The prices of these securities spiraled upwards, seemingly without an upper limit. Their complexity had made price rationalization an impossible task. Sooner rather than later, the speculation inflated bubble collapsed and has led to the severest economic crisis in over seventy years. While the epicenter of the crisis is in the United States, its repercussions have reached all corners of the world, including such emerging economies as China and India. As Alex Brummer explains, this phenomenon could not sustain forever:
“Such vehicles–Goldman Sachs’s Global Alpha fund, for instance, and several operated by Bear Stearns–were able to extract the maximum value from securities by borrowing against them and selling them on. Fabulous returns were made using sophisticated computer models. But as the sub-prime mortgage situation became worse and such lenders as the giant Californian company New Century Financial collapsed into bankruptcy, it dawned on nervous investors that the emperor had no clothes.” (Brummer, 2007, p.17)
The prevailing financial crisis can also be seen from an historical perspective. For example, many of the events and conditions that led to the present decline of the economy were similar to those leading up to the Great Depression of the 1930s. Then as is now, deregulation is seen as the chief culprit. Especially, during the tenure of the Bush Administration, the financial economy had repeated many of the same mistakes incurred during the 1920s. These excesses include stretching of borrowing limits to underwrite numerous speculative bets with money derived from the vulnerable middle class. Some of these financial mechanisms were poorly regulated, making the eventual economic crash inevitable. But, it would be simplistic to point fingers at the Bush Administration alone. The seeds for the disaster were sown further back in American political history. For example, in the last three decades, the Presidents of both parties, with the support of the Congress repealed important protective mechanisms from the original New Deal legislation. As a result, instances of exorbitant profits for business corporations have risen while real productive growth has been replaced by complex financial products such as derivatives. This, as a whole had made American economy vulnerable to recession (Roubini, 2008, p.46). Alongside derivatives, overpriced equities, inflated real estate prices and other complex financial instruments have played a role in creating the economic bubble. The bubble is further inflated by speculative borrowing, which feeds on itself, as it did during the Great Depression. This is so because an inflated asset is suitable collateral for further borrowing. To state that deregulation played a role in creating the bubble would be an understatement. In fact, the deregulated business and financial environment inevitably leads to periodic recessions. For example, in the years leading up to the current crisis, “the ratio of stock prices to corporate earnings is not quite as high as it was in 1929 or 2000, but it is still very high by historic standards” (Kuttner, 2007, p.20). As the author further explains,
“For decades, real-estate prices have appreciated faster than incomes. This could not go on forever, because a house is worth only what some buyer can afford to pay for it. Lately, housing prices got an extra nudge from artificially cheap mortgages extended to people who didn’t really qualify for credit. Mortgage companies could make these sketchy loans because some other speculator was willing to take the loans off their books, and because they expected housing prices to keep rising, adding a cushion of equity. Thanks to deregulation, the entire game operated largely beyond the purview of bank examiners.” (Kuttner, 2007, p.21)
When initial signs of an economic recession were visible in the horizon, the policy makers did not act expeditiously. Toward the end of Bush Administration’s tenure, there were ominous signs of an impending recession, but the actions taken since then are not substantial enough. For example, in his final State of the Union speech, President Bush mentioned about the need for an economic stimulus package. There were talks of a $150 billion bailout package that would include tax rebates and other incentives to encourage consumer spending and investment in the near future. Moreover, under the proposed plan, taxpayers would get rebate checks, which would put disposable money directly in the hands of consumers – an idea that got bipartisan political support. Yet, in spite of encouragement in the House of Representatives, the plan does not measure up when seen in the backdrop of the severity of the economic crisis. For instance, the unemployment rate has reached its highest level in last sixty years. Added to that is the dismal state of the manufacturing industry. The consolidation of the European Union and its common currency Euro is posing a serious threat to the strength of American dollar. Considering all these factors, the measures taken so far prove inadequate. The plan is also ridden with technical flaws. As William Hoar points out, “With both major parties offering spurious solutions for the economy, the bipartisan fix is bound to be even worse for the nation in the long run than a partisan one. The shot in the arm that the politicians are pushing is a shot of more debt–involving the spending or rebating of money that the government does not have. All that this remedy will boost is the budget deficit.” (Hoar, 2008, p. 42)