1. The Financial Crisis: Avoidable but Inevitable
Theoretically, the financial crisis could have been avoided as investigation findings revealed . Under the circumstances however, the crisis was an inevitable consequence of everything that was going.
The Federal inquiry concluded that the 2008 financial crisis could have been avoided. The crisis was the result of “widespread failures in government regulation, corporate mismanagement and heedless risk-taking by Wall Street”. It was the result of “greed, ineptitude or both” on the part of government and the private sector.
Among the persons found responsible for the crisis included Federal Reserve Chairman Alan Greenspan and, his successor, Ben Bernanke. The two were chiefly responsible for deregulating and protecting the use of derivatives as financial investments. To a lighter extent, the Secretaries of Treasury—Henry Paulson Jr. and Timothy Geithner—although Paulson issued some incorrect warnings early on, did not pursue investigating the problems or acted more decisively. Financial institutions like Lehman Brothers, Citigroup, American International Group (AIG) and Merril Lynch, and mortgage companies like Fannie Mae and Freddie Mac were also to blame. The companies were found to be greedy and to have acted with impunity without concern for public welfare. Among government agencies, the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Office of Thrift Supervision were also blamed for their inaction and failure to foresee and control the problem. Indeed, the crisis could have been avoided if concerned parties performed their jobs properly.
Sewell Chan quotes the inquiry report in his New York Times report:
“The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire The captains of finance and public stewards of our financial system ignored warnings, failed to question, understand and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble.”
According to Chan, the panel concluded the report with the following statement: “The greatest tragedy would have accepted the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again.”
All of these findings are clear in hindsight as the investigation revealed. Unfortunately, life has to be lived forward. All the people involved were “greedy and inept”; even if they were intellectually capable of doing right, they could not. Precisely because these people are managing the system, the financial crisis was inevitable even if it could have been avoided. The people involved were ethically blind and irresponsible.
2. Unwinding
Unwinding is the opposite end or end-process activity of quantitative easing (QE). It can be understood in the context of QE.
QE is one way that a country’s central bank control, in particular increase, money supply in the market by printing new money. The central bank can issue bonds to bring out money from savings and other hidden forms. The bank then pumps in the money into system by way of investment in productive activities. The Bank of England used QE to save the UK from a continued downward spiral. Government spending instead of private direct investments stimulated the productivity and the entire economy.
Unwinding is the process of the government buying back the bonds. It will terminate the bonds and pull out money from the system. The danger of this is that the economy could have become very dependent on government spending for the economic growth. Pulling out the money could bring the entire economy into its state before the QE was done. Timing of the unwinding is very crucial. An economy could suffer from adverse consequences in the unwinding process.
Cottle warns of the danger of QE and unwinding. QE is a fairly new policy in modern economic history largely done by Japan. Every time a country does some kind of QE and unwinding, it introduces artificial improvements in the economy. QE can be addictive. An economy might end up relying on QE every time a crisis crops up. The impact of the corresponding unwinding process is still unknown. The QE has only recently been in some countries and the unwinding process will still have to be implemented.
3. Regulating Banks
The most important agency that should regulate banks is the Treasury Department . In addition, as the Federal inquiry points, other bodies that could regulate certain aspects, Include the Federal Reserve Bank, the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Office of Thrift Supervision . Even US Congress could help in regulating banks. These agencies will merely have to perform their functions properly.
The crisis affected not only the US. At the international level, the same agencies and the Department of State and the Office of the US President can be involved. They should withhold their protection of misbehaving and greedy US banks. The US government should stop invoking sanctions against affected countries to force them to conform to the banks’ or US’s demands. Erring banks should be punished not protected as done in Iceland. The World Bank and the International Monetary Fund (IMF) should also exercise more control over the banks rather than the borrowing countries. The so-called aid to defaulting countries is not meant to help the countries improve the economy; these are sanctions to force the countries to cough up payments for their debt to banks, mainly US banks.
Can Banks Be Regulated
Banks can be regulated. Iceland has demonstrated what it can do to regulate banks and recover from the crisis. It takes political will to regulate banks. It also takes some change in the economic thinking of the people running the Department of Treasury and related agencies. The US follows a very laissez faire economy, especially with regard to running the finance industry. Regardless of this, the policies are heavily influenced by the economic philosophy of those appointed to head key agencies. So the appointments of important officials in the relevant government offices would affect what kind of policies is pursued. To be able to regulate banks, this one of the important steps that has to be taken.
The choice of appointments is important because the problem in the US is that the Department of Treasury, mainly its head, is resisting attempts to regulate bank. It resists or objects even at attempts to legislate laws to withhold government bailouts of failing banks. The argument is that some financial institutions are too big to fail and could spell financial disaster for the entire US. However, the experience of other countries, though smaller, indicates otherwise.
The Problems of Non-Regulation
The 2008 financial crisis and the Eurozone crisis have demonstrated the problems if banks are not regulated. The problem lies mainly in the banks being freely and greedily invent financial instruments and to shell out loans internationally. These are risks that banks take. However, unlike ordinary business risk-takers, they do not pay for their risks. Should some of the banks’ investments or loans (especially international loans to foreign governments), it is the people that pay. Government bails out the bank using taxpayers’ money. The Greece debt crisis is a study on how such bailouts affect ordinary people. It is important to emphasize again that the bailout was not intended to help the Greece economy. Rather, it was aid to help Greece pay for the bank loans, to benefit US banks.
4. Liquidity Trap
A liquidity trap is a situation where interest rate is close to zero and no amount monetary policies could stimulate the economy. Money remains stuck in savings instead of being spent to bring up consumption or investment activities that would grow the economy. Deflation causes and perpetuates a liquidity trap and creates a vicious cycle of stagnation and high interest rates. The Great Depression of the USA in the 1930s and the Japanese recession in the 1990s are the more famous examples of liquidity traps .
Implications to Ordinary People
If one reviews the experiences of people during the Great Depression, one will be concerned with the impacts of liquidity traps. A liquidity trap could lead to vanishing investment or plunging stock values. It can also lead to joblessness because there is lower spending, consumption and investment. Lower demand can lead to lower productivity and thus a lower need for labor. The situation today is further complicated because of globalization, technology and outsourcing challenges. Even if there is a high demand for goods, there could still be lower demand for labor as there have been alternative ways of producing goods without need for local labor.
5. Interest Rates in Japan: 1972–2016
Interest rates in Japan had been fluctuating steeply since 1972. Rates hovered at 8–9% and plunges to slightly below 4% until 1984. From 1984 to 1992, they a enjoyed a high of 6% and a low of 2–3%. Since 1993, interest rates were on a steady decline. From a high of about 2–3%, they went down to less than 1% in 2000. From 2000 to 2015, interest rates were just slightly above 0%. There was a slight, upward burst in 2008 but this was only for a very short time.
Interest rates in Japan are set by the Bank of Japan’s Policy Board, determined in meetings. These policy meetings set the guidelines for money market operations aimed at achieving set, monetary targets. Monetary Policy Meetings produce a guideline for money market operations in inter-meeting periods and this guideline is written in terms of a target for the uncollateralized overnight call rate.
Some countries in Europe have begun setting negative interest rates since 2014. The European Central Bank was the first to peg interest rates below 0%. Following these examples, Bank of Japan has finally begun setting negative rates in 2016. Rates in Japan have thus hit a low of 0.1%. From 1972 to 2016, they have had a high of 9% and a low of -0.1%. In the past 20 years until 2015, they had been below 1%. See Figure 1 in the Appendix.
Near 0% Interest Rates in Past 20 Years
Interest rates in Japan had been on the very low side in the past 20 years. Bank of Japan had been pursuing policies to pressure to bring the cash out for investment in other forms.
Japan in a Liquidity Trap
The interest rate policies being pursued in Japan indicates that Japan is in liquidity trap. Indeed it is. It has actually been in a liquidity trap for decades. “Japan has experienced stagnation, deflation, and low interest rates for decades. It is caught in a liquidity trap.” See Figure 1 in the Appendix.
Japan’s liquidity trap does not quite fit the Keynesian model. John Maynard Keynes assumes that people do not spend or invest out of fear of losses. In Japan, culture can be a factor that is not taken into account by Western economic models. Although there may be sound investment opportunities in the country, the Japanese, a thrifty people, prefer to save and secure themselves from possible crises.
6. Interest Rates in the USA
US Federal Fund rates enjoyed some high points of 5–8% from 2000 to 2008. However, since 2008 until today, interest rates plunged to near 0% levels. It never went higher than 1%. See Figure 2 in the Appendix.
Real interest rate however seems high and pegged at about 6% in 2016. It has been fluctuating from below 8% to below 2%. The figures are higher than nominal interest rates as reflected in the Federal Funds Rate. See Figure 3 in the Appendix.
USA in Liquidity Trap
It would seem that the US is in a liquidity trap. The Federal Fund rate has been near 0%. This rate is determined by monetary policy as dictated by the Federal Bank. Although real interest rate is significantly higher, it would seem that the nominal rate would be the better indicator.
Economic analyst Paul Krugman of the New York Times had been the first who raised alerts about the return of liquidity traps as regards the Japanese economy. Government should allow inflation to rise to be able to reduce liquidity trapped in saving.
Japan, the US and some members of the Eurozone are in liquidity traps. There is not enough spending these countries to support or stimulate full employment. The problem is that even if interest rates have hit 0% (or even -0.1%) there has been little response in the market. The problem is that central banks may lack credibility. Investment possibilities also lack credibility because of the crisis. However, prolonged periods of very low interest rates and higher inflation rates could force people to let out cash and spend more.
Implications of the US Liquidity Trap
US monetary policies seem to be working as unemployment rate has gradually declined. It spiked to a high of about 10% in 2008. Last time it hit above 10% was in the late 1970s and early 1980s. From 2008, the rate gradually went down to 4–5% as federal funds rate went down to almost 0%. See Figure 4 in the Appendix.
However, the problem of the liquidity trap still seems to persist. The government could not syphon out so it could have enough for spending and investment .
While unemployment has been reduced, there exist other problems that affect people so they should be concerned about this. One is quality of life. Another is inequality. While more people are getting employed, they may have not gotten back to their old quality of life.
Beyond monetary policies, there are other factors that economics does not take into account: the human factor: people’s humanity. Resistance to spending and investment seems to have come as a result of the crisis in the first place. People do not want to invest in financial instruments that caused the crisis in the first place. Many people lost their homes and jobs, and they had no savings. So, rather than spend or invest now, they save. They hold on to their savings to survive in the short term or until they find new jobs. People’s savings are not the result of having excess funds; it is just a way of securing and protecting themselves.
There are also external factors that could be affecting the economy that leads to excess liquidity and low productivity like globalization. All of these things are intertwined and it important for every person to understand the problem.
Appendix
Works Cited
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