According to past research the financial crisis was not just created in a couple of years, yet it has been building over time that can be contributed to a number of factors from various sources including banking, government, and other entities that have pumped or taken money out of the economy. In order to put the blame on one source, an understanding needs to make about the financial markets and the causes. The Great Recession labeled by many economists to describe the recent banking crisis of 2000 is labeled as the worst economic disaster since the Great Depression. The effects of the impact on the market are still being currently felt as the economy struggles to get back into its groove. The effects are not only being felt in the United States but globally as well as many countries suffered drops in their GDP, and value in their currencies. The crisis has contributed to record unemployment, increase of the number of citizens needing government assistant, increase in bankruptcies, and people being forced to leave their homes for apartments. The question that has been plaguing everyone is trying to understand who is to blame.
One of the main points this article brings to light is that the financial crisis was not created by Wall Street alone, but rather that it was a combination of poor government policies, greedy bankers, loose lending policies, and consumers who abused the easy financial system. Growing up in a generation where having debt was the norm, consumers had been living beyond their means, growing accustomed to borrowing to satisfy whatever their latest need was, and paying it off slowly. The banking industry, with their many lobbyists, profited handsomely of this structure, and the government did not do much do regulate it – in fact, the past few decades have proven to be the undoing of much regulation originally enacted to prevent the very recession we are in right now.
The obvious culprit that many of the world leaders are blaming is the United States government in pinpointing the start of where the crisis arose from. However, exacting the blame on one direct entity takes much research and gathering through the paperwork and red tape. In some perspectives economists and a majority of Americans feel that the banks are to blame, however, they only had a small part to play in a bigger scheme. Unlike the interviewer believes, the crisis did not begin with the banks in the 1980’s however, the crisis was actually a methodical failure of the entire system plagued with problems that eventually led to a meltdown in the economy. If we were to take the numerous opinions of critics and economics while some agree that deregulation of the banking system or lack of regulation attributed there are several reasons that stem from the overturning of the Banking Act of 1933, also known as the Glass-Steagall Act by the Gramm-Leach-Bliley Act, to the flood of cheap products in the market from China, and the Bush administration.
According to Ferguson the problem was not deregulation however, the over emphasis on regulation. Ferguson broke down the crisis into five chapters. The first being the 1988 Accord of the Basel Committee on Banking Supervision that permitted banks despite their capital to hold large amounts of assets that were classified as low risks. The second chapter is from the 1996 rules from the Basel committee that allows firms to set their own capital requirements based on their own risks assessments. Which gave way to private rating agencies that gave relatively low ratings to their securities. The third chapter was headed by the Federal Reserve monetary policy for central banks, “which taught that they should intervene by cutting interest rates if asset prices abruptly fell, but should not intervene if they rose rapidly, so long as the rise did not affect public expectations of something called “core inflation” – which excludes changes in the prices of food and energy and wholly failed to capture the bubble in house prices.”(Ferguson, 2012) The fourth chapter was due to the legislation developed from the US Congress that was lobbied to increase the percentage of low to medium minority families that owned houses. Which included the Fannie Mae and Freddie Mac entities that drove down the interest rates. The last chapter was due to the Chinese government that brought much of the United States debt while the yields on the securities were low, the partnership between the two countries help add to the debilitating housing market.
The former chairman of Citigroup, Richard Parsons laid blame to, “the repeal of Glass-Steagall — the Depression-era regulation separating investment and commercial banking — helped precipitate the financial crisis of 2008.” (Garafolo, 2012) Senator Phil Graham a representative from Texas, however said the Gramm-Leach-Bliley Act of 1999 (GLBA) and the Commodity Futures Modernization Act of 2000 (CFMA) are to blame, more specifically, “politicization of the housing market”. (Eboch, 2009) However, in some respect deregulation was not the problem but rather too much regulation that many of the major banking and loan institutions sponsored by the government such as, Fannie Mae and Freddie Mac to put pressure on the banks to give homeowners loans without verifying income to afford the mortgage loans. Specifically they help to facilitate the housing market crash by allowing the homeowners that could not afford the mortgage with low interests rates and small payments. They were attributing to what the Bush Administration referred to as the “an ownership society.” (Swift Economics, 2009) All of the various opinions of where the banking crisis started pinpoint to the subprime mortgage market. In addition, the rising prices in properties, and obligations for collateral debt were all toxic assets that assisting in the economy collapse. The many investors attracted to the CDO’s and the securitization of the mortgage backed securities, and asset-backed securities, that the investors were able to categorized in tranches that lead to low risks to investors, took over the government supported entities (GSEs) business. The method of securitization was a concept that was not thoroughly understood by either the homeowners or the investors.
The credit rating agencies played a pivotal role in that shift as they gave investment grade, and even AAA, ratings to many of securities, assets, and loans, even though the individual borrowers were much riskier. Many legislators and economics today believe “the crisis has exposed the flaws of ratings agencies, and he suggested doing away with them altogether (in place of relying on credit rating agencies, he advocates a policy of buyer beware).” (Eboch, 2009) The belief was that even if an individual cannot repay his or her loan, the pooling of borrowers reduced the default risk. The possibility of a bearish movement of the housing market, which would devalue the mortgages, was not given much consideration. Even the Federal Reserve chairmen at that time period Alan Greenspan dismissed that possibility. “Alan Greenspan’s Fed chose to stand aside as asset prices rose; it preferred to deal with bubbles after they popped by cutting interest rates rather than by preventing those bubbles from inflating.”(Mallaby, 2008) Additionally, the investment banks that were going to sell the securities to investors around the world that were they paid the agencies for their ratings that conflicted interests, and lead to poor investment decisions. Citizens took on home mortgages that could not afford, and investors made a poor investment decisions based on misinformation, which led to the crisis within the housing market and the economy.
Many key financial institutions were brought down because their assets in this market lost much of their value. Prominent examples were Bear Sterns and Lehman Brothers. Alan Greenspan is also often criticized for being part of the problem. During the time he was chairman of the Fed, he led a loose monetary police of extremely low interest rates. His critics say that this move resulted in a rise in commodity prices and in the forming of financial bubbles, most notably the subprime mortgage bubble. This crisis brought considerable turmoil in the financial world. However, responsibility cannot only be sought in the mortgage market. The structural problems in the large financial institutions, and their use of financial instruments, which lead to overexposure could have been triggered by a crisis in a different market, not necessarily the housing market in the USA. For instance, commodities prices were also going up. The prime example is the concept of credit default swaps, “which are contracts that require one party to pay the other in the event that a third party defaults on some obligation, could no longer be regulated by states as insurance or gambling.” (Barker, 2012) The credit default swipes usually guaranteed banks that if the borrowers could not pay they would be covered, the issuer would then pay a sum to the buyer of the loan where the issuer can make a profit.
After the subprime mortgage crisis began, and many borrowers started defaulting on their loans, the pressure on the companies that had issued CDSs was rising. There were companies that simply did not have enough money to repay everything they owed. Only the example that fit the deregulation thesis is in the famous example of AIG. “The insurance giant AIG came to grief because its London office sold vast quantities of mispriced insurance against outcomes that properly belonged in the realm of unmeasurable uncertainty.”(Ferguson, 2012) When firms’ credit defaults swaps prices decrease, the creditors want payments which worsens the firms’ condition. The subprime mortgage crisis and the bankruptcy of large financial companies, like Lehman Brothers, meant that AIG had to pay much more money that it expected and made the company insolvent, which required them to get a considerable bailout from the government. Normally, the issuers (major banking or financial institutes) of these CDS, assets, or securities are held responsible for issuing them, borrowers without having the ability to pay from them many of the credit ratings began to fall. Many financial institutions were misled by the agencies and conditions of the market. Many people argue that such securities needed to be regulated better, however that would lead to conflict of interests in many respects. However, even if CDS were to be done away with, banks would just think of something else to replace it and get around regulation. The problem does not lie with a need for more regulation but instead “because legislators and regulators acted with an almost complete disregard for the law of unintended consequences, they inadvertently helped to inflate a real estate bubble in countries all over the developed world.” (Ferguson, 2012) The internal structure of the financial companies played a crucial role in the crisis. The executives frequently overlooked long-term stability, when pursuing short-term gains. This was done for two reasons. First, the shareholders evaluate the performance of a CEO by the money he or she makes for them, and unfavorable results today can mean no job tomorrow. The second reason is the incentive structure. Better results mean more bonuses, and the executives were striving to produce such results, disregarding the long-term stability of the firm and of the market as a whole.
The blame is placed publicly on the greedy banks for the crisis, yet this is a flawed assumption. In fact, it is the executives, CEO’s, and stakeholders who were the puppet masters that orchestrated the downfall. The incentive structure itself is flawed. After the crisis many executive lost their jobs, but the damage was already done to the financial system. After the US market plummeted the world markets soon followed. Many financial institutions had problems with their refinancing. A famous example is Northern Rock, UK based bank. The bank borrowed money to securitize mortgages and resell them on the markets. When the housing prices dropped, it could not find money to repay its outstanding debts. Faced with a severe liquidity problem many of its depositors wanted to withdraw their money, creating the first bank-run in the UK in 150 years. (BBC, 2007) As a result, the government had to intervene and bail-out the bank. Although the bailouts were temporary solution, but they saved the system from concaving on itself. After they were bailed out, the financial institutions did not need to change the way they do business, which attributed to the fore long effects of the banking crisis.
The instability of the banks and the eventual meltdown in the economy can be attributed to the structure of the financial system. After the crisis, there was much discussion about leveraging and to what extent should the financial companies do it. Leveraging provides investors with positive returns, even when the market moves up just a couple percent. The problem is that during times of bust, a company can easily be wiped out, losing much of its assets, when the market moves slightly in a downward direction. Prior to the crisis, most banks and many companies were highly leveraged, using derivatives and off-balance sheet assets, making it difficult for the regulators to keep track of the risk of these companies. The big investment banks had ratios of about 30 to 1 just prior to the crisis. Fannie May and Freddie Mac had leverage of 100 to 1 at one point. The financial companies obviously used high leverage during the boom years to make substantial profits, but were not ready for the fall in prices and the consequences it had.
As a conclusion, there is no single party responsible for the banking crisis. It was a complex failure of the system, which meant that something wrong happened in many places at once. “Deregulation did not cause the financial crisis because financial regulation in the United States has always been flawed.” (Barker, 2012) In some ways, the new and old regulations of the banks and other financial institutes made the crisis worse. The subprime mortgage market in the US was the catalyst. People bought houses that they could not afford, lenders were giving them money through securities that they did not understand by relying on misled information from credit rating agencies of a bullish market. Financial instruments, like CDOs and CDSs, were not used properly and actually introduced more risk to the system. The executives of many firms were concentrated on short-term returns and maximizing bonuses while neglecting long-run stability. The banking crisis was a complex set of events, which showed the instability of the financial system. Today, the economy still has not fully recovered, and the effects will probably be felt for generations. However, the lessons learned will help to provide a complete rethinking the bank system, the government, and the way financial markets could be corrected.
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Eboch, Josh. “Is Deregulation to Blame?” The American. (2009). Retrieved from http://www.american.com/archive/2009/is-deregulation-to-blame
Ferguson, Niall. “Niall Ferguson: The Darwinian Economy. (2012). BBC Radio 4. Retrieved from http://www.bbc.co.uk/programmes/b01jmxqp/features/transcript
Garofalo, Pat. “Former Citigroup Chairman Blames Deregulation for the Financial Crisis.” Think Progress. (2012). Retrieved from http://thinkprogress.org/economy/2012/04/20/468164/citi-deregulation-financial-crisis/?mobile=nc
Mallaby, Sebastian. “Blaming Deregulation.” The Washington Post. (2008). Retrieved from http://articles.washingtonpost.com/2008-10-06/opinions/36837227_1_central-banks-financial-crisis-interest-rates
“Northern Rock gets bank bailout.” BBC News. (2007). Retrieved from http://news.bbc.co.uk/2/hi/6994099.stm
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