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Fixing The Economic Crisis

The economic crisis facing the United States is perhaps the worst since the Great Depression. The primary indicators of economic strength, the origin of the U. S. financial crisis is that commercial banks and investment banks lent vast sums—trillions of dollars—for housing purchases and consumer loans to borrowers ill-equipped to repay. (Sachs, 2008) The easy lending pushed up housing prices around the U. S. , which then ratcheted still higher when speculators bought houses on the expectation of yet further price increases.

(Sachs, 2008)When the easy lending slowed and then stopped during 2006-07, the housing prices peaked and began to fall. The housing boom began to unravel and now threatens an economy-wide bust. (Sachs, 2008) The U. S. economy faces four cascading threats: First, the sharp decline in consumer spending on houses, autos and other durables, following the sharp decline in lending to households, will cause a recession as construction of new houses and production of consumer durables nosedive.

(Sachs, 2008) Second, many homeowners will default on their mortgage payments and consumer loans, especially as house values fall below the mortgage values. (Sachs, 2008)Third, the banking sector will cut back sharply on its lending in line with the fall in its capital

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following the write-off of bad mortgage and consumer loans. (Sachs, 2008) Those capital losses will push still more financial institutions into bankruptcy or forced mergers with stronger banks.

(Sachs, 2008) Fourth, the retrenchment of lending now threatens even the shortest-term loans, which banks and other institutions lend to each other for working capital. Inter-bank loans and other commercial paper are extremely hard to place. (Sachs, 2008) The gravest risks to the economy is the fourth threat. If the short-term commercial paper and money markets were to break down, the economy could go into a severe collapse because solvent and profitable businesses would be unable to attract working capital.

(Sachs, 2008) Unemployment, now at 6 percent of the labor force, could soar to more than 10 percent. (Sachs, 2008) That kind of liquidity collapse was the basic reason why Asian national incomes declined by around 10 percent between 1997 and 1998, and why the U. S. economy fell by around 25 percent during the Great Depression. (Sachs, 2008) Only by restoring consumer confidence by increasing employment and shoring up the banking system can we prevent the economic crisis from getting worse.

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