the company to sell the assets” (Slaughter).
Matthew Slaughter, a former member of Mr Bush's Council of Economic Advisers and now a professor at Dartmouth College, believes that this shift in U.S. policy reflects an American public that is becoming more protectionist due to “stagnant or falling incomes” (Slaughter). While globalization may or may not be the cause of this stagnation, people think it is. According to Slaughter, “public support for engagement with the world economy is strongly linked to labor-market performance, and for most workers labor-market performance has been poor.”
These thoughts are alarming because of the enormous benefits that global trade poses to the U.S. economy. Thus, the following question must be answered: How should U.S. think tanks and public intellectuals respond to the idea that global trade benefits Americans less than their trading partners?
Should the notion that lower income is a result of free trade be believed, incomes must rise to prevent further barriers to trade. Mainstream, well respected economists such as Greenspan in his recent book, The Age of Turbulence, suggest the need for greater investment in education and assistance to shift workers from old industries to new industries as a means to combat this drop income.
However, “significant payoffs from educational investment will take decades to be realized, and trade adjustment assistance is too small and too narrowly targeted on specific industries to have much effect” according to Slaughter. I won’t even attempt to conceptualize a solution to this problem. I will merely offer the opinion of someone much more educated than myself. Slaughter believes that the best way to combat the recent rise in protectionism is to redistribute income throughout U.S. society. This may be accomplished in several ways. The tax system may be overhauled as to more heavily levy taxes upon the wealthy and cut taxes for the poor. Slaughter classifies this idea as a “New Deal for globalization,” echoing thoughts of Franklin D. Roosevelt’s series of programs and initiatives that responded to the Great Depression.
Whatever course of action the U.S. embarks upon should undoubtedly be met with strong resistance at the moment. The magnitude of all of these ideas is by no means small and will require a great deal of time to implement. Nonetheless, any solution must strongly explain to the American people the many benefits of a global economy.
Works Cited
Greenspan, Alan. "The Age of Turbulence." New York: Penguin Group, 2007.
Saturday, November 3, 2007
Recession Alert
There’s trouble brewing in the economy and it’s my duty to make you aware of it.
In The Economist's article American Jobs | Recession Alert posted on Friday, September 7th, the monthly jobs figures for August were analyzed with grave concern and caused me to more seriously question the possibility of a recession in America's near future.
Specifically, I looked at what The Economist claimed was a very strong correlation between the monthly employment figures, the recent turmoil in the financial markets, and the worsening housing market.
Apparently the monthly jobs figures for August were much worse than anyone expected with the U.S. economy losing 4000 jobs last month, "the first monthly loss of jobs since August 2003." In addition to this recent shortfall in jobs during August, revisions were made to the past several months' jobs figures. The updated figures indicated that the economy has been adding far less jobs per month than is needed to keep the unemployment rate from steadily rising.
While this entire article focuses on the labor market from an economist's point of view, I found it very interesting and important reading to anyone.
Since the shutting down and massive double digit losses in value of two multi billion dollar Bear Stearn's hedge funds this summer (Source: Reuters: Bear Stearns hedge funds near shutting down), I have been on the alert for further macroeconomic economy shaping events and news relating to a recession. If you don't know already, these hedge funds invested in securities backed by subprime mortgage loans. Subprime mortgages are loans made to homeowners with poor credit, unlikely to be paid back.
Wall Street created and packaged these loans into securities that investors such as pension funds, endowments, and individual investors could purchase. Additionally, ratings agencies such as Moody's rated these securities with Triple A, outstanding ratings.
However, these securities have recently posted huge losses because subprime borrowers simply cannot pay their mortgages and homes are foreclosing in the U.S. housing market at extremely high rates since the beginning of this summer.
As a result, investors who have literally poured billions of dollars into these investments have posted huge losses on their accounts.
Of greater importance however is that homeowners who were "sucked" into buying these subprime mortgages by companies such as Countrywide are unable to make the mortgage payments required by their loan contracts. Consequently, many homeowners are being evicted from their homes in the U.S. at rates never before seen.
This entire fiasco has caused the credit market to turn into chaos in the last month as it has "reduced the flow of credit to all borrowers while increasing the cost of borrowing for credit-worthy borrowers." In other words, so much credit was extended to purchasers of subprime mortgages for homes they could not afford, U.S. financial institutions no longer are willing to extend credit to even regular businesses and individuals ("credit-worthy borrowers") for their normal financing needs.
The Wall Street Journal in this article, "Recession 2008?" discusses the repercussions of the housing market troubles I have just discussed and supports the claims I have made.
However, John Makin in his article further points out "the fact remains that house prices continue to fall" and the housing market is still in trouble." While I have already discussed the August jobs figures, the housing market and credit markets in detail as possible indications of a recession down the road, further factors support this argument.
As the Wall Street Journal article by Mr. Makin notes "American recessions are unusual because negative consumption growth is, in most cases, a necessary condition for a recession." However, Mr. Makin predicts in the fourth quarter of 2007 exactly that - a sharp drop in U.S. consumption growth "driven by a credit crunch, a persistent and possibly enlarged drag from residential investment, and slower business fixed investment."
These signs are all troubling and obviously more recessions have been predicted than have actually occurred. However, we should certainly be alert and possibly anticipate an economic slowdown in the U.S near future.
Why should we care about an economic slowdown or recession? Because many of us are young women and men soon to enter the workforce who will be looking for jobs that companies may be much less willing to extend us offers for in addition to a myriad of other political, social and global economic reasons that may be discussed in the future.
In The Economist's article American Jobs | Recession Alert posted on Friday, September 7th, the monthly jobs figures for August were analyzed with grave concern and caused me to more seriously question the possibility of a recession in America's near future.
Specifically, I looked at what The Economist claimed was a very strong correlation between the monthly employment figures, the recent turmoil in the financial markets, and the worsening housing market.
Apparently the monthly jobs figures for August were much worse than anyone expected with the U.S. economy losing 4000 jobs last month, "the first monthly loss of jobs since August 2003." In addition to this recent shortfall in jobs during August, revisions were made to the past several months' jobs figures. The updated figures indicated that the economy has been adding far less jobs per month than is needed to keep the unemployment rate from steadily rising.
While this entire article focuses on the labor market from an economist's point of view, I found it very interesting and important reading to anyone.
Since the shutting down and massive double digit losses in value of two multi billion dollar Bear Stearn's hedge funds this summer (Source: Reuters: Bear Stearns hedge funds near shutting down), I have been on the alert for further macroeconomic economy shaping events and news relating to a recession. If you don't know already, these hedge funds invested in securities backed by subprime mortgage loans. Subprime mortgages are loans made to homeowners with poor credit, unlikely to be paid back.
Wall Street created and packaged these loans into securities that investors such as pension funds, endowments, and individual investors could purchase. Additionally, ratings agencies such as Moody's rated these securities with Triple A, outstanding ratings.
However, these securities have recently posted huge losses because subprime borrowers simply cannot pay their mortgages and homes are foreclosing in the U.S. housing market at extremely high rates since the beginning of this summer.
As a result, investors who have literally poured billions of dollars into these investments have posted huge losses on their accounts.
Of greater importance however is that homeowners who were "sucked" into buying these subprime mortgages by companies such as Countrywide are unable to make the mortgage payments required by their loan contracts. Consequently, many homeowners are being evicted from their homes in the U.S. at rates never before seen.
This entire fiasco has caused the credit market to turn into chaos in the last month as it has "reduced the flow of credit to all borrowers while increasing the cost of borrowing for credit-worthy borrowers." In other words, so much credit was extended to purchasers of subprime mortgages for homes they could not afford, U.S. financial institutions no longer are willing to extend credit to even regular businesses and individuals ("credit-worthy borrowers") for their normal financing needs.
The Wall Street Journal in this article, "Recession 2008?" discusses the repercussions of the housing market troubles I have just discussed and supports the claims I have made.
However, John Makin in his article further points out "the fact remains that house prices continue to fall" and the housing market is still in trouble." While I have already discussed the August jobs figures, the housing market and credit markets in detail as possible indications of a recession down the road, further factors support this argument.
As the Wall Street Journal article by Mr. Makin notes "American recessions are unusual because negative consumption growth is, in most cases, a necessary condition for a recession." However, Mr. Makin predicts in the fourth quarter of 2007 exactly that - a sharp drop in U.S. consumption growth "driven by a credit crunch, a persistent and possibly enlarged drag from residential investment, and slower business fixed investment."
These signs are all troubling and obviously more recessions have been predicted than have actually occurred. However, we should certainly be alert and possibly anticipate an economic slowdown in the U.S near future.
Why should we care about an economic slowdown or recession? Because many of us are young women and men soon to enter the workforce who will be looking for jobs that companies may be much less willing to extend us offers for in addition to a myriad of other political, social and global economic reasons that may be discussed in the future.
Thursday, October 25, 2007
The Antithesis of Globalization?
Get ready: US economic policy may soon make a complete u-turn and bump into several obstacles along the way. Hopefully it does not, but economic professionals may surprisingly pave the way for such a misguided point of view.
Recent and methodical analysis suggests that the effects of globalization are doing more harm than good for the individual. This is actually the conclusion of the latest report by the International Monetary Fund (IMF), one of if not the most long time celebrated supporters of globalization and its heralded contributions to the progress of mankind.
According to the report, the rapid rise of globalization throughout both rich and poor countries has improved their overall incomes, but at the same time increased income inequality among individuals. However, this larger gap between the earnings of more and less skilled workers represents a good consequence of globalization and not a bad one.
Over the past two decades, this inequality gap is attributed to the faster growth rates of incomes for the more skilled in greater quantities than the less skilled and means that “inequality has risen in all but the low-income country aggregates” (“Income and Inequality”). As countries in Latin America, Asia, and Eastern Europe have liberalized their economies, the level of income between rich and poor has widened. The surprising exception is sub-Saharan Africa where the income gap has diminished, but the IMF does not offer any clues as to why this anomaly occurs.
To understand why this spread in inequality may in fact be benevolent, one must first question what portion of this rise in inequality is in fact due to globalization and how much is due to other factors “such as the spread of technology and domestic constraints on equality of opportunity." The IMF found the effects of greater globalization are best grouped into three factors: “increased trade openness, an increase in foreign direct investment, and increased technological change” that have all increased per capita incomes of developing and developed countries (“Income and Inequality”).
However, the role of technology in increased globalization has most strongly created the inequality gap observed by the IMF. Since technological change favors those with higher skills such as using a computer, modern technology “exacerbates the skills gap” and “adversely affects the distribution of income in both developing and advanced economies by increasing the premium on skills and automating relatively low-skill inputs” (“Income and Inequality”). Further, newer technology favors those with better access to education and reinforces the skills gap.
Foreign direct investment also increases the “rewards for higher-value-added activities” and creates greater demand for the more skilled. On the other hand, increased trade openness has had the opposite effect and reduced income inequality according to the IMF. However, “the main factor driving the recent increase in inequality across countries has been technological progress” (“Income and Inequality”)
Thus, one must determine if these three variables effect upon the widening of the inequality gap is a positive result of globalization. Certainly greater inequality is a bad thing. However, the increased income gap by education “means that the returns on investments in schooling increased” (Becker-Posner). In other words, investment in human capital is paying off more and more as economies become more productive. This is certainly not a bad phenomenon, but it requires better access to education throughout the world.
Additionally, “although foreign direct investment is associated with greater income inequality over the period of this study, it is associated with higher growth overall” (“Income and Inequality”). The IMF thus believes that over a longer period of time, the effects of this factor of globalization would reduce income inequality.
Lastly, the IMF concludes that “trade globalization is not found to have a negative impact on income distribution in either developing or advanced economies” (“Income and Inequality”). Consequently, increased trade has actually diminished income inequality.
The report’s findings are summarized as follows: “Inequality has been rising in countries across all income levels, except those classified as low income” (“Income and Inequality”). Thus, while politicians from countries such as Africa and Latin America may condemn globalization, they misunderstand the problem. Their countries lack the greater access to education required to decrease income inequality.
Without doubt, this statement is of little comfort to the children of third world countries whose schooling systems are rudimentary at best. However, as the IMF report confirms, their problems are not the result of globalization. Instead, such countries must make increased access to education a key point on their policy agenda and not reduce foreign direct investment or suppress technological change. Hopefully the congresswomen and men in Washington agree with this assessment and do not scapegoat globalization as an easy way out of our problems.
Recent and methodical analysis suggests that the effects of globalization are doing more harm than good for the individual. This is actually the conclusion of the latest report by the International Monetary Fund (IMF), one of if not the most long time celebrated supporters of globalization and its heralded contributions to the progress of mankind.
According to the report, the rapid rise of globalization throughout both rich and poor countries has improved their overall incomes, but at the same time increased income inequality among individuals. However, this larger gap between the earnings of more and less skilled workers represents a good consequence of globalization and not a bad one.
Over the past two decades, this inequality gap is attributed to the faster growth rates of incomes for the more skilled in greater quantities than the less skilled and means that “inequality has risen in all but the low-income country aggregates” (“Income and Inequality”). As countries in Latin America, Asia, and Eastern Europe have liberalized their economies, the level of income between rich and poor has widened. The surprising exception is sub-Saharan Africa where the income gap has diminished, but the IMF does not offer any clues as to why this anomaly occurs.
To understand why this spread in inequality may in fact be benevolent, one must first question what portion of this rise in inequality is in fact due to globalization and how much is due to other factors “such as the spread of technology and domestic constraints on equality of opportunity." The IMF found the effects of greater globalization are best grouped into three factors: “increased trade openness, an increase in foreign direct investment, and increased technological change” that have all increased per capita incomes of developing and developed countries (“Income and Inequality”).
However, the role of technology in increased globalization has most strongly created the inequality gap observed by the IMF. Since technological change favors those with higher skills such as using a computer, modern technology “exacerbates the skills gap” and “adversely affects the distribution of income in both developing and advanced economies by increasing the premium on skills and automating relatively low-skill inputs” (“Income and Inequality”). Further, newer technology favors those with better access to education and reinforces the skills gap.
Foreign direct investment also increases the “rewards for higher-value-added activities” and creates greater demand for the more skilled. On the other hand, increased trade openness has had the opposite effect and reduced income inequality according to the IMF. However, “the main factor driving the recent increase in inequality across countries has been technological progress” (“Income and Inequality”)
Thus, one must determine if these three variables effect upon the widening of the inequality gap is a positive result of globalization. Certainly greater inequality is a bad thing. However, the increased income gap by education “means that the returns on investments in schooling increased” (Becker-Posner). In other words, investment in human capital is paying off more and more as economies become more productive. This is certainly not a bad phenomenon, but it requires better access to education throughout the world.
Additionally, “although foreign direct investment is associated with greater income inequality over the period of this study, it is associated with higher growth overall” (“Income and Inequality”). The IMF thus believes that over a longer period of time, the effects of this factor of globalization would reduce income inequality.
Lastly, the IMF concludes that “trade globalization is not found to have a negative impact on income distribution in either developing or advanced economies” (“Income and Inequality”). Consequently, increased trade has actually diminished income inequality.
The report’s findings are summarized as follows: “Inequality has been rising in countries across all income levels, except those classified as low income” (“Income and Inequality”). Thus, while politicians from countries such as Africa and Latin America may condemn globalization, they misunderstand the problem. Their countries lack the greater access to education required to decrease income inequality.
Without doubt, this statement is of little comfort to the children of third world countries whose schooling systems are rudimentary at best. However, as the IMF report confirms, their problems are not the result of globalization. Instead, such countries must make increased access to education a key point on their policy agenda and not reduce foreign direct investment or suppress technological change. Hopefully the congresswomen and men in Washington agree with this assessment and do not scapegoat globalization as an easy way out of our problems.
Friday, October 19, 2007
Credit Ratings Agencies: What Were They Thinking?
Today Standard & Poor’s, the credit ratings agency, downgraded its ratings for several thousand bonds that invested in mortgage related debt in 2007. Of these securities, more than several dozen were even rated of the highest quality triple AAA and thus least likely to default (Source: New York Times).
However, as the recent credit crisis continues to play out and develop in greater and greater significance, one must ask: Why were these bonds rated so highly before? Investment banks are the result of such shoddily rated investments. Merrill Lynch posted a writedown of $7.9 billion in mortgage related securities this month; Citigroup posted a $3 billion writedown; and Morgan Stanley posted a $940 billion writedown also related to subprime mortgages. These record losses are phenomenal compared to past earnings due to trading at financial services firms. This is indeed exemplified by the mass number of layoffs taking place across Wall Street, such as the firing of Merrill Lynch CEO Stan O’Neal.
However, not all the blame rests upon the executives at these investment banks, hedge funds, and private equity funds. Investigation of credit ratings firms such as S&P and Moody’s must take place immediately. These firms rated as extremely safe thousands of securities related to the subprime mortgages whose values have plummeted in a matter of weeks. Nobody knew how to value these investments and now that firms have been forced to sell their investments to raise cash, the values of these debt instruments are literally reaping $0.20 on the dollar.
As the New York Times illustrates today:
Hopefully these companies are held accountable and mistakes of this magnitude occur less frequently in the future.
However, as the recent credit crisis continues to play out and develop in greater and greater significance, one must ask: Why were these bonds rated so highly before? Investment banks are the result of such shoddily rated investments. Merrill Lynch posted a writedown of $7.9 billion in mortgage related securities this month; Citigroup posted a $3 billion writedown; and Morgan Stanley posted a $940 billion writedown also related to subprime mortgages. These record losses are phenomenal compared to past earnings due to trading at financial services firms. This is indeed exemplified by the mass number of layoffs taking place across Wall Street, such as the firing of Merrill Lynch CEO Stan O’Neal.
However, not all the blame rests upon the executives at these investment banks, hedge funds, and private equity funds. Investigation of credit ratings firms such as S&P and Moody’s must take place immediately. These firms rated as extremely safe thousands of securities related to the subprime mortgages whose values have plummeted in a matter of weeks. Nobody knew how to value these investments and now that firms have been forced to sell their investments to raise cash, the values of these debt instruments are literally reaping $0.20 on the dollar.
As the New York Times illustrates today:
"The action provides further evidence that lending standards remained loose even as default rates on home loans made in 2005 and 2006 were raising alarms among investors and regulators this year. A recent investment bank report showed that loans made to borrowers with weak, or subprime, credit this year had higher default rates than similar loans in 2006 did at the same time in their lives.
S.& P. downgraded bonds worth $23.4 billion, or about 6 percent of mortgages classified as subprime and Alt-A that it has rated through June; Alt-A loans are made to borrowers with better credit. The bonds that were downgraded included 39 securities that had been rated AAA, the highest grade awarded by the agency; some of these were downgraded several notches to A. (Bonds rated at BBB and above are considered investment-grade securities.)”
Hopefully these companies are held accountable and mistakes of this magnitude occur less frequently in the future.
Wednesday, October 10, 2007
The American South: A Burgeoning Economy
America’s southern states throughout history have been associated with images of violence, backwardness, and racism. However, the picture of this region today is dramatically different as discussed in The Economist’s recent article “Goodbye to the Blues.” In this special report, the author traverses the history of the American South and delineates the Civil War as the pivot of the region’s dramatic change.
Before this conflict, the south was plagued by low average incomes, few industries besides agriculture, and slavery. After the conflict, none of these problems immediately disappeared. However, slavery was eventually abolished, new industries grew, and incomes began to rise into the twentieth century. Throughout this entire time period, violence was ever present. However, what the past has taught is that
The article’s examples of individuals who have profited from the fruits of this new economy are particularly interesting. Their voices are positive and give hope to the future of these southern states.
While Hurricane Katrina focused national attention on the many problems in New Orleans, one needs not look very far to see a renaissance of sorts occurring throughout the rest of the state and its border states. How the South’s success affects its culture, politics, and economy should thus prove to be very fascinating.
Before this conflict, the south was plagued by low average incomes, few industries besides agriculture, and slavery. After the conflict, none of these problems immediately disappeared. However, slavery was eventually abolished, new industries grew, and incomes began to rise into the twentieth century. Throughout this entire time period, violence was ever present. However, what the past has taught is that
“non-violence works, both in that narrow sense and in a broader one. An economic system based on free labor and free exchange is far more dynamic and adaptable than a system based on coercion. And a political system that heeds all voices is far more stable than one that heeds some and seeks to silence the rest.”
The article’s examples of individuals who have profited from the fruits of this new economy are particularly interesting. Their voices are positive and give hope to the future of these southern states.
“Last May, Matthews's granddaughter, Katrice Mines, joined the southward surge of young black professionals and moved to Atlanta, Georgia. Over a lunch of chicken with peaches, crushed walnuts and snap peas, Ms Mines admits that, before she moved, she was somewhat afraid of the South. But she quickly found a job, as an associate editor of the Atlanta Tribune, a black business magazine. Up north in Sandusky, Ohio, she had felt her talents were untapped. Down South, she feels more optimistic. Atlanta is majority-black. It is also rich, with more Fortune 500 headquarters than any other American city bar New York and Houston. “There are so many African-Americans in powerful positions,” says Ms Mines. “You can get your foot in the door.”
While Hurricane Katrina focused national attention on the many problems in New Orleans, one needs not look very far to see a renaissance of sorts occurring throughout the rest of the state and its border states. How the South’s success affects its culture, politics, and economy should thus prove to be very fascinating.
Thursday, October 4, 2007
Religion: Just as Important as Economics
While analysis of American history is certain to delineate the importance of economics upon politics and public society, religion has played just as if not a more important role. Specifically, faith and spirituality always have held strong roles in radical social reform movements, where public intellectuals with theological backgrounds are at the front and center of them. This is the story of American history where change is inherent to the country’s democratic upbringing. However, according to Stephen Mack in “Wicked Paradox: The Cleric as Public Intellectual”, the men and women who advocated these revolutions are individuals “whose religious training and experience shaped their vision of a just society and required them to work for it” (Mack). This argument is proved further true by the public acts of religiously influenced individuals such as John F Kennedy, Al Sharpton, Jesse Jackson, Martin Luther King, and even Malcolm X. Therefore, American history proves that throughout time strong religious principles and beliefs instill the moral values that have allowed some of America's greatest public intellectuals to bring about social reform.
Indeed, public intellectuals in the church began one of the earliest social reform movements in America, the abolition of slavery. In the eighteenth century, before anyone else the Quakers questioned the morality of slavery and demanded its demise. The Quaker faith is a Christian religious denomination with a wide range of theological themes such as “peace, equality, integrity, and simplicity” (Hetherington). Members of the religion such as George Fox and Anthony Benzet are public intellectuals who literally became renowned for their fights against slavery (Duquella). Consequently, Quakers were radical Christians whose religious and moral beliefs of egalitarianism led them to conclude that slavery was morally repulsive. However, their moral beliefs soon spread to other public intellectuals such as Benjamin Franklin who turned abolitionist due to his relationship with Benzet (Duquella). Also, though not a member of any single religion, Franklin’s generic “religious experience shaped [his] vision of a just society” and must have at least partly influenced his acts in Congress that urged the abolition of slavery (Mack).
Nonetheless, this chapter of history characterizes American social reform’s relationship to spirituality only in its infancy. The American civil rights movement is perhaps an even better known blip in time where discrimination against African Americans was strongly denounced by many leaders who were influenced by religious beliefs. The civil right’s movement challenged discrimination through legislation such as Brown vs. Board of Education, but perhaps more importantly the concerted acts of individual citizens. For example, Martin Luther King urged tolerance and the mixing of all races. However, he stressed his religion in speeches such as where he states, “we are Christian people. We believe in the Christian religion. We believe in the teachings of Jesus” (Spartacus Educational). King wanted to achieve social change through nonviolence and very frequently suggested the influence Christianity had upon his actions and those of others. For example, when discussing Rosa Park’s ordeals, King states that “nobody can doubt the depth of her Christian commitment and devotion to the teachings of Jesus.” His spirituality rain deep through his veins and coursed his every thought. Just like Mack suggests, King is part of a “history of activist theologians,” whose faith led him to orchestrate change (Mack).
Later on after the civil rights movement, many other theologians have become involved in peace movements of various kinds. The fight against apartheid though similar to the American civil rights movement occurred throughout Africa and was only recently ended in the early 1990s. This effort was spearheaded by religious and other public intellectuals including most prominently Desmond Tutu. As Mack alludes, Tutu was truly molded by his religious experience and as a result was a “key player in [one] of our most important reform movements” (Mack). Tutu devoted his life to theological study earning many degrees in theology and held a wide range of Church affiliated positions ranging from bishop to the Dean of St. Mary’s Cathedral (“Desmond Tutu”). Due to his evangelical background however, he was raised with a number of beliefs that beckoned for correction in the apartheid era. This denomination believes in the absolute correctness of the Bible and largely must have inclined Tutu to object for “equal rights for all” in his fight to end apartheid (“Desmond Tutu”). Without a doubt, his unprecedented background in theology led Tutu to be a firm believer in Christian virtues and propelled him to advocate for social reform.
While these social reform movements represent only a small number of the many that have transformed American society, they are of immense symbolic importance. These examples highlight the role that religion and spirituality have played in the lives of many key leaders who commanded social development. From the abolition of slavery to the civil rights movement to the demise of apartheid, public intellectuals’ faith plays an integral role in the process of social change. As Mack alludes in his article, “in many ways, American political history is the history of activist theologians” (Mack). Hopefully this continues into the future, as these public intellectuals have certainly served America well thus far.
Works Cited
“Desmond Tutu – Biography.” 01 Oct 2007
Duquella, Guy. “Anti-slavery Movement: Quakers.” 01 Oct 2007
Hetherington, Ralpha. “Quaker Testimonies.” 02 Oct 2007
Mack, Stephen. “Wicked Paradox: The Cleric as the Public Intellectual.” 14 Aug 2007. 02 Oct 2007
Spartacus Educational. “Martin Luther King.” 01 Oct 2007
Indeed, public intellectuals in the church began one of the earliest social reform movements in America, the abolition of slavery. In the eighteenth century, before anyone else the Quakers questioned the morality of slavery and demanded its demise. The Quaker faith is a Christian religious denomination with a wide range of theological themes such as “peace, equality, integrity, and simplicity” (Hetherington). Members of the religion such as George Fox and Anthony Benzet are public intellectuals who literally became renowned for their fights against slavery (Duquella). Consequently, Quakers were radical Christians whose religious and moral beliefs of egalitarianism led them to conclude that slavery was morally repulsive. However, their moral beliefs soon spread to other public intellectuals such as Benjamin Franklin who turned abolitionist due to his relationship with Benzet (Duquella). Also, though not a member of any single religion, Franklin’s generic “religious experience shaped [his] vision of a just society” and must have at least partly influenced his acts in Congress that urged the abolition of slavery (Mack).
Nonetheless, this chapter of history characterizes American social reform’s relationship to spirituality only in its infancy. The American civil rights movement is perhaps an even better known blip in time where discrimination against African Americans was strongly denounced by many leaders who were influenced by religious beliefs. The civil right’s movement challenged discrimination through legislation such as Brown vs. Board of Education, but perhaps more importantly the concerted acts of individual citizens. For example, Martin Luther King urged tolerance and the mixing of all races. However, he stressed his religion in speeches such as where he states, “we are Christian people. We believe in the Christian religion. We believe in the teachings of Jesus” (Spartacus Educational). King wanted to achieve social change through nonviolence and very frequently suggested the influence Christianity had upon his actions and those of others. For example, when discussing Rosa Park’s ordeals, King states that “nobody can doubt the depth of her Christian commitment and devotion to the teachings of Jesus.” His spirituality rain deep through his veins and coursed his every thought. Just like Mack suggests, King is part of a “history of activist theologians,” whose faith led him to orchestrate change (Mack).
Later on after the civil rights movement, many other theologians have become involved in peace movements of various kinds. The fight against apartheid though similar to the American civil rights movement occurred throughout Africa and was only recently ended in the early 1990s. This effort was spearheaded by religious and other public intellectuals including most prominently Desmond Tutu. As Mack alludes, Tutu was truly molded by his religious experience and as a result was a “key player in [one] of our most important reform movements” (Mack). Tutu devoted his life to theological study earning many degrees in theology and held a wide range of Church affiliated positions ranging from bishop to the Dean of St. Mary’s Cathedral (“Desmond Tutu”). Due to his evangelical background however, he was raised with a number of beliefs that beckoned for correction in the apartheid era. This denomination believes in the absolute correctness of the Bible and largely must have inclined Tutu to object for “equal rights for all” in his fight to end apartheid (“Desmond Tutu”). Without a doubt, his unprecedented background in theology led Tutu to be a firm believer in Christian virtues and propelled him to advocate for social reform.
While these social reform movements represent only a small number of the many that have transformed American society, they are of immense symbolic importance. These examples highlight the role that religion and spirituality have played in the lives of many key leaders who commanded social development. From the abolition of slavery to the civil rights movement to the demise of apartheid, public intellectuals’ faith plays an integral role in the process of social change. As Mack alludes in his article, “in many ways, American political history is the history of activist theologians” (Mack). Hopefully this continues into the future, as these public intellectuals have certainly served America well thus far.
Works Cited
“Desmond Tutu – Biography.” 01 Oct 2007
Duquella, Guy. “Anti-slavery Movement: Quakers.” 01 Oct 2007
Hetherington, Ralpha. “Quaker Testimonies.” 02 Oct 2007
Mack, Stephen. “Wicked Paradox: The Cleric as the Public Intellectual.” 14 Aug 2007. 02 Oct 2007
Spartacus Educational. “Martin Luther King.” 01 Oct 2007
Friday, September 28, 2007
Intellectualism: A Foundation in Faith
Without doubt, the source of the public intellectual’s influence extends far beyond his or her use of statistical analysis to gain insight into the functioning of the economy, as previous blog posts have indicated. Rather, it reaches into much broader areas such as in “Wicked Paradox: The Cleric as a Public Intellectual,” where Stephen Mack makes the shrewd argument that “public intellectuals are a product of both our secular and religious traditions.” This point of view is particularly important, because it highlights the multifaceted role demanded of the public intellectual. Thereafter, an example of such a public intellectual, John Winthrop, is used to support this statement. In his sermon “City upon a Hill,” Winthrop proposes that the Puritans colonists are “defined by moral purpose” and had a special pact with God (Mack). However, the theologian Roger Williams strictly opposed Winthrop’s mixing of government with religion, because of secular reasons. Nonetheless, this conflict between public intellectuals is just one of many examples of the strong influence both spheres of tradition have exerted upon society. As a result, the history of public intellectuals demonstrates that religion and secularity profoundly affect many of these individuals’ thoughts and beliefs.
Indeed, John Winthrop is perhaps one of the first most influential public intellectuals whose convictions are deeply rooted in spiritual faith. He was a forefather of the Puritan experiment and set about forming a government that was not separate from the church. On the opposite side of the religious spectrum, Williams believed in secular traditions although he “was a theologian, deeply concerned with the health and vitality of the church.” Williams did not just believe in the separation of church and state, but more importantly that the people “are in charge of the church.” Consequently, both public intellectuals drew great strength in their logic and reasoning from the passionate belief that “religion and civil society are political codependents” (Mack). Whether or not this codependency is benevolent for society or not remained to be seen.
However, Winthrop and Williams represent a trivial number of the many public intellectuals whose authority is rooted in secular and religious customs. For example, Cotton Mather, the pastor of Boston’s North Church in 1723, was a prolific writer about the nation’s “moral tone.” He exerted great influence over younger generation Puritans and explained the American experiment by using the symbolic language of the Bible to connect past events with the present. Additionally, Mather wrote about his belief in diabolical possession and witchcraft to the Boston clergy during the Salem witch trials causing the execution of a number of individuals. Consequently, he was a significant force in both secular and spiritual matters (“Cotton Mather”). Indeed, the witch trials symbolized exactly what Williams feared where religion when enforced through law led to tragedy (Mack).
Additionally, Jonathan Edwards epitomizes an important episode of the influence the secular and religious played upon the American public intellectual. He is one of America’s most important theologians who defended Calvinism and the Puritan heritage. His work is most significant however, due to his public role during the First Great Awakening as a revivalist and particularly intelligent philosopher. Edwards believes that God is a sovereign power and humanity is depraved; thus necessitating “the New Birth conversion.” Edwards role as a public intellectual in the religious and secular domains was further accentuated, because of how greatly widespread across all of society the Great Awakening was. These beliefs were further placed into wedlock with politics, because of the role that Christian morality took upon leaders of New England (“Jonathan Edwards”).
Lastly, Ralph Waldo Emerson, the American leader of the Transcendentalist movement, also demonstrated the influence of lay and spiritual mores upon the public intellectual nearly a century after Winthrop first did. This development was unique, because a whole new generation of men and women “each believes himself inspired by the Divine Soul which also inspires all men” ("Ralph Waldo Emerson"). Emerson’s faith was the basis for many of his later actions such as social reform and serves a great example of “a deep religious sensibility” that had the power to transform hundreds of thousands of individuals through the power of God.
While these five social leaders derive their authority from different sources, the inherent role of secular and religious practices remains clear. One’s connection to their faith has throughout time and continues to be a succinctly important dynamic upon one’s way of life – particularly for the public intellectual. Additionally, the role of the public intellectual is sometimes rooted in secularity where religion is entirely separate. However, as Stephen Mack warns, politics and government is most dangerous when either side of the debate is at a complete extreme of the power pendulum. Indeed, perhaps American democracy is still functioning, because this has not yet occurred.
Works Cited
Mack, Stephen. “Wicked Paradox: The Cleric as the Public Intellectual.” 14 Aug 2007. 25 Sep 2007
NNDB: Tracking the Entire World. “Cotton Mather.” 24 Sep 2007
The Jonathan Edwards Center at Yale University. “Jonathan Edwards” 24 Sep 2007
American Transcendentalism Web. “Ralph Waldo Emerson.” 25 Sep 2007
Indeed, John Winthrop is perhaps one of the first most influential public intellectuals whose convictions are deeply rooted in spiritual faith. He was a forefather of the Puritan experiment and set about forming a government that was not separate from the church. On the opposite side of the religious spectrum, Williams believed in secular traditions although he “was a theologian, deeply concerned with the health and vitality of the church.” Williams did not just believe in the separation of church and state, but more importantly that the people “are in charge of the church.” Consequently, both public intellectuals drew great strength in their logic and reasoning from the passionate belief that “religion and civil society are political codependents” (Mack). Whether or not this codependency is benevolent for society or not remained to be seen.
However, Winthrop and Williams represent a trivial number of the many public intellectuals whose authority is rooted in secular and religious customs. For example, Cotton Mather, the pastor of Boston’s North Church in 1723, was a prolific writer about the nation’s “moral tone.” He exerted great influence over younger generation Puritans and explained the American experiment by using the symbolic language of the Bible to connect past events with the present. Additionally, Mather wrote about his belief in diabolical possession and witchcraft to the Boston clergy during the Salem witch trials causing the execution of a number of individuals. Consequently, he was a significant force in both secular and spiritual matters (“Cotton Mather”). Indeed, the witch trials symbolized exactly what Williams feared where religion when enforced through law led to tragedy (Mack).
Additionally, Jonathan Edwards epitomizes an important episode of the influence the secular and religious played upon the American public intellectual. He is one of America’s most important theologians who defended Calvinism and the Puritan heritage. His work is most significant however, due to his public role during the First Great Awakening as a revivalist and particularly intelligent philosopher. Edwards believes that God is a sovereign power and humanity is depraved; thus necessitating “the New Birth conversion.” Edwards role as a public intellectual in the religious and secular domains was further accentuated, because of how greatly widespread across all of society the Great Awakening was. These beliefs were further placed into wedlock with politics, because of the role that Christian morality took upon leaders of New England (“Jonathan Edwards”).
Lastly, Ralph Waldo Emerson, the American leader of the Transcendentalist movement, also demonstrated the influence of lay and spiritual mores upon the public intellectual nearly a century after Winthrop first did. This development was unique, because a whole new generation of men and women “each believes himself inspired by the Divine Soul which also inspires all men” ("Ralph Waldo Emerson"). Emerson’s faith was the basis for many of his later actions such as social reform and serves a great example of “a deep religious sensibility” that had the power to transform hundreds of thousands of individuals through the power of God.
While these five social leaders derive their authority from different sources, the inherent role of secular and religious practices remains clear. One’s connection to their faith has throughout time and continues to be a succinctly important dynamic upon one’s way of life – particularly for the public intellectual. Additionally, the role of the public intellectual is sometimes rooted in secularity where religion is entirely separate. However, as Stephen Mack warns, politics and government is most dangerous when either side of the debate is at a complete extreme of the power pendulum. Indeed, perhaps American democracy is still functioning, because this has not yet occurred.
Works Cited
Mack, Stephen. “Wicked Paradox: The Cleric as the Public Intellectual.” 14 Aug 2007. 25 Sep 2007
NNDB: Tracking the Entire World. “Cotton Mather.” 24 Sep 2007
The Jonathan Edwards Center at Yale University. “Jonathan Edwards” 24 Sep 2007
American Transcendentalism Web. “Ralph Waldo Emerson.” 25 Sep 2007
Tuesday, September 18, 2007
The Right Policy For Our Nation?
Since the shutdown and near collapse of two hedge funds managed by investment bank, Bear Stearns in August, the financial markets have been in chaos. These hedge funds invested in risky assets such as subprime mortgages that have rapidly lost billions of dollars of investors’ money. Further, without warning the public has been made aware that this situation was not isolated. Many other financial institutions and people made similar investments that have performed poorly. Not only the credit markets but also the housing and equity markets have performed poorly and are expected to continue to do so according to leading economists worldwide (Willis). Indeed, world leaders are seriously questioning whether a recession is in the American economy’s future and how best to act as to prevent one. Central bankers from not only the United States but the world’s other largest economies such as Japan, Germany, and the United Kingdom significantly impact every individual’s standard of living through monetary policy and must decide how to best respond to this financial crisis. Thus, the United States Federal Reserve must both act in response to these concerns immediately and also should act forcefully to prevent a recession by substantially lowering the federal funds rate.
The Fed must implement a change in monetary policy as soon as possible, because of three major reasons. They include “a credit market crisis, a decline in home prices and home building, and a reduction in consumer spending,” according to Martin Feldstein, president of the National Bureau of Economic Research (Feldstein). All of these factors pose the potential to seriously decrease economic growth in the United States. First of all, the Fed should respond to the credit crisis, because of the implied higher costs of credit that it poses in the future. The credit crisis refers to financial institutions flight from making investments in risky assets. Originally, these were subprime loans and other mortgage backed securities. Adjustable rate loans were made to borrowers with no or poor credit by mortgage brokers and in turn sold to other investors in large bundled packs (Kotkin).
However, many subprime borrowers recently have been unable to meet their required payments as rates increased above their initial levels. These defaults are more than what investors expected and have caused considerable distress (Feldstein). Investors literally were shocked in August upon the collapse of the Bear Stearns hedge funds and since then have been trying desperately to determine how to correctly price securities that invested in subprime mortgages. They have been unsuccessful and unable to sell these investments off. This is very significant, because hedge funds and private equity funds seriously increased the leverage used to purchase these loans by borrowing money themselves. In turn, the credit market has locked up and is unwilling to lend money to any borrowers who invest in risky assets (Seetharamdoo). This has prevented safe and normal borrowers of credit from receiving the loans they need to go about everyday business. Should the credit market continue to function incorrectly, the economy will grow at a decreased rate and slow any increase in our citizens’ living standards. Thus, the Fed must respond and improve the functioning of the credit markets in some way without delay.
Secondly, the United States Federal Reserve must implement a change in monetary policy as soon as possible, because a decline in home prices and construction will substantially aggravate the possibility of an economic downturn. Home building has experienced “about a 20 percent decline from last year to the lowest level in a decade” and the ripple effects are far from optimistic (Sarnoff). According to Economist Edward Leamer of UCLA, “Of the past 10 recessions, eight have been preceded by overinvestment and then a slump in housing” (Ip) Statistics such as this support the argument that housing is a critical driver of the economy. Further, home foreclosures have increased, because of the increase in mortgage defaults. These have resulted from owners with adjustable rate mortgages whose rates have jumped recently (Ip). Without a doubt, this increase is likely impacted by the large number of subprime mortgage holders. However, not only has home building declined, but also house prices are forecasted to fall 3.7% in 2007 (“Moody’s Forecasts”). Additionally, home prices are falling at their fastest rate in fourteen years (Nutting).
House prices could fall substantially further, because they “had been rising at unprecedented double-digit rates during the housing boom in 2003 to early 2006.” (Nutting). Should home prices decline in value more, to the point where the loans used to purchase the homes are worth less than the homes themselves, defaults may become even more of a problem. The result of this is standard macroeconomics 101. Once mortgage and home loan defaults become widespread, the supply of homes on the market increases and their prices decrease. As witnessed by the hedge fund fiasco, many financial institutions highly leveraged their investments in such assets. Thus, not only may the oversupply of homes and decline in home prices pose illiquidity problems, but also they “could become problems of insolvency” (Feldstein). In other words, while the housing market is illiquid right now and it is difficult to find buyers of many homes, current owners of homes’ loans and debt may exceed the value of their actual homes (Lanman). This would leave homeowners stuck with more liabilities than assets, tying up their ability to spend money at all. Quality of living would falter as people fight to merely maintain their standard of living. Therefore, in addition to the credit market crisis, federal policy must respond to this issue with urgency as to prevent further price deflation and home vacancies.
Thirdly, the decline of home prices and construction is important not only because it may cause additional declines in home building, but it also would decrease the wealth of American households and individuals nationwide. Thus, should a sizeable fall in house prices continue, it would substantially affect consumer spending. This is of even greater importance to the public intellectual, because consumer spending accounts for more than two thirds of the United State’s economy (Seetharamdoo). All that is needed to significantly decrease consumer spending and tip the United States into a recession is a decline in GDP or negative real economic growth, which would be caused by “a 20% cumulative fall in house prices” (Feldstein).
Additionally, the theory that mortgage refinancing plays a central role in consumer spending is gaining more and more ground. In March 2007, former United States Federal Reserve Chairman Alan Greenspan and Fed economist James Kennedy argued that “home equity served as a growing source of funds for American consumers from the early 1990s to 2005, when it financed close to 4% of total personal-consumption expenditures” (Blackstone). In other words, home owners use cash withdrawn from the equity of their homes as a source of wealth. This theorem suggests that the process of tapping into one’s home equity for funds contributes significantly to one’s consumer expenditure. An example of just how substantial this source of funding is offered by General Motor’s Vice Chairman Bob Lutz who believes that the mortgage industry meltdown has sharply reduced auto sales. “A lot of people are finding themselves in a position of reduced affordability and that has had an impact, not just on us, but across the industry,” Mr. Lutz told Reuters in April 2007 (“Moody’s Forecasts”). The government’s monetary policy plays a very strong role in determining whether or not consumer spending increases or decreases, because it sets such economic variables as interest rates. “The decline in home prices and rise in interest rates will shrink the future volume of mortgage equity withdrawals, causing consumer spending to decline” (Feldstein). This could push the economy into a recession if economic growth were to turn negative. Consequently, the U.S. Federal Reserve must respond soon as possible and prevent consumer spending from decreasing, by implementing economic policy that both prevents further drops in home prices and halts any future rises in interest rates.
The threats posed by turmoil in the credit markets, a decline of home prices and construction, and a reduction in consumer expenditure are all the more important, because of the connections that exist between them. All three scenarios are intrinsically linked to one another. Should the credit markets continue to not operate well, real estate will increasingly lose value and fewer homes will be built, while consumer expenditure will decrease. All three situations are being witnessed in the United State’s economy presently as mentioned by the examples above. Therefore, it is all the more dire that the United States addresses these issues soon as possible as to continue our economy’s expansion and ensure that the population’s well-being does not suffer but becomes better.
However, there are several alternatives the central bankers working for the Federal Reserve may implement as to respond to these risks. The Federal Reserve changes the direction of the economy through monetary policy, which is used to “promote ‘maximum’ sustainable output and employment and to promote ‘stable’ prices,” according to a 1977 amendment to the Federal Reserve Act (“US Monetary Policy”). While the Fed cannot directly affect inflation, unemployment, or output production it can affect them indirectly by changing the federal funds rate. It may be increased, decreased, or left alone and at varying magnitudes. Currently, the federal funds rate is 5.25%. This short term interest rate should be lowered greatly as to stimulate the economy and push it far away from future negative growth. Lowering the interest rates individuals, households and businesses are charged would lower their cost of borrowing, because they would then make smaller payments for their liabilities. This lower cost of extending credit would affect the economy in several ways that would help stem off a recession.
First of all, it would lower the cost of purchasing a home, because financing terms would be cheaper. The federal funds rate controls what interest rates banks and other financial lenders charge one another and their clients. So, if these short term interest rates were lowered, mortgages would require smaller loan payments to pay off balances. This would increase the demand for homes and cause home prices to move upwards preventing the downward spiral that home prices and home building is experiencing currently. Secondly, lowering interest rates “may increase banks' willingness to lend to businesses and households” and spur upward spending (“US Monetary Policy”). This would help prevent a significant decline in the economy output, because of the large portion that consumer expenditure contributes to gross domestic product. In particular, individuals like you and me would increase our spending, because the majority of us receive lines of credit primarily only from banks. Thirdly, if interest rates are lowered, the equity markets will perform better increasing the prices of stocks and other investments. If borrowing becomes cheaper for businesses, they generate higher future cash flows and the value of their businesses moves in the same direction: upwards. Fourthly, lowering interest rates will decrease the value of the dollar and increase the number of US exports to other countries. This will increase the total amount of spending on goods and services produced here in our country. Lastly, if interest rates are lowered, the increased demand for output produced in the US will fuel greater business investment and spending (“US Monetary Policy”).
All of these cause effect relationships affect the economy in positive ways. However, it must be emphasized that lowering the federal funds rate is a short term move and not long term. If the US Federal Reserve lowered interest rates forever, expansion would continue for a longer period at the expense of inflation and capacity. Lowering interest rates fuels inflation, because it decreases the real purchasing power of an individual. Additionally, should the country’s economic resources be used to their full extent the economy will over extend its capacity. However, at this point in time, fears of a recession are more pressing and urgent issues than inflation, because of the credit market crisis, a decline in home prices, and a reduction in consumer spending. Therefore, due to the severity of these imminent recession inducing factors, the United States Federal Reserve must act immediately and should lower the federal funds rate. To not do so would be to ignore our population’s right to a continuously improving quality of life.
Works Cited
Blackstone, Brian. “Greenspan Sees Spending Link to Home Equity.” 24 Apr 2007. 12 Sep 2007
Feldstein, Martin. “Liquidate Now!” 12 Sep 2007. 13 Sep 2007
Felsenthal, Mark, and Bull, Alister. “U.S. at risk of recession from housing.” 1 Sep 2007. 12 Sep 2007
Ip, Greg. “Should the Fed Target Housing?” 31 Aug 2007. 12 Sep 2007
Kotkin, Stephen. “Dangers of a Turbocharged economy.” 2 Sep 2007. 11 Sep 2007
Lanman, Scott. “Feldstein Warns of U.S. Recession.” 2 Sep 2007. 11 Sep 2007
“Moody’s Forecasts 3.6% Median House Price Decline in 2007.” 05 Oct 2006. 13 Sep 2007
Nutting, Rex. “Home prices fall at fastest rate in 14 years.” 27 Feb 2007. 11 Sep 2007
Nutting, Rex. “What will send the U.S. into recession?” 7 Sep 2007. 10 Sep 2007
Sarnoff, Nancy. “A Cloudy Forecast for Home Building: First Decline 13 Years Could Have Ripple Effect.” 27 Jun 2007. 12 Sep 2007
Seetharamdoo, Julien. “What if the US consumer stops spending?” 12 Sep 2007
“The Big Picture | More on Mortgage Equity Withdrawals.” 24 Apr 2007. 11 Sep 2007
“US Monetary Policy: The Fed’s Goals.” 11 Sep 2007
Willis, Bob, and Chandra, Shobhana. “US Economy: Confidence Wanes, House Prices Decline.” 27 Mar 2007. 12 Sep 2007
The Fed must implement a change in monetary policy as soon as possible, because of three major reasons. They include “a credit market crisis, a decline in home prices and home building, and a reduction in consumer spending,” according to Martin Feldstein, president of the National Bureau of Economic Research (Feldstein). All of these factors pose the potential to seriously decrease economic growth in the United States. First of all, the Fed should respond to the credit crisis, because of the implied higher costs of credit that it poses in the future. The credit crisis refers to financial institutions flight from making investments in risky assets. Originally, these were subprime loans and other mortgage backed securities. Adjustable rate loans were made to borrowers with no or poor credit by mortgage brokers and in turn sold to other investors in large bundled packs (Kotkin).
However, many subprime borrowers recently have been unable to meet their required payments as rates increased above their initial levels. These defaults are more than what investors expected and have caused considerable distress (Feldstein). Investors literally were shocked in August upon the collapse of the Bear Stearns hedge funds and since then have been trying desperately to determine how to correctly price securities that invested in subprime mortgages. They have been unsuccessful and unable to sell these investments off. This is very significant, because hedge funds and private equity funds seriously increased the leverage used to purchase these loans by borrowing money themselves. In turn, the credit market has locked up and is unwilling to lend money to any borrowers who invest in risky assets (Seetharamdoo). This has prevented safe and normal borrowers of credit from receiving the loans they need to go about everyday business. Should the credit market continue to function incorrectly, the economy will grow at a decreased rate and slow any increase in our citizens’ living standards. Thus, the Fed must respond and improve the functioning of the credit markets in some way without delay.
Secondly, the United States Federal Reserve must implement a change in monetary policy as soon as possible, because a decline in home prices and construction will substantially aggravate the possibility of an economic downturn. Home building has experienced “about a 20 percent decline from last year to the lowest level in a decade” and the ripple effects are far from optimistic (Sarnoff). According to Economist Edward Leamer of UCLA, “Of the past 10 recessions, eight have been preceded by overinvestment and then a slump in housing” (Ip) Statistics such as this support the argument that housing is a critical driver of the economy. Further, home foreclosures have increased, because of the increase in mortgage defaults. These have resulted from owners with adjustable rate mortgages whose rates have jumped recently (Ip). Without a doubt, this increase is likely impacted by the large number of subprime mortgage holders. However, not only has home building declined, but also house prices are forecasted to fall 3.7% in 2007 (“Moody’s Forecasts”). Additionally, home prices are falling at their fastest rate in fourteen years (Nutting).
House prices could fall substantially further, because they “had been rising at unprecedented double-digit rates during the housing boom in 2003 to early 2006.” (Nutting). Should home prices decline in value more, to the point where the loans used to purchase the homes are worth less than the homes themselves, defaults may become even more of a problem. The result of this is standard macroeconomics 101. Once mortgage and home loan defaults become widespread, the supply of homes on the market increases and their prices decrease. As witnessed by the hedge fund fiasco, many financial institutions highly leveraged their investments in such assets. Thus, not only may the oversupply of homes and decline in home prices pose illiquidity problems, but also they “could become problems of insolvency” (Feldstein). In other words, while the housing market is illiquid right now and it is difficult to find buyers of many homes, current owners of homes’ loans and debt may exceed the value of their actual homes (Lanman). This would leave homeowners stuck with more liabilities than assets, tying up their ability to spend money at all. Quality of living would falter as people fight to merely maintain their standard of living. Therefore, in addition to the credit market crisis, federal policy must respond to this issue with urgency as to prevent further price deflation and home vacancies.
Thirdly, the decline of home prices and construction is important not only because it may cause additional declines in home building, but it also would decrease the wealth of American households and individuals nationwide. Thus, should a sizeable fall in house prices continue, it would substantially affect consumer spending. This is of even greater importance to the public intellectual, because consumer spending accounts for more than two thirds of the United State’s economy (Seetharamdoo). All that is needed to significantly decrease consumer spending and tip the United States into a recession is a decline in GDP or negative real economic growth, which would be caused by “a 20% cumulative fall in house prices” (Feldstein).
Additionally, the theory that mortgage refinancing plays a central role in consumer spending is gaining more and more ground. In March 2007, former United States Federal Reserve Chairman Alan Greenspan and Fed economist James Kennedy argued that “home equity served as a growing source of funds for American consumers from the early 1990s to 2005, when it financed close to 4% of total personal-consumption expenditures” (Blackstone). In other words, home owners use cash withdrawn from the equity of their homes as a source of wealth. This theorem suggests that the process of tapping into one’s home equity for funds contributes significantly to one’s consumer expenditure. An example of just how substantial this source of funding is offered by General Motor’s Vice Chairman Bob Lutz who believes that the mortgage industry meltdown has sharply reduced auto sales. “A lot of people are finding themselves in a position of reduced affordability and that has had an impact, not just on us, but across the industry,” Mr. Lutz told Reuters in April 2007 (“Moody’s Forecasts”). The government’s monetary policy plays a very strong role in determining whether or not consumer spending increases or decreases, because it sets such economic variables as interest rates. “The decline in home prices and rise in interest rates will shrink the future volume of mortgage equity withdrawals, causing consumer spending to decline” (Feldstein). This could push the economy into a recession if economic growth were to turn negative. Consequently, the U.S. Federal Reserve must respond soon as possible and prevent consumer spending from decreasing, by implementing economic policy that both prevents further drops in home prices and halts any future rises in interest rates.
The threats posed by turmoil in the credit markets, a decline of home prices and construction, and a reduction in consumer expenditure are all the more important, because of the connections that exist between them. All three scenarios are intrinsically linked to one another. Should the credit markets continue to not operate well, real estate will increasingly lose value and fewer homes will be built, while consumer expenditure will decrease. All three situations are being witnessed in the United State’s economy presently as mentioned by the examples above. Therefore, it is all the more dire that the United States addresses these issues soon as possible as to continue our economy’s expansion and ensure that the population’s well-being does not suffer but becomes better.
However, there are several alternatives the central bankers working for the Federal Reserve may implement as to respond to these risks. The Federal Reserve changes the direction of the economy through monetary policy, which is used to “promote ‘maximum’ sustainable output and employment and to promote ‘stable’ prices,” according to a 1977 amendment to the Federal Reserve Act (“US Monetary Policy”). While the Fed cannot directly affect inflation, unemployment, or output production it can affect them indirectly by changing the federal funds rate. It may be increased, decreased, or left alone and at varying magnitudes. Currently, the federal funds rate is 5.25%. This short term interest rate should be lowered greatly as to stimulate the economy and push it far away from future negative growth. Lowering the interest rates individuals, households and businesses are charged would lower their cost of borrowing, because they would then make smaller payments for their liabilities. This lower cost of extending credit would affect the economy in several ways that would help stem off a recession.
First of all, it would lower the cost of purchasing a home, because financing terms would be cheaper. The federal funds rate controls what interest rates banks and other financial lenders charge one another and their clients. So, if these short term interest rates were lowered, mortgages would require smaller loan payments to pay off balances. This would increase the demand for homes and cause home prices to move upwards preventing the downward spiral that home prices and home building is experiencing currently. Secondly, lowering interest rates “may increase banks' willingness to lend to businesses and households” and spur upward spending (“US Monetary Policy”). This would help prevent a significant decline in the economy output, because of the large portion that consumer expenditure contributes to gross domestic product. In particular, individuals like you and me would increase our spending, because the majority of us receive lines of credit primarily only from banks. Thirdly, if interest rates are lowered, the equity markets will perform better increasing the prices of stocks and other investments. If borrowing becomes cheaper for businesses, they generate higher future cash flows and the value of their businesses moves in the same direction: upwards. Fourthly, lowering interest rates will decrease the value of the dollar and increase the number of US exports to other countries. This will increase the total amount of spending on goods and services produced here in our country. Lastly, if interest rates are lowered, the increased demand for output produced in the US will fuel greater business investment and spending (“US Monetary Policy”).
All of these cause effect relationships affect the economy in positive ways. However, it must be emphasized that lowering the federal funds rate is a short term move and not long term. If the US Federal Reserve lowered interest rates forever, expansion would continue for a longer period at the expense of inflation and capacity. Lowering interest rates fuels inflation, because it decreases the real purchasing power of an individual. Additionally, should the country’s economic resources be used to their full extent the economy will over extend its capacity. However, at this point in time, fears of a recession are more pressing and urgent issues than inflation, because of the credit market crisis, a decline in home prices, and a reduction in consumer spending. Therefore, due to the severity of these imminent recession inducing factors, the United States Federal Reserve must act immediately and should lower the federal funds rate. To not do so would be to ignore our population’s right to a continuously improving quality of life.
Works Cited
Blackstone, Brian. “Greenspan Sees Spending Link to Home Equity.” 24 Apr 2007. 12 Sep 2007
Feldstein, Martin. “Liquidate Now!” 12 Sep 2007. 13 Sep 2007
Felsenthal, Mark, and Bull, Alister. “U.S. at risk of recession from housing.” 1 Sep 2007. 12 Sep 2007
Ip, Greg. “Should the Fed Target Housing?” 31 Aug 2007. 12 Sep 2007
Kotkin, Stephen. “Dangers of a Turbocharged economy.” 2 Sep 2007. 11 Sep 2007
Lanman, Scott. “Feldstein Warns of U.S. Recession.” 2 Sep 2007. 11 Sep 2007
“Moody’s Forecasts 3.6% Median House Price Decline in 2007.” 05 Oct 2006. 13 Sep 2007
Nutting, Rex. “Home prices fall at fastest rate in 14 years.” 27 Feb 2007. 11 Sep 2007
Nutting, Rex. “What will send the U.S. into recession?” 7 Sep 2007. 10 Sep 2007
Sarnoff, Nancy. “A Cloudy Forecast for Home Building: First Decline 13 Years Could Have Ripple Effect.” 27 Jun 2007. 12 Sep 2007
Seetharamdoo, Julien. “What if the US consumer stops spending?” 12 Sep 2007
“The Big Picture | More on Mortgage Equity Withdrawals.” 24 Apr 2007. 11 Sep 2007
“US Monetary Policy: The Fed’s Goals.” 11 Sep 2007
Willis, Bob, and Chandra, Shobhana. “US Economy: Confidence Wanes, House Prices Decline.” 27 Mar 2007. 12 Sep 2007
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