Politicians and Government officials in US may say that things are moving in the right direction. However it becomes difficult to understand how such a solution can ever work. If we study the history of economic problems in various countries, it is evident that such a solution has never worked. Countries had to take tough measures of austerity and cut down Government spending to reduce budget deficits. Otherwise the country is left with only two options: default on the debt or print money to cause very high inflation.
The US Government has taken many steps after the crisis to solve the problems. Iâ€™ll briefly describe two steps that tell me that they are not solving, but only postponing, the problems. The â€œCash for Clunkersâ€ programstarted after the crisis gave tax incentives to consumers who would sell their old cars and buy new fuel-efficient cars. This program was marketed as aâ€œclean, green and sustainableâ€ initiative. However the real intention was to artificially increase demand in the automobile industry. The poor consumer who had a decent car would now get a new car (which was not required), and his personal debt would increase sharply.
The video below describes that program:
Another important change that happened after the crisis was an accounting rule called â€œMark-to-Marketâ€. Itâ€™s difficult to calculate the exact value of complicated and illiquid securities (e.g Level 3 assets). Prior to the crisis, these securities were valued at their market price. As the value of these securities started declining dramatically, banks had to write-off these assets and that resulted in a huge loss. It was hurting the banks and some senior executives of finance firms blamed this rule for the financial crisis. Thatâ€™s like blaming the X-ray machine for a fracture!
The US Congress agreed that the rule was a problem and pressurized the Financial Accounting Standards Board (FASB) to change this rule. Now banks can use â€œMark-to-Modelâ€ to value those securities. Ever since this change has taken place, all banks have started showing good profit numbers. Guess why? Itâ€™s because the banks are allowed to create their own financial models to value these securities. If all these financial models were perfect, then the crisis wouldnâ€™t have occurred in the first place.
Why is this information important if you are not investing in US? Whether you are a student or a working professional, it is good to understand the global macroeconomic trends. US has considerable power and influence, and is the largest economy in the world. So if it has economic problems, then we will definitely experience some adverse effects - whether we are working in the Finance industry or planning to study abroad.
Sedatives can reduce pain but not really cure the root cause of the pain. Bailouts and stimulus packages in an economy are similar to sedatives. Weâ€™ll have to wait for 3 - 5 years to see the actual impact.