The Contention that Inadequate Regulatory Oversight in the United States of America - Assignment Example

The Contention that Inadequate Regulatory Oversight in the United States of America Introduction The sub-prime mortgages sector of the US economy is today believed to have triggered the 2008 – 2009 global financial crisis (Tirole, 2003, pp 102). This crisis when critically evaluated appears to have been a consequence of combined market failures, the US market being the epicenter of what would later turn out as a global quake. Experts currently agree the crisis was caused by three core failures (Stiglitz, 2010, pp. 307 – 342). Adverse US macro-economic conditions coupled by bad corporate governance (marked by greedy corporate boards) and more importantly punctuated by loose government regulatory oversight are the main causes of the crisis. There are different perspectives on the contributing causes or which among the three was the most pronounced (Stiglitz, 2010, pp. 307 – 342). This critical essay argues that when the turn out of the crisis is reviewed objectively from without the US and its domestic justification, flawed governance practices (such as inadequate regulatory oversight) that are evident in both the private and public sectors plus a greedy corporate in the financial markets are the two causes that remain largely responsible for the 2008 – 2009 financial catastrophe. The essay also argues with convincing evidence that the tendency to blame the crisis on the US corporate world downplays the role of the US government to protect the public from exploitation. The essay relies largely on secondary data observations and analysis of relevant banking procedures, practices and results to support the aforementioned contention. The Wrong Scapegoat It is hard to conceptualize how minute losses experienced by the US subprime housing loans sector, which is only estimated to be about $100 million (early 2007) could lead to such a global economic and financial (Zandi, 2009, pp. 64-67). The crisis was perhaps the greatest since the Great Depression, and unlike any other in history, its impact was global. The worldwide stock markets dived to their greatest plunge in 60 years, the housing values all over the world declined sharply and world output reduced drastically (Norberg, 2009, pp. 58 – 79). The crisis was so major that IMF projected output losses to the tune of US$ 4.7 trillion starting from 2008 to 2015 consequent to the crises (Desai, P, 2003, pp. 58-91). Experts were mainly blind-sided and amazed by the speed and the magnitude of the financial crisis, even within the US market where it originated as well as in the rest of the world (EL-Erian, 2008, pp. 118). One thing is for sure, the small scale subprime market is not to blame since its size and its market significance could not trigger such a full-scale market failure even if it crashed completely. Large corporations, wealthy investment banks and influential market players are the ones who triggered the meltdown, as was illustrated by the September 2008 collapse of Lehman Brothers. A series of very greedy decisions by the board, encouraged by an network of all-permitting government regulatory organs helped the Lehman kill the dreams of so many American investors. So significant was this greed and poor regulation that had Lehman been bailed out, experts believe that the U.S. financial system could have been salvaged before the subsequent melted down (Seter and Roubinini, 2009, pp. 171 – 182). Lehman represents the real culprits of the financial crisis, greedy financial corporate entities and a permitting government regulation. Financial institutions such as investment banks triggered the global recession, because their credit systems had grossly exceeded the sustainable levels even with the government regulatory bodies watching passively as trillions of dollars were borrowed against marginal asset bases in both stock and housing markets (Zandi, 2009, pp. 64-67). It was this ill-advised housing bubbles that ended up in defaults and surged foreclosures. With foreclosures and defaults, a plunge in mortgage-backed securities prices was inevitable. The real cause of the crisis was financial institutions who borrowed heavily against a marginal capital base relative to the total debt in a bid to make more profits from a booming housing market (Diamond, 2000, pp. 14–23). The US government regulatory organs watched this happen with total disregard to the risks created for the average American by some greedy group of investors if the then booming housing sector flopped (Norberg, 2009, pp. 58 – 79). Yet objectively, there are many culprits who should be implicated in the crisis besides greedy financial institutions and government regulatory failure. The other markets also failed, due to high overdependence on financial markets. The lack of foresight can be explained by extended periods of low interest rates, abundant liquidity, rising asset prices and allowances for non-mitigated risks. Investors and corporate boards had grown used to good times such that they did not foresee any possibility of market failure (Shiller, 2009, pp 102 – 137). The government had registered economic growth and decreasing unemployment until regulation seemed unnecessary since the market was doing great without regulation. The macroeconomic sectors were steadily appreciating and government reserves building up. The problem was, everybody had become too complacent and optimistic. The Role of Inadequate Regulation Lack of regulatory control made the hitherto disciplined financial market players to become mischievous. The financial systems initiated nontransparent financial instruments, most of which were either mispriced or misunderstood in terms of risk levels (Markus, 2009, pp. 77–100). Banks and lending institutions became careless since nobody was watching them or demanding accountability. The government was sleeping on the job. The regulators failed to foresee, control or respond to a slow build-up of imbalances between credit and assets. The banking services providers such as loan originators, credit rating agencies and payment collectors started playing their cards carelessly and without accountability, at great risks (Stiglitz, 2010, pp. 307 – 342). During the 2007 summer Jackson Hole international conference held for financial officials and central bankers, experts concurred that 2003-2005 excessively low interest rates that had been set by the US Federal Reserve were a primary trigger of an unprecedented housing boom during the 200-2006 trading season (Markus, 2009, pp. 77–100). The boom outgrew itself until it subsequently bust. As a regulatory organ, the Federal Reserve failed to foresee the likelihood of every investor rushing into the housing sector to exploit the boom and the risk of having most of all credit being submerged into one sector of the economy since everybody would be borrowing and investing in the boom. The problem was that the government regulatory organs did not foresee the danger of letting the market play with sums exceeding the asset bases out there. The government organs watched as investment banks placed risky bets with practically anything that promised to create enormous profits out of nothing i.e. borrow, invest and make interests without paying interests themselves. Derivatives were totally unregulated since they don’t trade on public exchanges (Goldstein, and Institute for International Economics, 2004, pp. 217 – 242). This means that their loan originators deliberately hide any vulnerability that could have helped the government predict the meltdown before it happened. Rather than be blamed on the housing markets, the crisis should thus be blamed on the government regulatory mechanisms and the greedy corporate financial institutions. Yet the irony is that these institutions which are responsible for that crisis are the same ones that the government moved in to help with multibillion bailed outs (Ikenson, 2009, pp. 18). The government rewarded greed using tax payer’s money, the same tax payers who had been uninsured against the tragic consequences of inadequate regulation and greed (Ikenson, 2009, pp. 18). The victims were used to reward the aggressors, even as livelihoods were threatened fortunes lost, jobs slashed, inflation increased and food became increasingly expensive (Ikenson, 2009, pp. 18). As it played out, banks, investment institutions and hedge funds became over-confident since they were not accountable to the government or the public whose money they were moving around risky potholes. To most of these legendary institutions (Lehman was for instance the stable of American economic stability), it seemed they had finally crafted the genius way of embracing risk to make gigantic sums of money without having to qualify for it or explain it to anyone (Smick, 2009, pp. 179 – 183). Initially, most of these corporations made good money by taking the ill-advised risks. Unfortunately, the initial positive results are what reinforced the conviction that they had finally figured it out and taking risks had finally proved to the bridge to trillion-dollar balances. Yet even as this happened, the government watched passively. Institutions borrowed and lent out monies far beyond their asset assurance. Even when such institutions started noting defaults in repayments and a decreasing reliability of the market, they did not stop . Incidentally, the more they continued to perpetuate debt, the more it seemed they could profit (Markus, 2009, pp. 77–100). The government was still passive and did not read the potential risks. The credit default swap market (the derivative of insurance on business loan defaults) grew so enormous that it exceeded the entire world’s economic output standing at US$ 50 trillion in 2008 summer. By the time government regulators moved in, it was too late. The world’s largest financial and insurance company, AIG, had already accumulated a credit default amount of over $400 billion, alone (Acharya and Richardson, 2009, pp. 141 – 182). The US market was greatly exposed and there was little regulation both when it was building up and now that it had happened. It did not help that like most institutions, AIG had bet most of its credit on mortgages. So when the housing sector went down, so did AIG. The credit maze had created a web of interlinked institutional dependencies, a chain with very weak but significant links (highly risky). What happened to one institution affected every sector of the market. The US government had no choice but to commit over US$ 150 billion to help salvage AIG, if only to keep other dependant credit institutions on their wobbling feet (Ikenson, 2009, pp. 18). The Role of Greed The blame of the global crisis is squarely placed at the feet of a greedy Wall Street. The Wall Street houses the most influential financial institutions, banks and ideologues in the US if not in the world (Cochrane, 2009, pp. 58-91), these entities are responsible of pushing for the regulatory policies that allowed them to be bosses of the economy without any sense of accountability. Given their clout in both Whitehouse and the US Senate, the Wall Street gurus have been able to muzzle government regulatory measures that could otherwise delimit their greed. Yet these are the few individuals and entities that benefited not only when creating the crisis but also from the crisis (Shiller, 2009, pp 102 – 137). Once the effects of the melt down became pronounced, the Bush Administration came up with a $700 billion bailout plan that targeted the US financial system. Notably, the first thing that most of these institutions did with the bailout funds was to award their boards with hefty packages for a job well done (creating the crisis) (Ikenson, 2009, pp. 18). This finally broadcasted the extent of their greed even with astounding public outcry. The problem was, the crisis had emerged from a series of greedy maneuvers by the financial institutions and banks. The low interest rates on housing had motivated all investment players at Wall Street to move in for a kill. There were soaring profits to attract them and borrowing heftily seemed wise, as the only available means of funding what seemed like a brilliant opportunity to make profits. Banks borrowed huge amounts of money to lend out to investors who wanted a piece of the housing market. Banks forgot their savers pool and capitalized on the credit market (Diamond, 2000, pp. 14–23). Even when their deposits and assets were marginal, they went on to borrow from lenders and other banks so as to sell the capital as loans. US investment banks such as Lehman Brothers did not see giving out loans as adequate exploitation of the opportunity so they got into mortgage too. Other banks loaned more than they had at hand in a bid to securitize those loans profitably (Diamond, 2000, pp. 14–23). The lending craze stretched to the riskiest loans available, the subprime. With the house prices rising, the lenders thought that it wasn’t too risky since even for the bad loans for which they repossessed property, the property was still highly valued in the market and in demand. Even when people stopped borrowing, banks started trading securities between themselves and other lenders (Smick, 2009, pp. 179 – 183). Greed had finally led high street banks to risky investment banking where they primarily traded, bought and sold risk (Markus, 2009, pp. 77–100). The investment banks on the other hand, were not contented with trading, buying, selling risk, they got into mortgage, home loans, etc. The fact that there was no government control meant that the institutions could indulge in the risky games without a second thought or need for accountability (Markus, 2009, pp. 77–100). Conclusion This essay has critically analyzed the causes of the 2008-2009 global financial crises. It has detailed how greedy institutions in the financial market led to the crises by being overzealous in trading credit and credit securities. This greed was motivated by prospects of making a kill in the low interest housing sector, which had prices of houses sky-rocketing. All credit risks were converged at the housing market such that when that market crashed, the financial markets went down with a boom (Norberg, 2009, pp. 58 – 79). This happened under the watchful eyes of a passive government regulatory infrastructure. Government passivity in fiscal management, specifically an inadequate regulatory mechanism on the financial markets, helped mitigate, perpetuate, prolong and worsen the 2008-2009 global financial crisis (Cochrane, 2009, pp. 58-91). While many other factors are certainly to blame, the US government regulatory mechanisms failed in their role of protecting the public from overzealous and greedy investment institutions. References Acharya, V. and Richardson, M 2009, Restoring financial stability: how to repair a failed system, John Wiley & Sons, New Jersey, pp. 141 – 182. Cochrane, J 2009, ‘Lessons from the Financial Crisis’, Regulation, Vol. 32, (4), pp. 34-37. Desai, P, 2003, Financial crisis, contagion, and containment: from Asia to Argentina, Princeton Education Press, Princeton NJ, pp. 58-91 Diamond, D et al, 2000, ‘Bank Runs, Deposit Insurance, and Liquidity’, Federal Reserve Bank of Minneapolis Quarterly Review Vol. 24, No. 1, pp. 14–23 EL-Erian, M 2008, When Markets Collide: Investment Strategies for the Age of Global Economic Reform, McGraw-Hill, New York, pp. 118. Goldstein, M. and Institute for International Economics (U.S.), 2004, The Asian financial crisis: causes, cures, and systemic implications, Institute for International Economics (U.S.), Massachussets, pp. 217 – 242. Ikenson, D 2009, ‘Hard Lessons from the Auto Bailouts’, Cato Policy Report, Vol. 31 (6), pp.18. Seter, B. and Roubinini, N 2009, Bailouts or bail-ins?: Responding to financial crises in emerging economies, Institute for International Economics (U.S.), Massachusetts, pp. 171 – 182. Markus, B 2009, 'Deciphering the liquidity and credit crunch 2007-2008'. 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Zandi, M 2009, Financial shock: a 360° look at the subprime mortgage implosion, Pearson Education Inc., New Jersey, pp. 64-67 Read More