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Financial Crisis of 2007-2008: Laws and Policies Essay

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Updated: May 28th, 2020


The global financial crisis that broke out in 2007 continues to attract the attention of economists, lawyers, and policy-makers. One of their main tasks is to identify the main lessons of this event and develop strategies that can minimize the possibility of such threats in the future. This essay is aimed at discussing the laws that could have contributed to this event. In particular, one should focus on regulations and legislative acts that could have encouraged or at least allowed unscrupulous practices of financial institutions and their extreme risk-taking.

Furthermore, these regulations did not ensure complete transparency of the organizations that were involved in financial transactions. These are some of the main aspects that can be identified. Nevertheless, one should not assume that the absence of legal safeguards is the only factor that led to this crisis since it is necessary to consider the development of the economy and lack of internal controls in many institutions. These are the main questions that should be examined in greater detail.

Laws and policies that increased the fragility of the financial system

It is possible to mention several important laws that are closely related to this crisis. In particular, one can refer to the Gramm-Leach Bliley Act adopted in 1999 because it enabled the integration of commercial and investment banks (Stowell 32). It should be taken into account that investment banks are usually more tolerant to risk (Stowell 32). They are more likely to put capital into projects which can yield higher returns, but at the same time, these investments are more likely to fail. One should take into account that the clients of these organizations are aware of these dangers, and they can withstand the impact of possible failures.

This is one of the main issues that should be considered. In contrast, commercial banks are averse to risks since deposit holders expect bankers to avoid aggressive investment. These clients want the management to minimize the risk to their assets. The integration of commercial and investment banks was prohibited according to the Glass-Steagall Act implemented in 1933. The risk management strategies in these organizations were not consistent with one another. In turn, the Gramm-Leach Bliley Act eliminated this restriction (Stowell 32).

More importantly, this law resulted in the creation of institutions that were described as “too big to fail” (Stem and Feldman 7). In this case, one should speak about various financial organizations that are very interconnected and large, and they are supposed to be supported by the government if they experience difficulties (Stem and Feldman 7). Among such institutions, one can distinguish Lehman Brothers or AIG. In many cases, the managers of these organizations pursued risky policies that were based on the assumption that the state would not let them go bankrupt. This case indicates that this crisis could have been caused by imperfect legislation, and its negative impact cannot be overlooked.

There are other important laws that could have lead to the financial crisis. For example, one can mention the Commodity Futures Modernization Act that was signed in 2000. This legal act decreased the regulation of credit default swaps or CDS (Kolb 33). It should be taken into account that a CDS is an obligation of a certain organization, usually an insurance company, to compensate the buyer of the CDS in case of a default (Kolb 33). One can argue that CDS is a useful tool that can minimize the risks of inventors (Kolb 33).

Yet, many financial institutions misused this financial instrument, and as a result, they became exposed to many liabilities. For instance, one can mention such an insurance agency as AIG that had to be bailed out by the government because it gave a great number of credit default swaps (Kolb 33). Moreover, the total market of these financial instruments equaled approximately $35 trillion (Kolb 33). Certainly, one cannot say that the Commodity Futures Modernization Act was the only factor that intensified the risk.

Such a statement can hardly be called accurate. Much attention should be paid to the reckless policies of the senior executives who did not properly evaluate the risks of selling CDS in such quantities. This aspect is also vital for discussing this financial crisis. However, the absence of regulations prevented the government from intervening in the activities of companies that misused credit default swaps. Overall, this aspect is also vital for understanding the origins of this financial crisis and its long-term effects.

It is also necessary to discuss the deregulation of rating agencies that also played an important role in the financial market. These organizations were responsible for providing accurate information about the value of securities (Friedman and Craus 33). A great number of investors relied on the data provided by these institutions. They believed that in this way, they could make informed purchasing decisions.

Nevertheless, rating agencies did not cope with their duties effectively. For example, many securities received a triple-A rating from these agencies, and this assessment affected the choices of the investors (Friedman and Craus 33). In turn, one can say that the activities of rating agencies were not closely monitored by the government. Thus, one can say that laisser-faire policies were not efficient. One should take into account that the failure of rating agencies might not produce devastating effects if investing companies adopted appropriate risk management strategies. Nevertheless, this aspect was often disregarded by individual and corporate investors.

Apart from that, one should remember the role of the Sarbanes-Oxley Act. This law was designed to ensure that companies provided accurate about their financial performance. This regulation was supposed to reduce the risk of corporate fraud (Prentice and Bredeson, 54). Certainly, this law did bring some improvements, but it did not include specific provisions about mortgage lending (Tressel, Mishra, and Igan 17). There are other areas that were not properly covered in the Sarbanes-Oxley Act.

For example, one can mention excessive leverage of investment banks, the real estate market, and mortgage obligations (Prentice and Bredeson 54). These are the main drawbacks that can be identified, and they could have contributed to this financial crisis. Nevertheless, possible deficiencies of this legal action should not be viewed as the main cause of environmental crisis because regulations and laws cannot be the only safeguards against a financial crisis (Tressel, Mishra, and Igan 17). One should not forget about the absence of internal controls that could minimize the risk of losses. This is one of the main points that should be taken into account.


Again, it is important to mention that policies and regulations should not be viewed as the only force that could have brought the crisis. One should keep in mind that these laws cannot explain the irresponsibility of many senior executives and the lack of concern for various stakeholders such as investors or employees. Moreover, these legal acts could not shape the development of the global economy. This is one of the main aspects that are vital for discussing the origins of the crisis.

Nevertheless, one can still argue that legislators and policy-makers failed to provide a system of checks and balances that could minimize the possibility of risks. To some degree, the laws which existed during that period were based on the premise that the players in the financial market could always act in a rational way. Yet, this assumption proved to be wrong. This is one of the main arguments that can be made. It should be one of the main lessons for legislators who should eliminate the drawbacks of existing policies.


On the whole, the discussion of the financial crisis suggests that it is not possible to focus only on a single factor or aspect. Such an approach cannot capture the complexity of this event. The examples presented in this paper indicate that the absence of adequate policies and laws could have increased the impact of various risks, especially the inefficiencies of internal controls used in different financial organizations. It is possible to identify several aspects that were not properly addressed in the legislation and policies existing during the period. Close attention should be paid to risk-taking in financial institutions, their transparency, and the disclosure of information to various stakeholders. Yet, the inefficiencies of laws were only one of the factors contributing to the crisis.

Works Cited

Friedman, Jeffrey and Wladimir, Craus. Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation, Philadelphia: University of Pennsylvania Press, 2011. Print.

Kolb, Robert. Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future, New York: John Wiley & Sons, 2010. Print.

Prentice, Robert, and Dean Bredeson. Student Guide to the Sarbanes-Oxley Act: What Business Needs to Know Now That It Is Implemented, Boston: Cengage Learning, 2010. Print.

Stem, Gary, and Ron Feldman. Too Big to Fail: The Hazards of Bank Bailouts, New York: Brookings Institution Press, 2004.

Stowell, David. An Introduction to Investment Banks, Hedge Funds, and Private Equity, New York: 2010. Print.

Tressel, Thierry, Prachi, Mishra, and Deniz, Igan. A Fistful of Dollars: Lobbying and the Financial Crisis, New York: International Monetary Fund, 2009. Print.

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