Understanding The Recession: The Credit Crunch

Feb 15, 09 Understanding The Recession: The Credit Crunch
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The government has sunk (understatement alert) a lot of money thus far trying to move the country out of this recession.  As of this writing, their attempts have proven futile.  “Why”, you may wonder, “have we spent all of this money and it has not helped?”

Comparing our economy to a human body accurately illustrates the problem.  Right now, our economy’s arteries are severely blocked.  The government keeps giving us blood transfusions, but this does nothing to eliminate the blockage.

The blood is diverted to cells and organs thirsting for blood, but this only staves off the inevitable.  In essence, this describes the credit crunch.

A credit crunch is a decrease in the availability of loans, credit, and the tightening of conditions needed to obtain a loan from a lending institution.

When the housing bubble finally burst, the largest investment banks, insurance companies, and savings and loans, were left with billions of dollars in toxic debt.  The effect on global financial markets was so severe that credit flow ceased.

In in order to slow the precipitous drop in stock prices, Henry Paulson proposed the TARP (Troubled Assets Relief Program) on September 18, 2008.

Unfortunately, this bill was defeated and the stock market plummeted.  Congress was forced to amend many parts of the original proposal in order to insure passage on October 3rd.

Although the TARP money was supposed to stimulate the economy by providing capital so that banks could begin lending again, it was unsuccessful.

Instead, banks diverted the money and used it to prop up their bottom lines.

The credit crunch affected a broad swath of the economy, including the retail, manufacturing, automotive, and real estate industries.  Since consumers and businesses could not borrow money, consumer spending dried up, which in turn led to a sharp decline in business profits.  Thus, businesses cut jobs, which led to increased unemployment and further decreases in consumer confidence and spending.

If the banks had lent the money when they were supposed to, it is a very real possibility that the recession would not be this deep.

Now, the Obama administration and economists are debating the best way to inject the large amount of capital needed to end the credit crunch.  Geithner wants to inject capital into the markets by encouraging private buyers to purchase the bad bank assets.

In addition, Geithner is also seeking to enact measures that would encourage consumer and small business lending.

Unfortunately, no one knows if even these measures will ease the credit crunch.  However, something has gotta give, because the consequences of a stifled credit flow could be fatal for our economy.

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