This paper explores the factors, which caused the recent financial crisis of 2008. Furthermore this paper will explain how the Federal Reserve’s (Fed) monetary policies and the Federal Government’s fiscal policies are crucial in limiting and perhaps eliminating future catastrophes.
The Financial Crisis of 2008
Factors and Prevention
The financial crisis of 2008 is widely considered the worst financial crisis, since the Great Depression (Pendrey, 2009). The repercussions of the crisis were mind-boggling, and unfortunately for many, it was life altering. Families lost their houses, their jobs, and in many cases, they lost their entire life savings. Furthermore, neither businesses nor banks escaped the massacre. The financial crisis not only devastated the United States, it also had far reaching worldwide consequences. The global economy suffered, as a result of what was happening here.
The devastation was so severe, that the economy has yet to fully recover. To make matters even more frustrating, Sewell Chan of the New York Times explained, “The 2008 financial crisis was an “avoidable” disaster caused by widespread failures in government regulation, corporate mismanagement and heedless risk-taking by Wall Street…” (2011). This paper will attempt to discuss the factors, which led to the crisis, and perhaps more importantly, attempt to provide courses of action, which would prevent similar incidents in the future.
In the years that led up to the financial crisis, seemingly everyone who could fog a mirror could get a home loan. These loans were often much more than the borrower could ever possibly afford to pay back. The government commission, which investigated the crisis, believes one of the main factors causing the financial crisis was the Federal Reserve’s and other regulators failure to recognize the poisonous combination of careless mortgage loans, in addition to the packaging and sale of loans to investors and risky bets on securities backed by the subprime loans (Chan, 2011).
The previous statements are best summarized, when Leon Hadar, a research fellow in foreign policy studies, opines in his Cato Institute commentary, “The housing boom and bust that precipitated the crisis were facilitated by extremely loose monetary policy.” (2009).
Faulty monetary policies are not alone in the blame, however. The Federal Government’s shoddy fiscal policy also played a role. The Gramm-Leach-Bliley Act, also known as the Financial Modernization Act of 1999, repealed the injunction on the collaboration between investment and commercial banking established by the New Deal-era Glass-Steagall Act’s of 1932 and 1933. According to Hadar, this policy also proved dreadful. He states the Act, “…caused the crisis by clearing the way for investment and commercial banks to merge, and thus giving investment banks the incentive to take greater risks, while reducing the amount of equity they are required to hold against any given dollar of assets.” (2009).
Not surprisingly, the incompetency and, in some cases, illegal actions of corporate management, in addition to Wall Street’s propensity to risk, also contributed to the 2008 financial meltdown. The US government’s official report, on the financial crisis, concluded, “several financial industry figures may have broken the law in the run-up to the crisis.” (Rushe, 2011). Furthermore, risk taking is an every day occurrence with Wall Street. Charles Ferguson pulls no punches with respect to Wall Street’s share of the blame, in an online article.
The article titled “Heist of the century: Wall Street’s roll in the financial crisis” orates, “It is no exaggeration to say that since the 1980s, much of the global financial sector has become criminalised, creating an industry culture that tolerates or even encourages systematic fraud. The behaviour that caused the mortgage bubble and financial crisis of 2008 was a natural outcome and continuation of this pattern, rather than some kind of economic accident.” (2012). Solution
With the previous factors given, one might wonder how to prevent another financial crisis from occurring. Costas Markides provides a very reasonable thesis in my opinion. In a Bloomberg.com blog, which addresses actions needed to avoid the next predicament, Markides contemplates, “If you want to change how people behave, don’t tell them. Instead, change the underlying environment that produced their “bad” behavior in the first place.” (2012). In other words, it is human nature to demand punishment and thereby obtaining a sense of instant gratification. To prevent future financial calamities, however, it is wise to address the underlying causes and understand what went wrong.
Although there can never be a hundred percent solution to managing the national economy to such an extent that there will never be another crisis, the needed adjustments seem to lay at the feet of the Federal Reserve’s monetary policy and the Federal Government’s fiscal policy. The Fed addressed one major cause of the financial crisis by implementing much needed regulations regarding mortgage loans and requiring proof of borrowers ability to pay the loan back (Warner, 2013).
The Government, on the other hand, initiated mass government spending in order to stimulate the economy. Both the Fed and the Federal Government need to tighten regulations, but perhaps more importantly, they need to act more quickly and decisively to limit, or even more optimistically, prevent the next financial crisis. Mark Thoma of CBS best summarized this point by stating, “This disaster could have been prevented by a strong regulatory response, but the belief that markets would self-regulate… led to a regulatory hands-off approach… The hands-off regulatory approach was a mistake.” (2009).
In summary, it is clear that the financial crisis of 2008 was caused by errant monetary and fiscal policies. Furthermore, there was a delayed reaction by both the Fed and the Federal Government, which was caused by a hands-off regulatory approach. In the future, the Fed and the Federal Government need to act more decisively and promptly to better steer the economy away from a downward trending economy. Both the monetary and fiscal policies are vital to the ongoing recovery and future growth of the country’s economy.