One of the contributing factors to the wealth of America is home ownership; and as such, housing is considered as the biggest sector in the American economy. But with the current state of economy, both the housing and auto sectors have been pulled down. The government has produced bailout plans in order to address the problems. However, the level of the problems has led to negative effects affecting America’s once powerful economy.
Housing Sector and Housing Bailout
In 1998, United States had around 100 billion households. 67 million of them own their homes. The mortgage finance system has also the largest part of the financial system. In 1947, there were 15 million homeowners which increased to 67 million by 1998. Records also showed a 44 percent homeownership rate when the World War II ended. In 1998, the rate increased to 66 percent. The number of homeowners also increased by 52 million from 1947 to 1998. In addition, the mortgage debt outstanding by the late 1946 amounted to $17 billion. It increased to $4 trillion by 1998. This statistics was presented by James Johnson, who used to be chairman and Chief Executive Officer of Fannie Mae. Fannie Mae is the largest “source of funds for home mortgages in the United States (Johnson, 1998, p.2).
Fannie Mae is sponsored by the government. Since it is the largest investor of apartment buildings, the largest investor in mortgage revenue bonds, and the largest investor in low income housing tax credits, Fannie drives the housing sector (Johnson, 1998; De Coster & Englund, 2007). As such, it also drives the American economy (De Coster & Englund, 2007).
The housing sector could well be a threat to the economy because it spends and borrows in what economists consider as unsustainable level. Looking back at the household savings rate in 1980s, disposable income was 10%. But now it became one percent. Moreover, household debt increased from 65% in 1980s to 80% in 1990s to 95% in 2000 and 114% in 2004. The picture has gotten worse with the rapid increase in mortgage debt. The housing sector is in bad situation due to high levels of debt and low record of savings. This affects the economy and the stock market bubble caused decreases in the total household assets to income value. Records showed that after enjoying relatively high levels of household assets, it suddenly dropped in 2004 (Karlsson, 2004).
Another problem that would definitely affect the economy is the housing market’s high leverage. Housing prices have risen rapidly, but housing debt increased even faster. Economists observe that with that increase in housing values, housing debt to income would surely double. In fact, in 1990s, housing debt was more than 40%, but in 2004, it reached 85% (Karlsson, 2004).
This means that home owners would suffer from having their home equity wiped out and could possibly go bankrupt if the decline in house prices continue. This also means that there could be a price correction to the price range existing for many years now. Since home owners could possible have their housing equity wiped out, and with savings near zero, this could lead to a financial crisis worse than the stock market bubble (Karlsson, 2004).
The financial crisis in the housing sector will continue and might lead to the shut down of real estate if lawmakers would not do something to resolve this problem. In 2006, it was reported that the prices of homes fell about 20 percent. Prices were expected to further drop by another 10 percent in the following year. This can greatly affect the economy and can increase unemployment rate. Furthermore, more businesses will shut down, thus laying off workers. To make things worse, many of homebuyers have difficulty qualifying for a mortgage. Lenders only give loans to those who have best credit records. Despite the fact that working families had access to homes because of falling prices, news about the current state of stock markets and bank failures will negatively impact home shoppers. Many people who plan to buy a house will generally consider the state of the economy and how it affects the housing sector before buying a house (The Associated Press, 2008).
Auto Bailout
Most of financial institutions are on the verge of economic meltdown. Thus, the government creates bailout plans to rescue them in order to keep the economy strong. Not even the auto industry was spared from the America’s economic crisis. Three of the country’s top automakers were also affected.
A plan surfaced regarding the American government extending $25 billion dollars in loans to the auto industry to keep it afloat during the economic recession (Petruno and Hamilton, 2008). Without these bailouts, bankruptcy for Chrysler and General Motors are possible (Spetalnick, 2008). Many investors realized that this was clearly a temporary respite to a long-term setback that could negatively affect the country’s economy. In addition, the bailout will not be effective and is “not a true solution to the problem” because it fails to consider how the auto industry gets out of the current situation. Reports also showed that GM Corporation’s share jumped from 11.2% to $4.07 compared to Ford Corporation’s share which jumped from 1.1% to $2.87 (Seetharaman, 2008).
As bailout seems to be the most promising salvation, there are issues which arose, showing the negative effects of bailout. Last year, there was a purported $14 billion emergency fund for automakers. However, it collapsed because workers did not agree to the Republican demand regarding wage cuts. Many were disappointed because the deal for the emergency fund to save Detroit’s Big Three was not finalized. The Republicans wanted to give federal aid to the automakers if and only unions agree to wage cuts “to bring them in line with those of Japanese carmakers.” The United Auto Workers (UAW) agreed if the wage cuts are done not until 2011 (Hirschfeld and Thomas, 2008).
Lawmakers and representatives of the auto industry tried to negotiate in order to come up with an agreement so that the auto bailout is saved. The two sides were close to a deal. The only problem was that the unions refused the wage cuts that are supposed to take effect in 2009. The UAW was hesitant to agree because their contracts will expire in 2011. Much of the issue revolves around wage and benefit and debt-restructuring of the General Motors (GM), Ford Motor (F), and Chrysler. Many were afraid that if the deal was not sealed, there would be more people who would lose their jobs and homes (Hirschfeld and Thomas, 2008).
On the other end of the economic spectrum, others blame auto companies for not revolutionizing their standards to keep up with the demands of consumers. In particular, auto companies had poor model designs that were not really people’s choice and they fought fuel efficiency standards (Spetalnick, 2008). Additionally, those who oppose the bailout believe that extending bailout funds to the companies might send the wrong message. The companies might think that the government will always be there to assist when crisis occurs. Critics have also pointed out that in the present time, there are other struggling companies besides the auto companies. Letting somebody or a company fail sends a message to others that not every company can be salvaged (Cox, 2008).
As more and more people have become affected by the threatening dissolution of these automakers, the scrutiny turns to why Detroit faces dissolution. It lies with the cost structures of the companies. The problem is said to stem from this because the automakers’ labor costs is higher than what the auto market can support. The UAW members used to enjoy inflated wages for more than 50 years, but it is no longer appropriate in the present state global automobile market. UAW members’ wages were more than twice the wages of foreign competitors. In addition, many say that American workers are no longer as productive as they used to be, thus profits are not high enough. This leads to more problems. As long as the cost structure of Detroit’s Big Three is not in line with the foreign competitors, more money will be wasted. This is because more ‘loans’ will be extended to support autoworkers. Once the bailout is approved, losses will be used to send more money to the auto companies. Moreover, it will be easier to continue paying the overpaid automakers than to reason out with the UAW to lower the wage demands (Morley, 2008).
Despite these arguments, Chrysler and GM have already accepted bailout funds from the federal government by February 2009 (Tucker, 2009).
It would be interesting to note that the Big Three has endured the same situations some 30 years ago. The auto companies’ almost bankruptcy was attributed to the economic turmoil during that time, the oil shocks, the flood of imports and labor relations. By the end of 1970s, Chrysler ran to the government for help. The government, in turn, aided Chrysler with $1.5 billion in federal loans. Ten years later, the Big Three was on a much better footing. The companies manufactured cars that were better than the ones before the import challenge. Additionally, large vehicles such as pickup trucks and minivans were exempted from fuel-economy regulations the government imposed. By the late 1980s, the Big Three dominated the auto sector and they did not have much foreign competition. However, oil prices began increasing again by the start of 2001. As the oil price increased, the Big Three’s profits decreased. The companies were unable to cut their costs in time to keep up with the declining auto market. This situation was further worsened by the economic meltdown in 2007 (New York Times, 2009).
The economic recession in the 21st century has greatly affected the housing and auto sectors of the United States. More problems stemmed to negative effects of housing and auto bailout on the market. The housing sector can drive the economy. Thus, any anomaly in the housing sector can affect the economy. Even the auto bailout was seen as wasting money as bailouts can send the wrong message. Thus, the auto companies must revolutionize their standards and cost structures to be able to keep up with competition.
References
Cox, J. (2008). No auto bailout? Investors may just say ‘No Problem.’ CNBC. Retrieved February 11, 2009, from http://www.cnbc.com/id/27803683
De Coster, K, and Englund, E. (2007). Fannie Mae: Another new deal monstrosity. Ludwig von Mises Institute. Retrieved February 10, 2009, from http://mises.org/story/2627
Hirschfeld, J., and Thomas, K. (2008). Auto bailout talks collapse in senate over union wages. USA Today. Retrieved February 11, 2009, from http://www.usatoday.com/money/autos/2008-12-10-house-approves-auto-bailout-bill_N.htm
Johnson, J.A. (1998). Housing sector. Retrieved February 10, 2009, from http://www.excelgov.org/admin/FormManager/filesuploading/Johnson_Transcript.pdf
Karlsson, S. (2004). America’s unsustainable boom. Ludwig von Mises Institute. Retrieved February 11, 2009, from http://mises.org/story/1670
Morley, R.D. (2008). Facts, distortions, and the coming auto company bailout. Ludwig von Mises Institute. Retrieved February 11, 2009, from http://mises.org/Community/blogs/morley/archive/2008/11/23/facts-distortions-and-the-coming-auto-company-bailout.aspx
New York Times. (2009). Auto industry bailout. Retrieved February 11, 2009, from http://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/auto_industry/index.html
Petruno, T., and Hamilton, W. (2008). Stocks fall as jobless claims jump. Los Angeles Times. Retrieved February 11, 2009, from http://articles.latimes.com/2008/nov/21/business/fi-markets21
Setharaman, D. (2008). US stocks – Wall St gains after auto aid, but retailers drag. Reuters. Retrieved February 11, 2009, from http://www.reuters.com/article/marketsNews/idCAN1945657620081219?rpc=611
Spetalnick, M. (2008). Bush may tap bailout fund to aid automakers. Reuters. Retrieved February 11, 2009, from http://www.reuters.com/article/newsOne/idUSTRE4B50CL20081212
The Associated Press. (2008). Bailout’s failure bad news for housing market. International Herald Tribune. Retrieved February 10, 2009, from http://www.iht.com/articles/ap/2008/09/29/america/Financial-Meltdown-Housing.php
Tucker, S. (2009). Auto bailouts rolling across globe. US News Rankings and Reviews. Retrieved February 11, 2009, from http://usnews.rankingsandreviews.com/cars-trucks/Auto-Bailout/
