The major financial crisis of 2007-2008 was caused by vending Fannie Mae-backed hypothecation packages, commercial real estates and the misuse of credit default swaps. Under the commercial real estate, the speculative real estate bubble in those years went beyond residential homes to affect all kinds of commercial real estate’s (Conserverpedia, 2013). To the extreme the bubble also affected office buildings, shopping centers, apartment complexes, casinos and hotels. This was characterized by people buying high with expectations of selling even higher. Contrary to their expectation, the market collapsed. The real estate creditors were expecting to get a 20% return but they approximately lost 25%. The same was it the office building which plunged a 43% after the peak and therefore most of the investors who had bought in 2007 lost all their investment.
The misuse of the credit default swap was another contributing factor to the crisis. CDSs are a contract between entities which are designed to mitigate against risk of a credit default. It is an insurance policy that is designed to protect the insured against excessive loss in a separate financial deal (Conserverpedia, 2013). However, before the crisis, companies other than the insurance companies could offer the CDSs due to the structuring of the contract as a derivative swap rather than a traditional insurance policy. The contradiction come where insurances were required to retain cash flow to pay for losses but the other companies were not. This move left insurance companies open to great risks. The CDSs issued by a firm were hedged or financially backed up by CDSs with other companies. This was not effective as all the other companies were similarly exposed to the market risks.
Marketing Fannie Mae-backed hypothecation packages to annuity reserves and recognized investment was also a major cause of the crisis. Before the crisis, Americans owed ten trillion US dollars on mortgages whereas most of them were comprehensive with payments that were actually completed on time. Nevertheless, financiers bundled into extremely intricate bundles which were called collateralized obligation responsibility (CDOs). CDOs worth hundreds of dollars were sold to financial institutions in America and Europe as a whole. However, the money to by the CDOs were borrowed which implied that if their values declined, they would be incapable of paying the depts. (Conserverpedia, 2013). The CDOs venture attracted many investors since they remained uncontrolled by state government.
The systematic deregulation in the banking industry during decade that lead up to the crisis made the way for over-sized and unmonitored loans. This in return fuelled the mortgage and lending boom which eventually triggered the crisis. As a result of the housing bubble burst, the financial innovation which had grown out of and alongside the deregulation inflated the American economy (Acharya, 2011). The deregulation of the financial investment by the government non-involvement encourages investors to make riskier investment hoping for better returns. As a result of the absence of the regulatory measures by the government, the investment industry became more vulnerable and eventually collapsed. If the government had intervened in the initial stages when the danger of such devastating consequences was just emerging, the situation might have been contained.
The three agencies of the federal government failed to act appropriately and timely solve the crisis at its earlier stages. The Federal Reserve Board, the Office of the Comptroller of the Currency and The Federal Deposit Insurance Corporation are the three agencies that are mandated to control and regulate financial institutions (Acharya, 2011). The Office of the Comptroller of Currency is particularly mandated to regulate national banks and also to foster financial industry. It ensures that all Americans gain fair and equal access to financial services and enforce ant-money laundering and terrorism attacks. However, the office and other agencies failed and these exposed the investment industry to the extreme of the crisis. If the agencies had acted on their full capacity, the financial state of the Americans and the economy would have been rescued.
The stability and benefit that comes with the regulation of the financial institution regulations by the federal government were not realized (Acharya, 2011). The financial benefits that were projected by various actors were not realized as the financial crisis embraced the economy making all the investments futile. However, the blame should not entirely be directed to the government but it is important to recognize that if the government acted fast and swiftly to regulate the investments activities of the banks and other financial institutions, a great deal would have been saved.
The United States of America government in respond to the financial crisis is planning to enact the Volcker rule. The rule is a measure that the government will use to prevent the occurrence of such financial crisis in the future by regulating the financial banks (Acharya, 2011). The rule will lead to emergence of new challenges for banks that engage in buying and selling of securities on clients’ behalf, which is called market making and hamper reimbursement arrangements that embolden perilous trading. The Volcker rule will ban banks from engaging in any form of gambles with their money and limit their capability to invest in various trading vehicles such as hedge funds and private-equity vehicle.
Works Cited
Acharya, Viral V. Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance. Hoboken, N.J: John Wiley, 2011. Print.
Conserverpedia. "Financial Crisis of 2008 - Conservapedia." Main Page - Conservapedia. 2013. Web. 12 Dec. 2013.
