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Cause of the Financial Crisis Cause and Effect Essay

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Updated: Aug 23rd, 2019

Nowadays, it became a commonplace practice among many American economists and politicians to suggest that it is specifically the Federal government’s failure to introduce regulatory measures, as the mean of preventing banks from providing financially non-credible citizens with mortgage loans, which created objective preconditions for the outbreak of 2007 financial crisis. The close analysis of such an idea, however, reveals it being essentially deprived of a rationale.

The reason for this is quite apparent – it was namely the Democrats’ preoccupation with ‘combating poverty’ (under Carter and Clinton’s administrations) that resulted in passing of the infamous Community Reinvestment Act (CRA) and in reinforcing its provisions through the course of late nineties, which in turn gave banks a ‘green light’ to qualify socially-unproductive Americans for mortgage loans (Wallison, 2011).

Moreover, the Federal government is being simply in no position to regulate dynamics on the American financial market de facto, since it has long ago delegated its monopoly on designing monetary emission-policies to the privately owned Federal Reserve System.

Therefore, the suggestions that the government should pass additional bylaws, in order for the financial market’s dynamics to be more predictable, cannot be referred to as anything but the part of Democrats’ sophistically sounding but essentially meaningless rhetoric. In this paper, I will aim to substantiate the validity of this statement at length. Let us elaborate on the actual causes of the most recent financial crisis first.

By the year 2006, the volume of so-called ‘non-standard’ and ‘alternative’ mortgage loans, provided by banks to Americans, accounted for 40%. In other words, almost a good half of mortgage loans were given to people that would not normally be qualified to receive them.

Yet, even though that this particular financial policy did not make any rational sense, whatsoever, through years 2003-2006 American banks strived their best to cease the opportunity to simply ‘give away’ money to those citizens that were simply in no position to be able to afford repaying annual interest rates. Why was it the case? This was because, prior to the outbreak of 2007 financial crisis, the real estate market in America was experiencing a particularly dramatic growth.

In its turn, this caused more and more Americans to realize that they could make utterly lucrative profits by the mean of buying houses with bank-loans, waiting for a year or two, without even being required to pay interest on the received loans, and then selling these houses for often twice as much.

Thus, as time went on, a growing number of Americans were beginning to perceive mortgage loans not in terms of an opportunity to buy otherwise non-affordable real estate per se, but rather in terms of an opportunity to indulge in financial speculations. This, of course, caused the growth of the real estate market in America to attain an exponential momentum.

Eventually, American bankers concluded that ‘non-standard’ and ‘alternative’ mortgage loans could also be provided to citizens for investment purposes. That is, banks started to sell mortgage agreements and potential profits (which were yet to be obtained in the future) to each other.

It is needless to mention, of course, that banks were not financing these types of loans with their own assets, but with largely virtual assets of some third parties. In other words, non-financially sustainable citizens were receiving personal mortgage loans from organizations that were simultaneously applying for corporate monetary loans, in order to have these loans simply given away to as many people as possible.

One debt was generating another debt, which in turn was ‘backed’ by another debt, and so on. Yet, there was an artificially maintained respectability to all of this, as the ‘reselling of debts’ became a widespread practice. The mechanics of how the proper functioning of American economy was being undermined from within were quite simple.

The likelihood of a particular mortgage loan not to be returned was evaluated by credit rating agencies, which used to result in security equities being rated according to the extent of their perceived ‘riskiness’. Loan agreements, considered most ‘secure’, were easily sold. Yet, given the continuous boom of the real estate market, even clearly risky loan agreements could be successfully resold to investors.

As a result, all the involved parties were able to benefit from participating in the scheme – banks could get rid of legally bounding agreements with private citizens, investors could benefit from making almost instantaneous profits, and private borrowers could close their mortgage loans – hence, qualifying to apply for new ones.

This situation lasted for seven years, while resulting in the rapid growth of America’s GDP. Millions of citizens were making huge money out of the thin air, without being required to contribute to the de facto growth of the American economy.

Nevertheless, the sustainability of the earlier described debt-pyramid was maintained solely by the continual but thoroughly artificial growth of the real estate market, which was attracting more and more investors. In its turn, this growth came because, as of 2003, Federal Reserve System reduced interest rates down to 1%.

This poses us with the question – given the fact that the cause of financial crises has always been the lack of financial liquidy, what caused the lack of financial liquidy in 2007? The answer to this question is simple – it was the FRS’s decision to dramatically increase interest rates through 2006- 2007.

In essence, FRS simply followed the classical ‘recipe’ of making a financial crisis, which it had already resorted to during the time of Great Depression. The consequential guidelines for making a financial crisis are as follows: a) Increase the money’s physical volume as much as possible, b) Create loan-agitation by the mean of qualifying even jobless people to apply for loans, c) Drastically reduce the amount of money in circulation and demand borrowers to immediately return their debts.

What it means is that, far from being spontaneous, the financial crisis of 2007 was intentional and thoroughly regulated, with its foremost goal having been the elimination (due to banks’ bankruptcies) of trillions of ‘excessive’ dollars, printed by FRS without bothering to back up their actual value with any material assets, whatsoever.

Therefore, the suggestions that this crisis came because of the America’s financial system having been deregulated simply do not stand much ground. Quite on the contrary – it is specifically because, ever since 1913, FRS exercises a complete regulatory control over monetary emissions in this country, that the financial crisis of 2007 was bound to occur. In this respect, the Federal government’s regulations simply assisted FRS.

The validity of this statement can be well explored in regards to the passing of enforcing bylaws to the earlier mentioned Community Reinvestment Act of 1977, “Bill Clinton… passed laws to enforce the original (CRA) bill.

The purpose of the CRA is to force banks to make risky loans to people who can’t afford to repay those loans” (Knight, para. 1). In other words, the government’s meddling in financial affairs, as the part of governmental officials pursuing its ideologically driven and clearly utopian agenda of ‘eliminating poverty’, contributed substantially to the outbreak of 2007 financial crisis.

Apparently, left-wing politicians simply do not understand a simple fact that the proper functioning of the free-market economy cannot be ‘regulated’ and that if it nevertheless becomes the subject of regulations (especially if these regulations are being ideologically motivated), this necessarily results in the economy’s functioning becoming susceptible to crises.

There is another aspect to the earlier argument – as of today, the Federal government simply does not have instruments to regulate the functioning of FRS. This is because, contrary to the provisions of U.S. Constitution, which endows U.S. Congress with the exclusive right to exercise a unilateral control over the process of designing this country’s financial policies, this right has been delegated to FRS – a private financial organization, over which the government does not have any control.

After all, it is FRS that lands money to the Federal government and not vice versa. Can borrowers control a money-lending organization? President Kennedy did believe that it was in fact the case, which is why under his Presidency, the U.S. Ministry of Finances issued $2 and $5 banknotes, backed by silver from the National Treasury. This, however, had sealed the Kennedy’s eventual fate.

Therefore, the suggestions that the functioning of the America’s financial sector could be regulated by governmental decrees appear utterly fallacious. As the example of CRA’s passing points out to, the government’s attempts to regulate this functioning simply create yet additional preconditions for the country’s richest bankers, who own FRS, to act on behalf of their sense of greed, at the expense of undermining the economy’s vitality from within.

As Randazzo noted it, “Ironically, it was government action (the enforcement of CRA’s provisions) that created incentives for financial firms to be less risk adverse, not a lack of regulation” (2009, para. 6). Thus, we can well conclude that the more a particular ‘progressive’ politician talks about introducing more regulations, meant to apply to the America’s financial sector, the more he or she is being in cahoots with those greed-driven bankers, who are supposed to suffer from these regulations’ enactment – pure and simple.

After all, as the history indicates, recently passed regulatory measures (such as CRA), originally conceived to work on behalf of ensuring the American economy’s stability and the ‘underprivileged’ citizens’ well-being , did not only fail at that but they actually strengthened the acuteness of the ongoing financial recession. As the famous saying goes – the road to hell is made out of good intentions.

Therefore, it will only be logical, on our part, to conclude this paper by reinstating once again that the introduction of new regulatory bylaws, designed to prevent the outbreaks of financial crises, such as the one of 2007, will not possibly change the situation for better. The reason for this is simple – the periodic outbreaks of these crises can be well seen as the very purpose of the FRS’s existence.

However, since the functioning of FRS cannot be regulated by governmental decrees de facto, it means that the government cannot effectively regulate the financial market’s dynamics either. I believe that this conclusion is being thoroughly consistent with the paper’s initial thesis.


Knight, W. (2009). . WordPress.Com. Web.

Randazzo, A. (2009). . Web.

Wallison, P. (2011). . The Atlantic. Web.

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