Addressing the Ongoing Crisis in the Housing and Financial Markets

Source: Douglas W. Elmendorf, Congressional Budget Office, Testimony before the
Committee on the Budget United States Senate, January 28, 2009

A strong financial sector is a necessary component of a robust economy. Financial markets and institutions channel funds from savers to borrowers who need the money to build businesses and hire workers and to buy homes and other goods and services. Indeed, credit is often required to support the ordinary operations of businesses–for example, to finance their inventories and to meet payrolls before payments are received. If the customary means of obtaining credit break down, the disruption to
households’ and businesses’ spending can be severe.

Thus, the ongoing crisis in the U.S. financial system has significantly depressed economic activity during the past year and a half, and it poses a serious threat to the nation’s ability to quickly return to a path of solid economic growth. Losses on mortgages, on assets backed by mortgages, and on other loans to consumers and businesses, together with an associated pullback from risk taking in many credit markets,
have raised the cost and reduced the availability of credit for borrowers whose credit ratings are less than the very highest. To be sure, among the fundamental causes of the crisis was the provision of too much credit at too low a price as well as insufficient capital. However, the sudden shift to a much higher price for risk taking has led to a significant reduction in wealth and borrowing capacity; it has also forced a number of financial institutions to close and others to be merged with stronger operations. Those forces, in turn, are weighing heavily on consumption, the demand for housing, and businesses’ investment.

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