The word “crisis” perfectly characterizes the period between 2008 and 2009. The global financial crisis has affected virtually all countries except the poorest ones, which were already in a permanent financial and economic crisis. The crisis that started with the financial turmoil in the United States has become a worldwide phenomenon by the end of 2008 and tested the strength of economic models, which have been established in various countries during the last 5-6 years. The uniqueness of the U.S. 2008 financial crisis is conditioned by the great diversity of the opinions on the reasons of the financial crisis. However, this diversity acts contradictory: the more explanations are expressed, the more doubts arise. The critical analysis of the reasons of the crisis may reveal its root causes. This paper will attempt to analyze and describe the backgrounds, root causes, and consequences of the 2008 financial crisis in the United States.
OVERPRODUCTION OF THE DOLLAR
The backgrounds of the 2008 economic crisis were growing for decades. The theory of capitalism lies in the fact that the amount of demand (in money) always corresponds to the number of supply, and the number of supply is constantly growing due to scientific and technological progress. One needs to give money to consumers in order to pay off scientific and technological progress, and it is exactly what the Federal Reserve System has been doing for the last 30 years by increasing the emission of dollars. Emission was between 100 and 200 billion dollars monthly (Brenner and Jeong 2). The crisis of overproduction began in United Stated in the 1970s, because it was necessary to do something with all the products and services. A default on the dollar was declared and it was further stated that dollar was not any more supported by gold, resulting in unlimited money printing.
Apparently, the main and the only reason of the global economic crisis is overproduction of the world’s main currency – the U.S. dollar. Dollars began to be printed in unlimited quantities since 1971, when a binding of the dollar to the gold content ensured by the gold reserves of the United States was abolished. The purchasing power of the dollar was protected not only by the United States GDP (as it occurs in every normal country), but also by the GDP of countries of the entire world.
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Such a fact would not be a problem, but the states with economies that began to provide the dollar’s strength never had and still do not have a control over the volume of dollar emission. The United States Government does not actually have this control as well. Such a kind of control is granted only to the Federal Reserve System.
The Federal Reserve System of the U.S. is a private organization, owned by 20 private banks of the United States. It is their main business to print world money. In order to achieve it, the current owners of the Federal Reserve spent much time and efforts to afford the World War I and II, the Bretton Woods agreement in 1944, and the creation of the Federal Reserve System in 1907.
Thus, a group of individuals finally won the right to release dollars into circulation, determine their amount, timing, etc. From 1971 to 2008, the volume of the dollar supply in the world has grown tenfold, exceeding many times the actual volume of the commodity mass in the world. Such situation was extremely profitable to the owners of the Federal System as a private organization in the first place, and to the United States as a state in the second place. The list of the U.S. benefits may include the possibility of the U.S. to live beyond its means largely at the expense of the rest of the world since 1944 and especially since 1971 (Ely 98).
Thus, the United States GDP is 20% of the world GDP, but it consumes 40%. It is logical to assume that someone has to cover the expenses. In this case, this role has been given to the rest of the world, which gives its goods to the United States in exchange for its currency.
It is important to understand why the Federal Reserve System had to issue more dollars than world’s economy needs for the normal functioning. Indeed, if all the countries which have voluntarily integrated their economies into a mechanism for maintaining and purchasing the power of dollar would have a right to control the emission of the dollar, nothing wrong with the economy of the world would have happened. The real dollar supply, in this case, would correspond to the actual volume of assets that would have to be ensured in dollars. However, if a private person has a right to print the dollar provided by the economies of the whole world, such a person will start the oversupply of the dollar, since it will give them great opportunities.
Significant funds were spent on providing “affordable” loans, i.e. consumer loans, including housing loans. Namely, someone could earn nothing, while having been provided with a house, a car, etc., however, within the obligation to work for 30 years to repay the loan. The way to pay for all similar projects (to give huge amounts of loans) was only possible at the expense of unsecured dollar emission. At the same time, the owners of the Federal Reserve knew perfectly that the consumer would not have to return that money in full because the stage of “controlled collapse” will come and everything will change, including the collapse of the dollar. Thus, the overproduction of the dollar is one of the main reasons and root cause for the U.S. financial crisis of 2008.
Another reason is an unsecured mortgage. Demand for housing by the population was growing in the U.S. from 2001 to 2005, and such a growth was influenced by the so-called real estate growth (Ely 99). The increase in prices is always accompanied with the increased demand. Buying an apartment in a period of rising prices, people thereby increase the capitalization of their money. In this period, the subprime loans (that is, unreliable loans) were actively provided in the United States (Yeoh 30). They reduced the requirements for the loan taker, while at the same time reasonably but naively believing that even if a loan taker cannot pay the debt on time, then it would be possible to withdrawn the loan taker’s apartment, sell it, and earn money on the price increase. Infinite number of organizations offering such loans has appeared in the market. It, to a large extent, can be explained by a desire of people to earn money easily. Thus, the market had grown but the next generation did not want to buy a house at the stated price. Consequently, the market economy has responded and, as expected, the prices began to fall immediately.
Loan collateral is the property itself, but its final value at the time of the sale is much lower than the amount of the original loan. The person who received subprime loan cannot pay it back. As a result, the company that provided a loan takes away debtor’s house, but its market value becomes two times less than the loan amount. In a single case it would not play a significant role, but the American market is huge, thus, the panic has begun.
In 2006, subprime loans accounted for about 20% of the total number of mortgage loans, whereas in 2002 their number has not exceeded 6% (Rose and Spiegel 344). The most widely used loans were the ones with floating interest rate, which was adjusted annually beginning with 2003. Most creditors who have worked in the market provided loans with the subsequent resale of loans to investors, which had virtually no own funds, mainly involving short-term bank loans.
Thus, the following factors should be allocated as the reasons of unsecured mortgage:
- Improper (inflated) assessment of the proposed mortgage property caused by a desire of financial and credit institutions that provide mortgages to earn more (the larger amount of a mortgage loan, the larger amount and interest thereon).
- Unsubstantiated general economic indicators of growth in property prices that created the illusion in the society that real estate investment is the most stable, efficient, and profitable kind of investment. Thus, the average American tried to solve all of his or her credit problems due to the growth in housing price by pawning their own housing (selling it to oneself in rehypothecation). In this case, the creditor and/or investor earned by creating a mortgage pyramid.
- Failure to comply with mortgage safety regulations related to overestimation of the LTV coefficient value in the provision of mortgage loans and issue of mortgage-backed securities. In the U.S., the figure was 97-100%, while the average recommended norms are 60-70%. As a result, the securities were not supported and it turned out that it is more profitable to not repay the loan at all.
- Issuance of loans to the borrowers with poor creditworthiness and solvency.
- Rising interest rates of the Federal Reserve System associated with worsening of economic situation since 2001.
- Lack of available own funds to compensate the losses in creditors.
- Condescending attitude to the borrower, especially in case of the fictitious early loan repayment.
- Constant growth of operations in the mortgage market associated with an increase in the riskiness of mortgage-backed securities (non-observance of mortgage safety rules in the issuance of mortgage-backed securities) and the loss of control over their emissions, which converted the market into the “virtual” one.
- The majority of loans were issued relying on refinancing.
In addition to the above mentioned eight causes of the unsecured mortgage, there is the principal cause which underlies each of them, namely, financial and credit institutions’ desire to gain super profits and greed.
MONETARY MODEL OF THE ECONOMY
In fact, almost every country in the world has or tries to follow the monetary model of economy. However, the analysis of globalization models, as well as the analysis of the events occurred in the last hundred years shows that economic stability cannot be achieved following the principles of the monetary economy neither in a separate state nor within a united, globalized world (Lal 273). If the expansion of the market in a separate state reaches its limit, it leads the country to the crisis due to the inability to expand further. In the global economy, the expansion takes place within the confines of the whole world. Enterprises are concentrated in certain countries weakening the economic power of other states, which immediately starts the economic failure with the gradual collapse of the entire economic system (Liang 112). The problem lies in the very structure of the monetary economy, the principles of distribution of products manufactured and principles of the labor organization.
In order to analyze the structure of the monetary economy, it is necessary to consider the model of destruction of the monetary management style economic system. Upon saturation of market, the growth of production stops, profits of the enterprise fall, and market’s maintaining becomes impossible. It becomes complicated to pay salaries to the employees, as well as taxes. Other payments, such as fees for the light, heat, and fuel also cannot be made. If it had been possible to transfer companies in other industries upon saturation of markets by goods, then the crisis expressed in unemployment and declining of living standards could have been avoided.
However, it is not possible in circumstances when all spheres of production are involved. The crisis of monetary economy does not even lie in the fact that it has inequitable distribution of products manufactured, because the system can grow and expand for a long time even with the unjust distribution. The main crisis of the monetary economy is not in the fact that it is impossible to continue producing products upon saturation of the market, but rather in the fact that it is impossible to keep the welfare of the population, even if the goods can still be produced. It is necessary to seek an economic system in which the liberation of people from labor will not affect their well-being and prosperity. There may be only one solution, which is the scientific and technological progress that should focus on the full automation of production and economic systems.
Automation is not possible in a monetary economy because the income that provides a person’s life can only be obtained through person’s participation in the total production of goods. The worker becomes unnecessary within the automation of production, and such a worker is deprived of an opportunity to have an income for survival. At the same time, the production itself loses its meaning if the worker deprived of income cannot buy the products that the company produces. Therefore, one of the ways out of the crisis is in the search and introduction of the non-monetary principles of economic management.
The reasons behind 2008 crisis can be considered from the standpoint of sociology as well. The above reasons are, by no means, very important causes and roots of the crisis. Anyway, there is another reason which is not so obvious but is no less important and is connected to every reason mentioned. It is overconsumption. Overconsumption is an eminently destabilizing process which is characterized by excessive consumption, exceeding the normal requirements, and, thus, leading to a sharp decrease in the value of consumed things (Yeoh 46). Overconsumption is essentially connected with the underconsumption. It deprives people of the most necessary things, including the persons that overconsume. For example, overconsumption reduces the degree of satisfaction with the process of extraction and arrogating of goods. Dysfunctions of overconsumption appear on the macroeconomic, microeconomic, and social levels. Individual consumption ceases to be a stimulus for further development of technology and economic growth with a certain level of economic development. If the “pre-consumer” economy can function without its planning and state intervention, then “pre-established harmony” of the market disappears in consumer society and macroeconomic chaos occurs.
Overconsumption is associated not only with excess demand, but also with the expansion of consumption in the previous “non-consumer” areas. The pre-crisis society differed with the system processes of commodification, i.e. extrapolation of consumer mechanism on non-market social areas: sports, arts, family, sexual life, education, medicine, military, etc. Thus, education is gradually transformed from a classic social institution in the economic entity of a service industry. Indicators of this process include paid nature of education, the contract system of relations within the educational process, the leveling of cultural determinants and factors in the situation of globalization of education, the use of economic criteria of efficiency, etc.
Consumption becomes a substitute for social activity. Post-industrial society forms new consumer morale and ethics. Within such new morality, virtue is not a labor but consumption, and the middle class receives not a “free labor” but “free and endless consumption” for its self-realization.
The expansion of the consumer market has led to an uncontrolled extensive process of socioeconomic hyperstimulation of the system, creation of numerous pyramids, which effectively applies only within the expansion of production processes, marketing “charging” of the consumer market and its subjects, and, ultimately, consumption processes in the ever-expanding progression. Overconsumption creates an environment in which market conditions lose their objectives, the phenomenological basis. The value of assets begins to emerge mainly from the cost of intangible capital, and financial institutions begin to master the speculative instruments of increasing the value.
Sociological studies in the United States since the 1940s has shown that people who are in the 20% stratum of income distribution see themselves as happier than those who are in the next quintile, and so on up to the bottom, where people see themselves as less happier (Yeoh 51). However, this trend is limited to a certain threshold, excess of which begins to reduce the subjective level of life satisfaction. Economists believe that when GDP reaches approximately 10 000 USD per capita, the further economic growth will not lead to an increase in the average level of satisfaction, and this threshold in North America has already been passed.
For several decades, social scientists have monitored the level of subjective wage for creating “a decent life” and during all these years the number has steadily increased, almost exactly reflecting the general level of economic growth. According to statistical data, per capita income has increased adjusted for inflation between 1965 and 1995 from 14,792 to 26,615 USD. At the same time, spending on private consumption has increased from 9,257 to 17,403 USD.
Concerning the relationship of income level and the degree of subjectively assessed individual happiness, it can be concluded that happiness is not associated with the absolute income, but with the relative income. Moreover, the satisfaction from the wealth is the process of comparing and further “pride” for the own material well-being. Thus, there is an inflation of a “happiness” category, which is arbitrarily connected to the material factors. Jealousy, in turn, becomes a mechanism initiating a modern person to the eternal race for the constantly elusive standards of living and consumption, which are reflected in the infinitely increasing demand for all types of loans.
Thus, overconsumption is a global phenomenon which defines the mechanisms of modern Western Socio-Economic System that creates a powerful destructive potential manifesting itself in economic crisis and social and economic dysfunctions.
CONSEQUENCES OF THE CRISIS
The U.S. financial crisis began in late 2006 with the subprime mortgage crisis. It appeared as a result of the mortgage market bubble caused by the Fed’s low interest rates, abundant liquidity, and frivolous attitude of mortgage companies to the borrowers. Mortgage companies started to sell mortgages to institutional investors in the U.S. and other countries, trying to escape a difficult situation and thereby causing the chain reaction around the world. When real estate prices in the U.S. fell, the companies that bought these mortgages suffered huge losses because the prices of the real estate were much lower than the prices of mortgages (Lal 275). The U.S. housing bubble burst and affected the entire global economy. In essence, the American mortgage companies dealt with unfair and speculative low-income clients, and when the latter have ceased to pay debts, the U.S. mortgage companies just resold mortgages to other companies around the world.
The most striking consequences of the financial crisis in the U.S. was the nationalization of the mortgage agencies Fannie Mae and Freddie Mac, the bankruptcy of the largest systemically important banks, and the nationalization of the U.S. insurance giant AIG. In September 2008, the financial crisis in the U.S. triggered a crisis of liquidity of world banks. Due to the U.S financial crisis, the Bear Stears bank went bankrupt, the Lehman Brothers bank went bankrupt as well, and the Merrill Lynch bank was bought by the Bank of America. The Fed bought 80% stakes in the American International Group, the world’s largest insurer, nationalizing it in fact.
As a result, the pillars of the U.S. financial system were in a difficult situation. The Fed has created a fund to buy bad debts back. The Paulson plan was adopted to maintain the country’s financial system. The essence of the plan is to create a state corporation that will be engaged in further purchase of troubled assets from banks. The amount of $700 billion should have been allocated for this plan. Later, the government refused to purchase the assets, and allocated $800 billion for banks to maintain consumer credit instead (Lal 280).
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Overproduction of dollar, unsecured mortgage, monetary model of economy, and overconsumption are closely intertwined roots of the 2008 economic crisis. The crisis has seriously shaken the U.S. economy, as well as the economy of the whole world. However, it should be noted that the U.S. has played mainly constructive role in the world economy in recent decades, acting as one of the most powerful centers of the real demand and putting economic growth on a global scale. Not only the current economic crisis, but also the rapid rise of Asian economies in 1980-1990s would not have occurred without American overconsumption. No sector of the “new economy”, which largely determined the technological development of recent decades, would have been possible without the formation of “bubbles” in the U.S. stock market. Effective financial assistance for developing countries in Latin America and South-East Asia in 1994-1998 would not have been provided without the dollar’s status and the role of the U.S. in its emissions.
It might be said that the world economy has entered a long strip of recession. The wave of privatization leads the world economy to a standstill due to the global spread of neoliberalism. More and more people in the world are becoming poor, and they continue to grow poor. Rich people are less numerous and they are only getting richer. Impoverishment occurs in almost all countries. If the measures are not taken in the next decade at the level of each individual country, the consequences of the global financial crisis could prove fatal for the entire world.
It is clear that the current model of the economy is not suitable for such a global phenomenon as overconsumption. If people want to avoid crises, which, certainly, would repeat in future in the current state of the economy, they just need to change the economy model. However, in this case, the other problem occurs: what model will be effective enough? In order to answer the question, further research has to be performed.