The 2007/2008 financial meltdown greatly affected the economy of the whole world. There are sets of factors that might have led to the occurrence of this global recession. According to IMF report, the market instability is traceable back to 1997, in which rise in capital flows or global imbalances, loose monetary policies, and lack of proper regulation and supervision in the financial market might have escalated the financial meltdown.
The crisis that began in the summer of 2007 in the United States exposed the irregularities that had been common in the subprime assets. Even though researchers and policymakers still not agree on the factors that initiated the financial crisis, there are clear factors that might have led to the build-up of financial imbalance. However, the combined factors that the essay discusses reveal the fuelling of the crisis from a joint aspect.
The essay expounds on roles that essential aspects of regulation and supervision played in building-up of the crisis. Here, weaknesses in the supervisory environment might have opened the setting for rampant malpractices in key business sectors. Lastly, the treatise looks into stringent approaches that regulators have taken or are in the process of implementing to avert a repeat of such a financial crisis.
The build-up in the prices of houses together with the Federal Reserve’s accommodative policy increased the demand for assets. In the US, there have been close relations between asset prices and long-term rates since interest rates at the money market vary with changes in demand for houses. In the run-up to 2007, the connection between long and short-term rates had been weak, which made the policy to have little control over the rates. Notably, the escalation in prices of houses had occurred across advanced economies.
According to Moseley, cumulative appreciation in prices of houses between 2000 and 2006 had a negative correlation to the ratio of the current account to the GDP (par. 6). The US Federal Reserve had kept monetary policy rates low for too long, which went on to decrease the cost of wholesale funding for intermediaries, thus causing a rise in leverage.
Again, the loose monetary policy made financial institutions to engage in risky ventures like taking liquidity and credit risks, as well as augmenting the demand and supply for mortgages, thus lowering the prices of real houses. As a result, banks were under pressure to lend to minorities and low-income consumers who even had no security for the loans.
Notably, some of the borrowers who accessed the sub-prime loans had poor credit ratings, did not make down payments for homes and had no verifiable assets. So misguided were the housing policies that unqualified borrowers could access mortgages with the support of the federal government. After the banks and other lending institutions had loaned the low-income earners, house prices peaked and turned down completely.
At this point, borrowers who had inadequate capital compared to their debt started to default the repayment of mortgages (par. 7). Notably, the high prices propelled these categories of borrowers to borrow with the hope of increased prices of houses in the future to repay the mortgages or sell their properties at high prices. This was not to be, as prices of essential products went down too.
The occurrence led to a rising in the number of defaulters on nonprime-mortgages — the increased numbers of toxic mortgages made investment banks lose trillion of dollars. The rest of the Wall Street felt the effect with Federal Reserve Chairman Ben Bernanke making critical moves to salvage the Bear Stearns Investment Bank, which had remained the subject of rumors that it would be falling soon. The monetary and housing policies opened the way for uncontrolled lending by financial institutions.
For instance, two main mortgage firms, the Fannie Mae and Freddie Mac Corporation eased the credit requirements on loans it purchased from lending institutions (Moseley par. 8). In September 2008, the two giant mortgage companies faced the danger of bankruptcy as they had guaranteed close to half of the total mortgages in the US.
Deregulation of financial institutions and markets weakened the supervisory powers of the Federal Reserve Board, as it expanded the cycle of optimism among financial institutions and borrowers to take more risks (Raja par. 3). The repealing of the Glass-Steagall Act of 1933, which came into force to salvage the fall of over 5,000 banks in the 1929 Wall Street Crash, in 1999 had opened-up the stage for the 2008 financial meltdown (Chossudovsky par. 2).
Initially, there were effective controls in the US financial institutions, thanks to President Roosevelt’s ‘New Deal’ that mitigated insider trading, financial manipulations, and corrupt practices. With the repealing of the act, a few financial conglomerates took over the role of supervising the entire US financial market composed of security firms, pension funds, and insurance firms (par. 3).
Notably, these financial conglomerates had great interests in the defense industry, key oil and mining associations, and high-tech firms given that they were shareholders and creditors in these firms. At the same time, the financial conglomerates were able to control the conducts of public policy. In the wake of the crisis, the US Senate passed a policy that increased the powers of the financial companies in the US money market. The legislation jump-started the deregulation within the banking sector.
After lengthy negotiations, President Clinton revoked all regulatory restraints on powerful financial institutions, thus allowing free investment and integration of financial services among brokerage firms, commercial banks, and institutional investors. The weakening of the supervisory powers of the Federal Reserve resulted in the displacement of some Wall Street banks, as well as the failure of many financial institutions (par. 4). Asymmetric information on risk estimations led to excessive leverage on financial institutions.
In a bid to avert the occurrence of such financial crisis in future, the US government, especially some state governments have taken strong steps to negotiate with mortgage lenders, create ‘rescue funds’ and enact state laws that regulate or control lending of mortgage. Patrick in Massachusetts and Schwarzenegger in California are some of the Governors who have taken drastic steps to mitigate the extent of the crisis, as well as prevent the occurrence of such financial recessions in the future.
Also, independent mortgage brokers who are never subject to federal regulations have drafted working relations with lenders given that states cannot regulate subprime mortgages from the sense that they are not federally chartered (Mallach). To eliminate foreclosure for borrowers and creditors, the US government has opted to refinance existing loans, thus permitting house owners to continue residing in their assets. The states are making legislation that protects borrowers and enforce regulations on creditors in case of foreclosure.
At the same time, the government has put in place measures that avert predatory and fraudulent foreclosure activities through the consumer protection authority. Notably, Illinois and New Hampshire states have implemented statutes to eliminate such fraudulent contracts; the statutes require tabling of detailed contracts and offering for a right rescission.
Also, several nations have initiated the implementation of fiscal stimulus measures and plan that aimed at preventing the financial crisis from transforming into a global economic recession.
Later, the adoption of the austerity policy that targeted to institute sets of structural reforms and reforms the loose monetary policy came into force — this approach aimed at curtailing possible debt and inflation across countries to restore growth (Mallach). However, the unwillingness among borrowers to go for loans, as well as the reluctance by banks to lend have resulted in stagnation of the banking credit, which banks offered to the private sectors.
The US has also come up with plans to cut its spending through budget cuts. The sequestration process intends to reduce US debts, which may cause instability in the market. Markedly, the government will record an increase in outlays by over $238 billion annually up to 2023 (Mallach). Notably, the rate at which the outlays will increase will be lesser than the past fiscal years owing to budget sequestration. The federal government applied this process to curb increasing debt margins.
Some of the programs and departments that budget sequestration targets include Social Security, Medicare, and Military pensions. An example of reductions in budget spending is in Medicaid, where the sequestration procedure will reduce the spending by 2% per annum as compared to the initially planned level. The Obama administration held that initiating spending cuts is a long-term strategy of reducing the escalating debts to stimulate economic growth.
Chossudovsky, Michel. Global Financial Meltdown: Sweeping Deregulation of the US Banking System. Global Research. N.p., 2008. Web.
Mallach, Alan. Tackling the Mortgage Crisis: 10 Action Steps for State Government. Brookings. N.p., 2008. Web
Moseley, Fred. “The U.S. economic crisis: Causes and solutions.” International Socialist Review – ISSUE 81 January-February 2012. International Socialist Organization, 2009. Web.
Raja, Kanaga. Financial deregulation at root of current global crisis. TWN Info Service on Finance and Development . N.p., 2009. Web.