Credit crunch in the US

The adoption of a free market economic system in the US led to deregulations in the financial sector. The monetary stance taken by Fed was to allow freedom in the market for players on their investment decisions. Over the 1990s America felt that with free trade and international capital flows deregulation was inevitable to provide an entrepreneurial environment. (economist. com). America had to allow a capitalist situation in the domestic financial and mortgage sectors. This allowed lenders and investors to invest even in risky portfolios which promised high returns.

The Small and Medium Enterprises tend to be the worst hit in a recession due to freeze on credit by banks. The SMES are considered to be the economic drive engine of any developing country. The adverse credit rating resulted from accumulation of debts and high financing costs for accrued loans. (cf. o. com). The initial signs for a looming recession were the panic in many stock counters and the bursting of the housing bubble. Asymmetry in information resulted from misinformation on the correct values sub prime properties and the associated risks on mortgages.

The giant mortgage companies Fannie Mae and Freddie Mae have over the years helped many home owners acquire properties despite high risk involved in the lending process. High cost of living caused inflation leads to workers demanding higher wages to afford the more expensive standard of living. Wages are related to the supply side economics in that a rise in wages causes producers to increase the prices of the final output offered in the market. Fed has learnt various lessons from previous recessions in America. In addition to govern authority private companies have learnt lessons to cushion themselves and weather an economic recession.

(Taub). The private firms set in place measures to minimize losses resulting from the drop in asset prices and reduction in production. Many US firms have adopted conventional ways to weather a financial melt down. Firms result to outsourcing part of the production process to low cost producers. (Gorton 1). This ensures full capacity utilization and increased productivity. The excess labor force is discharged from plants and suppliers are offered lower prices for their supplies. (King and Kushman 2) A recession is a period characterized by high rates of inflation and high unemployment. This condition is referred to a stagflation.

The manufacture of bio fuels in US has precipitated high global food prices. (Taub p). The high food prices are worsened by a credit crunch and adverse weather conditions caused by misuse of the environment. The disruption of crude oil flow by hurricanes and storms has contributed to high prices due to increased cost of production. America was by September 2008 in a budget deficit of more than $456 billion. A negative current account has resulted from excessive borrowing from Asian countries like China, Japan and Taiwan to the values of over $1. 3 trillion to foot a high expenditure bill.

Credit crunch in the US followed the collapse of several major financial institutions like Fannie Mae, Freddie Mc, JP Morgan Chase, Lehman Brothers and AIG. The housing market being capital intensive is used by economists to indicate the general economic outlook. The real estate is a durable investment thus a critical economic fundamental. The $700 billion stimulus package passed by Congress during the Bush administration will help in recapitalization in the financial institutions and correct market imperfections. The monies will be used to help rescue mortgage and financial institutions.