Subprime Mortgage Crisis - Implications

Implications

Estimates of impact have continued to climb. During April 2008, International Monetary Fund (IMF) estimated that global losses for financial institutions would approach $1 trillion. One year later, the IMF estimated cumulative losses of banks and other financial institutions globally would exceed $4 trillion.

Francis Fukuyama has argued that the crisis represents the end of Reaganism in the financial sector, which was characterized by lighter regulation, pared-back government, and lower taxes. Significant financial sector regulatory changes are expected as a result of the crisis.

Fareed Zakaria believes that the crisis may force Americans and their government to live within their means. Further, some of the best minds may be redeployed from financial engineering to more valuable business activities, or to science and technology.

Roger Altman wrote that "the crash of 2008 has inflicted profound damage on financial system, its economy, and its standing in the world; the crisis is an important geopolitical setback...the crisis has coincided with historical forces that were already shifting the world's focus away from the United States. Over the medium term, the United States will have to operate from a smaller global platform – while others, especially China, will have a chance to rise faster."

GE CEO Jeffrey Immelt has argued that U.S. trade deficits and budget deficits are unsustainable. America must regain its competitiveness through innovative products, training of production workers, and business leadership. He advocates specific national goals related to energy security or independence, specific technologies, expansion of the manufacturing job base, and net exporter status. "The world has been reset. Now we must lead an aggressive American renewal to win in the future." Of critical importance, he said, is the need to focus on technology and manufacturing. “Many bought into the idea that America could go from a technology-based, export-oriented powerhouse to a services-led, consumption-based economy – and somehow still expect to prosper,” Jeff said. “That idea was flat wrong.”

Economist Paul Krugman wrote in 2009: "The prosperity of a few years ago, such as it was – profits were terrific, wages not so much – depended on a huge bubble in housing, which replaced an earlier huge bubble in stocks. And since the housing bubble isn’t coming back, the spending that sustained the economy in the pre-crisis years isn’t coming back either." Niall Ferguson stated that excluding the effect of home equity extraction, the U.S. economy grew at a 1% rate during the Bush years. Microsoft CEO Steve Ballmer has argued that this is an economic reset at a lower level, rather than a recession, meaning that no quick recovery to pre-recession levels can be expected.

The U.S. Federal government's efforts to support the global financial system have resulted in significant new financial commitments, totaling $7 trillion by November, 2008. These commitments can be characterized as investments, loans, and loan guarantees, rather than direct expenditures. In many cases, the government purchased financial assets such as commercial paper, mortgage-backed securities, or other types of asset-backed paper, to enhance liquidity in frozen markets. As the crisis has progressed, the Fed has expanded the collateral against which it is willing to lend to include higher-risk assets.

The Economist wrote in May 2009: "Having spent a fortune bailing out their banks, Western governments will have to pay a price in terms of higher taxes to meet the interest on that debt. In the case of countries (like Britain and America) that have trade as well as budget deficits, those higher taxes will be needed to meet the claims of foreign creditors. Given the political implications of such austerity, the temptation will be to default by stealth, by letting their currencies depreciate. Investors are increasingly alive to this danger..."

The crisis has cast doubt on the legacy of Alan Greenspan, the Chairman of the Federal Reserve System from 1986 to January 2006. Senator Chris Dodd claimed that Greenspan created the "perfect storm". When asked to comment on the crisis, Greenspan spoke as follows:

The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business.