Root Cause of the 2008-2009 Economic Crisis
As of today, the 2008-2009 Global Economic Crisis has left its mark in the international community as many countries have slowly succumbed into depression and recession. Many experts have argued as to how exactly did the crisis spread out from the United States, into the international economy. Some have noted that it was due to the foreclosure of many US companies due to bankruptcy, while others saw it was due to the wars happening in the Middle East. There were also arguments as to the resolution of the problem, and how countries could recover from the losses accumulated from the crisis. However, the losses in the financial crisis have enabled governments to concentrate their efforts to restore stability as the continuous economic crisis may ultimately close down country economies around the globe.
According to Hawley, Kamath, and Williams (2011), the Global Economic or Financial Crisis had slowly begun its course in 2001, when inflation and recession replaced US economic stability as the primary concern of the Federal Reserve. The Federal Reserve allotted only 1% of the federal funds in lieu of the recession in 2001 as they reduced the interest rates for loans and mortgages. The reduced interest rates enabled investments to enter, but it failed to undertake measures to ensure that the economy could easily respond to the competition. Loans were affordable enough for companies to file expensive investments that would pressure the economy’s capacity to deliver the intended results these companies would like to see. Operating with this type of environment would have been prevented if there was a supplementing interest rate over the investment book. However, with the low interest rates applied in most of these investments, malinvestment and overinvestment became plausible, thus creating a flow of superfluous investment.
Effectively, this similar change in interest rates and easy money affected the housing bubble sector has mortgages were provided to the public, especially to those who cannot afford such venture. Many were enticed to support this action by the government as they believe this would easily allow them access to mortgage credit, which they can use for other activities. Mortgage companies such as Fannie Mae and Freddie Mac were given a target number of loans form families coming from low-income classes. To ensure loans continue to increase from low-income sectors, mortgages were bought from banks either by trading mortgage-backed security and returns. Mortgage companies also have benefits for maintain mortgage deals like tax backup, and the capacity to request for funds from the Federal Reserve. These advantages enabled Fannie and Freddie to claim at least $1.87 trillion in 2003, which increased over the demand for house loans. Even if these mortgage companies are given enough benefits to ensure mortgage is sustained, the government has the capacity to influence the policies released by these companies.
However, giving much power to the government may cause devastating effects such as increased in bad loans, and encourage people to purchase investments they cannot afford. Eventually, this will not increase the country’s national production and continue malinvestment. Additional power on the side of the mortgage companies also amplified risks especially when the home values around the US have depreciated. Securities investors lost their money due to their subprime deals, and it spread out to other investment sectors. In addition to this, most of these security investors had accumulated large amounts of short-term debts that would have been difficult to finance given assets due to their price and selling capacity. Since they cannot sell these assets, the investors would have to find other ways to raise capital, but with the excessive leverage given to banks, it contributed to the decline of assets. Since most of the investment banks and mortgage companies depend on short-term loans to finance their capital, they have slowly seen their funding dry up completely .
Kates (2011) also adds that even policymakers were the ones to blame over the global financial crisis of 2008 as they have laid down the conditions to enable destabilizing policies to exist in the market such as the tax code manipulation, criteria shifting, and implementation of policies that only creates uncertainty. The tax code was continuously changed to entice American house ownership to accommodate the reduced mortgage rates already applied by banks and mortgage companies. This shift in policies has already been in the government even before the crisis; however, the changes had enabled distortion of asset prices that destabilize stability of the economy. The government has also sheltered the credit ratings released by security rating agencies such as the Securities and Exchange Commission’s National Recognized Statistical Rating Organizations.
With the sheltering of the credit ratings from all possible competitions, the regulations reduced the capacity of these rating agencies to rate securities. Policies like the Recourse Act had also restricted credit rating agencies as the Recourse Act enabled banks to hold back mortgage-backed securities by altering their capital reserve requirements. The government’s actions to bail out firms encouraged systematic risks due to the policies that they have implemented to help these companies . Some policies, which were introduced by the wake of the crisis, held uncertainty for investors like the healthcare bill. Meltzer (2010) noted that many of Obama’s proposals like the healthcare bill had increased the uncertainty in the economy by the start of the crisis. In the healthcare bill, many employers were weary as to the estimates released by the Congressional Budget Office in the total cost that would be shouldered when new employees are hired. There was also uncertainty in the healthcare bill as it depends on the spending cuts in a specific sector funds in the future, causing fears over tax increases and inflation to accommodate the spending cuts. The author adds that there is a need for a credible plan that would enable authorities to act immediately to reduce debt and deficiencies .
Solutions to the crisis have varied and proposals to ensure recovery have met both scepticism and optimism. Dennis and Pinkowish (2011) noted that the United States, including the Federal Reserve and the Congress, enacted several strategies to ensure recovery in the US market due to the crisis. For the US Federal Reserve released funds for the stimulus packages to help banks, preventing them to go on default. The Federal Reserve bought almost $2.5 trillion to support these banks and to buy additional stocks Monitory policies were also developed to create recovery and refinance of mortgage deals. Bailouts were also applied to support firms, developing a framework to balance policy interest during crisis. Barack Obama has also launched regulatory proposals to address various sectors like consumer protection, financial aid, and capital requirements. There was also a proposal to enable banks to utilize proprietary trading or the “Volcker Rule”. Both US Congress and Senate have also proposed regulatory reform bills to entice financial stability and consumer protection. Some of these proposals were the Wall Street Reform and Consumer Protection Act of 2009, Restoring American Financial Stability Act of 2010, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 .
Murphy (2008) proposed a nationalization of the depository institutions of companies instead of allowing them to go bankrupt and go on default. Nationalization would enable these companies and banks to go back in making loans and create secured credit-granting decisions for the public. The only downside of this policy to taxpayers is relatively small as most of the losses would be incurred by investors. Institutions suffering from liquidity but have excess liabilities could enforce regulations that would enable short sales to ensure continuous recovery. Since there have been illegal short sales that contributed to the crisis, enforcing the requirement of short sellers would enable securities to be held and enable these sales to be sorted legally like normal selling. This act would also enable securities to be sold to investors. It may also be able to inhibit bankruptcy. For the mortgage and housing sector, it could be resolved by allowing mortgage companies to refinance with shared appreciation mortgages (SAMs) that would lower their debts, at the same time allow lending institutions to receive shares in assistance. The SAMs can also reduce legal costs that would help in reducing foreclosure .
It is still uncertain as to how the international economy can recover fully from the aftermath of the 2008-2009 Economic Crisis. The United States is still experiencing recession, and the Eurozone is currently undertaking several recovery measures to help the Euro countries from debt and recession. The continuity of the crisis may cause further economic damages not only for the developing countries, but also for the developed countries as the international economy requires all markets to have stability. If one fails to have a stable market, it is possible that the effects would domino to other countries and continue raising risks if not immediately remedied. However, with the current crisis still affecting the majority of the developing countries, it has enabled each state to let go of their differences to come up with policies that would ensure recovery. For the United States, it opens up their position in identifying what went wrong in their policies and accept that they had flawed over their rule. Although recovery is still far from reality, the policies that have been implemented had enabled a steady change in the financial sector.
Resources
Dennis, M., & Pinkowish, T. (2011). Residential Mortgage Lending: Principles and Practices. Belmont: Cengage Learning.
Hawley, J., Kamath, S., & Williams, A. (2011). Corporate Governance Failures: The Role of Institutional Investors in the Global Financial Crisis. Philadelphia: University of Pennsylvania Press.
Kates, S. (2011). The Global Financial Crisis: What Have We Learnt? Glos: Edward Elgar Publishing.
Meltzer, A. (2010, June 30). Why Obamanomics Has Failed: Uncertainty about future taxes and regulations is enemy No. 1 of Economic Growth. Retrieved April 15, 2012, from The Wall Street Journal Online - Opinions: http://online.wsj.com/article/SB10001424052748704629804575325233508651458.html
Murphy, A. (2008). An Analysis of the Financial Crisis of 2008: Causes and Solutions. Rochester: Oakland University School of Business Administration.
