The U.S. Financial Crisis: The Global Dimension with Implications for U.S. Policy

Summary

What began as a bursting of the U.S. housing market bubble and a rise in foreclosures has ballooned into a global financial crisis. Some of the largest and most venerable banks, investment houses, and insurance companies have either declared bankruptcy or have had to be rescued financially. In October 2008, credit flows froze, lender confidence dropped, and one after another the economies of countries around the world dipped toward recession. The crisis exposed fundamental weaknesses in financial systems worldwide, and despite coordinated easing of monetary policy by governments and trillions of dollars in intervention by governments and the International Monetary Fund, the crisis continues. The process for coping with the crisis by countries across the globe has been manifest in four basic phases. The first has been intervention to contain the contagion and restore confidence in the system. This has required extraordinary measures both in scope, cost, and extent of government reach. The second has been coping with the secondary effects of the crisis, particularly the slowdown in economic activity and flight of capital from countries in emerging markets and elsewhere who have been affected by the crisis. The third phase of this process is to make changes in the financial system to reduce risk and prevent future crises. In order to give these proposals political backing, world leaders have called for international meetings to address changes in policy, regulations, oversight, and enforcement. Some are characterizing these meetings as Bretton Woods II. On November 15, 2008, a G-20 leaders' summit recommended several measures to be implemented by participating countries by March 31, 2009. The fourth phase of the process is dealing with political and social effects of the financial turmoil. The role for Congress in this financial crisis is multifaceted. A major issue is how to ensure the smooth and efficient functioning of financial markets to promote the general well-being of the country while protecting taxpayer interests and facilitating business operations without creating a moral hazard. In addition to preventing future crises through legislative, oversight, and domestic regulatory functions, Congress has been providing funds and ground rules for economic stabilization packages and informing the public through hearings and other means. The largest question may be how U.S. regulations should be changed, if necessary, and how closely any changes are harmonized with international recommendations. Other questions include: should the United States promote global regulatory standards to be voluntarily adopted by countries or should a supranational regulatory institution be created that would impose rules on international financial markets? Where would enforcement authority reside; at the state, national, or international level? Congress also plays a role in measures to reform international financial institutions and in recapitalizing the International Monetary Fund. Also, should U.S. policies be designed to restore confidence in and induce return to the normal functioning of a self-correcting financial system or has the system, itself, become inherently unstable?download