The 2008 Financial Crisis Analysis

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

The Federal Government needs to make sure to enforce strict guidelines on who can and cannot be accepted for a home loan, and not allow big investors to borrow excessive money at low interest rates to inflate the investor’s financial advantage. If the government starts allowing lower standards on mortgages, we are going to end up in the same catastrophe once again. In an article written by U.S. News and World Reports entitled Should the Federal Government Provide Support to the Mortgage Market?, the Federal government and the President attempted to get involved with the housing market. The passage implicated that Obama wanted to do away with federally funded conglomerates Fannie Mae and Freddie Mac and implement another type of government assisted program ("Should the Federal Government"). The program would prevent the mistakes made by Fannie and Freddie which created the original “housing bubble burst” ("Should the Federal Government"). One of the Senate bills suggests the government create “a new agency, the Federal Mortgage Insurance Corporation to replace Fannie and Freddie” ("Should the Federal

On June 27, 1934, President Franklin Roosevelt signed the National Housing Act, with the goal to improve the housing standards and conditions, as well as provide a mutual mortgage insurance system. It came at a time when at least half of the nation’s home mortgages were in default, millions of people were losing their homes, and the construction industry was halted. This law in turn created the Federal Housing Administration (FHA). The FHA set standards for construction and underwriting, and it provided mortgage issuers, such as banks and private lenders, a federal guarantee of repayment. The purpose of this was to revive mortgage lending for house construction, home improvement projects, and home purchases. Not only did the FHA’s program

However, it is clear that these unethical practices served as catalyzers of the financial crisis. Even though many financial institutions that could be held responsible for the 2008 crisis no longer exist and that legislation, as the Dodd-Frank, has been passed in order to further regulate financial institutions, many of the institutions responsible for the crisis are still in the core of the economy, controlling a very big part of it. It might be impossible for the general public to fight against a possible future recession, as the power of an individual is close to insignificant in comparison to the power of an established financial

The Federal Reserve had began lowering interest rates from 6.5% in the late 2000, all the way down to 1% in November of 2003 and kept it there until June of 2004. These artificially low interest rates encouraged consumers to buy houses and builders to produce more houses. However, the low interest rate was not an accurate reflection of the true demand for houses in the marketplace. At the same time, Congress amended the Community Reinvestment Act, encouraging banks to offer mortgages to lower income borrowers who would ordinarily not qualify for a loan. In addition, the Federal Government required Fannie Mae and Freddie Mac, the now two infamous government sponsored lenders, to provide over half their mortgages to low-income buyers, also known as subprime mortgages. Essentially, this meant that banks and other mortgages lenders were told to relax their lending standards, and provide mortgages to people who

The relative successes and failures of that Act are becoming more apparent with time, and the shortcomings are subject to intense partisan criticism. As discussed below, Dodd-Frank seeks to address the highly sensitive and controversial notion that Wall Street banks have been designated by the Federal Reserve as too-big-to-fail. In fact, during the most severe moments of the crisis, the voices of free market proponents could be heard advocating that these troubled big banks, suffering massive losses due to their own bad bets, and if weakened to the point of failure, should be allowed to fail. Hindsight shows that allowing just one to fail, Lehman Brothers, had serious and lasting detrimental effect on the US and global financial system and markets. Had Lehman been saved, it would have been the most effective agent to unwind all of the transactions and trades to which it was a party, and likely in a rapid manner. However, being thrust into bankruptcy, and thereafter receivers were appointed to unwind the business, took months upon months and vast resources to settle Lehman accounts. Had Citibank, Bank of America, Bear Stearns, or AIG been allowed to fail, it may have been possible that the US financial system would have melted down completely. So these super banks, and non-banks, cannot be allowed to fail in crisis, due to the system-wide risk. Notwithstanding, such an implicit assurance, that they will always get a bailout, no matter how toxic

Some of the main provisions of the Dodd-Frank Act removed the burden imposed on the taxpayers and are now holding Wall Street accountable for any firm that fails in the future7. In addition, the Volcker Rule has been implemented, in essence this rule prohibits banking institutions to do other activities unconnected to assisting their customers; this provision separates “proprietary trading” (which includes the banks being “allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit”) from the activity of banking

While Dodd Frank was held as an act that would increase capital and liquidity buffers banks held and reign in the risky behavior of financial institutions. In doing so it has cost a heavy burden to bank in the form of compliance cost and implications about its future impact on households and the financial sector. Listed are the six key provisions of Dodd Frank, in each highlighted area the pros and cons of that key aspect that will be discussed.

FDR’s affordable housing initiative was responsible for the rapid expansion of home ownership throughout the United States (Allen and Barth, 2012). This was accomplished in part through the creation of The Federal National Mortgage Association, which provided affordable low down payment mortgages extended over a 30-year period of time. Over the past several decades the United States economic policy has been to encourage home ownership (Bluhm, Overbeck and Wagner, 2010).

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into federal law by President Obama on July 21, 2010 as a response to the financial crisis of 2007-08. From an economic standpoint the overall consensus leading to the financial crisis can be linked to not only greed, but to ‘excessive deregulation’ and the “finanicialization of everything” (Knight 2015). Supposedly, the failures were due to the financial sector being funded by debt, which already sounds unethical and a poorly planned system. Prior to Dodd-Frank legislation was the Banking Act of 1933, which had similar intentions of providing stability. However, the Act was eaten away over time and companies weren’t as strictly regulated (Acharya 2013).

Can banks become “too big to fail”, and should they be allowed to stay that way?

Before the beginning of the financial crisis in 2007, rules and policies passed in the United States had required the banking sector to allow more consumers to be able buy homes (Nielsen, 2008). Starting in the year 2004, the bursting of the housing bubble took place, when Freddie Mac and Fannie Mae, two of the largest and most well-known mortgage lenders in the United States, obtained a large quantity of mortgage assets, including some chancy mortgages. They charged substantial fees and accepted lofty margins from these subprime mortgages. The mortgages were used as safety or security for getting private label mortgage-based

In this essay I will be addressing the “Too Big To Fail” (TBTF) problem in the current banking system. I will be discussing the risks associated with this policy, and the real problems behind it. I will then examine some solutions that have been proposed to solve the “too big to fail” problem. The policy ‘too big to fail’ refers to the idea that a bank has become so large that its failure could cause a disastrous effect to the rest of the economy, and so the government will provide assistance, in the form of perhaps a bailout/oversee a merger, to prevent this from happening. This is to protect the creditors and allow the bank to continue operating. If a bank does fail then this could cause a domino effect throughout

All in all, I aim to assist in creating an illuminating understanding on American financial system and reforms through this public policy paper.

This was demonstrated during the latest financial crisis, when banks faced the threat of a bank run, not only by depositors, but also by institutional investors. In fact, following the 2007–2008 crisis, the interbank market almost dried up, suggesting that bank runs may move from the retail to the wholesale market. To prevent bank runs and their effects, governments usually create implicit or explicit guarantees to protect depositors (for a concise review see Allen et al., 2009). Deposit insurance schemes however might produce unwanted effects and increase moral hazard because they can induce banks to take higher risks.1 Prudential authorities enforce capital regulation2 in order to limit bank