The financial crisis which hit the American banks in the fall of 2008, and then spread to the financial markets all across the globe, is the worst crisis since the Great Depression which hit the Wall Street in 1929.Many time honored economic theories proved wrong and there was a stir among the economists and the statesmen alike as to how this could be explained. While this discussion was continuing, American government came up with a bailout package in an attempt to contain the crisis. This policy ignited another controversy regarding necessity of such package. In my view there are numerous reasons for the governments to take affirmative actions such as bailouts to prevent the economy from a complete collapse, and I support the measures initiated by the U.S. government without an iota of doubt in my mind. However, before analyzing it further, it will be better to define the key terms.
What is financial crisis? Financial institutions or assets suddenly lose a large part of their value. Many financial crises were linked with banking panics, and many recessions coincided with these panics. Include stock market crashes and the bursting of other financial bubbles, currency crisis, and sovereign defaults. Financial crises directly result in a loss of paper wealth; they do not directly result in changes in the real economy, but may indirectly do so, notably if a recession or depression follows. Bailout in economics and finance is a term used to describe a situation where a bankrupt or nearly bankrupt entity, such as a corporation or a bank, is given a fresh injection of liquidity, in order to meet its short term obligations. Often bailouts are by governments, or by consortia of investors who demand control over the entity as the price for injecting funds.
The current global financial crisis was triggered by the credit crisis with the USA as its epicenter and then quickly spread across the globe. The crisis started spreading around the world in the middle of 2007 and all along the 2008, whence stock markets in major economies fell, followed by the collapses of large companies and leading financial institutions. In a world where economies are integrated, the spread of such crisis was unavoidable. Now question arises as to whether Government should have bailed out in order to accelerate the rehabilitation of the financial system or not?
A stable financial system is necessary for enhancing the efficiency of intermediation, which is achieved by mobilizing domestic savings, channeling them into productive investment by identifying and funding good business opportunities, reducing cost of information, transaction, and monitoring. This results in efficient allocation of financial resources. In the financial system, banks and non-banking financial institutions play vital role for development of economy. Numerous sectors and industries are associated directly and indirectly with the financial system, and depend upon it. If financial system is stable and functioning properly, it is an indication of economic development and growth. Financial institutions and other sectors is a source of revenue for government in the shape of taxes. The US Government was therefore justified in taking reasonable measures for stability of failing financial system. US strong financial system proved helpful for achieving global financial stability, investor well-beings, job securities, and credit freeze. Recession, if not been controlled, would have resulted in loss of nearly 20 million jobs in America alone, as per predictions made by ILO, and would have brought worldwide unemployment to 200 million for the first time in history (Reuters, 2008)
Critics of the bailout package argue that to make all the citizens of the United States should suffer the loss is literally nonsense. The one who must suffer the loss should be the one who made the bad loans. Anything else is an organized theft. If the bank did not inquire as to whether the borrower could repay the loan, or if it did not require an adequate equity cushion, then it must be responsible for such “stupid loans”. The same goes for those who bought those loans and thereby became the lender. The result of enough such loans should be insolvency. But the economics and businesses are not run by sentiments. There has to be a strong rationale behind every economic action. Only those actions which are in overall benefit of society are economically sound actions. To allow the banks to go bankrupt would not have been an economically sound action in my opinion. This rationale was explained by President Bush when he stated in a speech address to congress in March 2008 "we would get our money back..When the government sells bonds at 3.5 percent and buy preferred stock at 5 percent for five years (and then ten percent thereafter), the government makes money if firms pay the dividends. The market demands 12 percent, but the government, with a lower cost of borrowing money and a very long time horizon for returns, can demand much less”. (Bush, 2008). True enough. It was supported by President Obama in his State of the Union address delivered to the congress on 27th Jan 2010 when he said “Look, I am not interested in punishing banks; I’m interested in protecting our economy. A strong, healthy financial market makes it possible for businesses to access credit and create new jobs. It channels the savings of families into investments that raise incomes” (Obama, 2010).
Finally, the true rationale behind the bailout can be understood through a simple simile. If a house in a street starts burning, what will be the reaction of owners of other neighboring houses? If they take prompt and timely action and control the fire, it is good for all houses. Otherwise, this fire is dangerous and harmful for all. Similarly if the financial crisis starts and financial system becomes unstable, it is harmful for the whole economy. If financial system becomes unstable, it’s a responsibility of government to take appropriate action for rehabilitation and stability of the system.
Bibliography
1. Dorfman, D. (2008, September 22). For, Against Uncle Sam's Bailout. The Sun, New York .
2. Jones, S. (2008, October). A juddering halt to world trade. The Financial Times .
3. Obama, B. (2010, January). Retrieved from state of the union address: http://stateoftheunionaddress.org/
4. BBC Debate on Bailout. (2010, Febuary), www.bbcnews.com
5. Bush, J.W. (2008, January). Retrieved from Congress address: http://stateoftheunionaddress.org/
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