The two key sectors that take the blame for the financial crisis of 2008 and 2009 are the financial sector and the real estate industry. The financial sector generally receives blame for its activities, which included high risk lending, and high-risk investment in derivatives.
The real estate sector on the other hand bore the brunt of the activities of the financial sector because when people started defaulting on loans, banks and other mortgage financiers foreclosed homes, and repossessed properties whose owners defaulted.
Soon, there were too many properties in the market against the prospects of dwindling demand, eventually leading to a collapse of the property markets.
Other sectors that receive blame for the crisis include regulators, and legislators. On one hand, regulators seem to have failed to offer direction for the finance sector until it was too late.
One count is the ease with which lenders offered credit without due diligence because of their excessive capitalization, and demands by government to provide cheap credit. People who did not have the capacity to pay back loans took them anyway and there was no one to stop them.
Legislators created this situation by repealing of the Glass Steagall Act in 1999, which many people consider “to be one of the more critical regulatory changes that played a role in the financial crisis”. This act originally prohibited one institution from acting as a commercial and an investment bank, or as a banker and an insurer.
The key issues that the case presents include the role of government in industry, the effectiveness of regulation in industry, human behavior versus market forces, and the question of institutional learning. The traditional role of government in industry, especially in capitalist economies is regulatory in nature.
The government creates the rules within which all parties play and creates institutions to enforce those laws. When the government intervenes in industry such as through the bailouts the Federal Government gave to the big banks, then it means that there is a widespread systemic failure.
On the other hand, too much regulation stifles business. The government must find some sort of balance as it creates the laws to govern industry, and as it enforces regulations.
The next question is that of human behavior versus market forces. Human behavior in this context refers to the values and activities of both consumers and industry players. The western world is very materialistic. Success and status in society comes from the kind of things a person owns.
Therefore, there is a very big motivation for consumers to keep looking for more things even if they are beyond their means. Industry players on the other hand typically respond to demand in order to make profit.
Therefore, when there is demand for something, industry will strive to provide it to turn a profit in the process. However, when industry makes profit the super aching goal despite values, then the result is a financial crisis. There ought to be some kind of value-based system for industry to operate within if the economy will have balance.
Institutional learning is important for the prevention of the recurrence of challenges that an institution undergoes. This seems to be sorely lacking in the financial sector in America. The repealing of the Glass Steagall Act of 1929 showed that the legislative arm of government did not appreciate the consequences of its actions.
In this sense, repealing the law reset the economy to pre-1929 days, which was “the last time the level of debt was 100% of GDP”, hence the exposure.
In addition, the executive has not instituted stronger regulatory measures that can allow for the documentation of crisis in the same way as engineering or medical associations do. The lessons simply do not stick long enough because there is no institution to collate them.
There are a number of options available to prevent the recurrence of the events of 2008-2009. They include nationalization, stronger regulation, and self-regulation within a stronger legislative framework. Nationalization is the least popular way of handling economic problems in a capitalist system.
The main argument against it is that the government is not supposed to be a market player because of its multiplicity of concerns. Government is also very slow to innovate and slow to adapt hence the sector will stagnate if the government runs it.
If the government chooses to nationalize any bank, “it is important to ensure that the bank returns to the hands of private investors after the liquidity crisis is over by giving the bank the ability to call back or repurchase the equity it issued to the government”.
On the other hand, it means that the sector will not be profit driven hence it will not have the same appetite for risk compared to that of the private sector. In addition, the government can afford to bail itself out in case of any problems without involving the entire economy.
Another practical solution is simply limiting the size of financial institutions. This will make sure that if one of them is in trouble, then the normal systems for dealing with the problem can follow without affecting the entire economy. The current size of banks gives them undue influence on policy and their collapse has a huge impact on the economy.
The other side is that this will be against the capitalist ideals. It means that the system will punish the most innovative and hardworking participants in the industry. In addition, enforcement will be difficult because companies will simply divest and have independent companies under a single umbrella.
The third way is to strengthen “banking supervision and regulation” through relevant institutions and legislation . This option will more or less allow financial institutions to carry on with their duties but with more scrutiny and under stricter rules. The scrutiny should aim at identifying trouble before if turns into a catastrophe.
It may have been possible to halt the forces that led to the financial meltdown if there was some consistent source of information regarding the operations of the financial sector. Stricter rules do not also mean limited operations. It just means that the things financial institutions should do must be clear just as what they should not do.
The recommended way of approaching this issue is by using stronger legislative and regulatory measures. This approach will ensure that there is the least government interference in the running of the private sector. In addition, the government will play its more accepted role as a regulator and arbiter industry.
The market forces should do the rest of the work in ensuring that consumers get the best level of service within the broader framework defined by government. As compared to the other options, it actually utilizes less resources and already established institutions.
The process of nationalization would require so many people and the government simply do not have the experience to run financial institutions.
The industry will suffer as a result. Limiting the size of financial institutions will send capital away to places that do not have similar restrictions. The overall impact on the economy will be negative. In conclusion, the best way to stem the recurrence of these events is regulation.
Reference List
Black, K. (2009). Business Statistics: Contemporary Decision Making. John Wiley and Sons: New York, NY.
Chacko, G., Sjoman, A., Gunawan, H., & Evans, C. L. (2011). The Global Economic System: How Liquidity Shocks Affect Financial Institutions and Lead to Economic Crises. Upper Saddle River, NJ: FT Press.
Reavis, C. (2009). The Global Financial Crisis of 2008-2009: The Role of the Greed, Fear and Oligarchs. San Francisco CA: MIT Sloan Management.
World Bank Group. (2011). The World Bank Group’s Response to the Global Economic Crisis: Phase I. Washington, DC: World Bank Publications.