2008 Housing Crisis: Cause, Effect, and Prevention of Future Similar Outcomes - Research Paper Example

2008 Housing Crisis: Cause, Effect, and Prevention of Future Similar Outcomes As a primary function of understanding the fundamental issues that contributed and aided the housing crisis of 2008, this brief paper will analyze some of the ways in which this student believes it could have ultimately been prevented. Although it is oftentimes noted that hindsight is 20/20, it is worth discussing these mechanisms as a function of gaining a further insight into the way that the market works and seeking to prevent a similar situation occurring within the future. Due to the high level of understanding that current economists have with regards to the Great Depression, many forms of protection have been placed within the current economy as a means of ensuring that the same type of catastrophe, based on the same causal factors, does not occur within the current market. In much the very same way, it is necessary to know, understand, and discuss the forces which could have prevented or at least greatly assuaged the crisis as it has been presented to the financial markets and subsequent global economies over the period of the past 5 years time. In this way, such an exploratory look into the realm of the financial crisis and its subsequent aftermath can allow for a more informed understanding of how the crisis itself could have been prevented as well as the formulation and creation of new and insightful ideas within the reader with regards to how such a situation might be stopped in the future. The first aspect of anticipation and reduction to the crisis came as early as the mid to late 1990s when a number of lawmakers and political analysts began to make a series of warnings concerning the untenable nature of the ways in which the financial sector was being deregulated. Although this deregulation has been attributed to both sides of the political spectrum, in all fairness it can be assumed from a moderate interpretation that both sides were complicit in the wholesale deregulation of the financial sector which ultimately caused the collapse of the real estate bubble (The Banking Crisis 9). Moreover, the first real and measurable signs of impending difficulties on the horizon were first demonstrated around the year 2006 when the Department of Commerce noted that new home permits had dropped an astounding 28%. Normally incremental increases and/or decrease in the reduction or expansion of new home permits are little cause for alarm; however, when something as earth shattering and innately odd as nearly a 1/3 reduction in the demand for housing should have been a major red flag to the Federal Reserve as well as the entire regulatory system. However, rather than heed such a statistic, the Federal Reserve remained unrealistically optimistic regarding how the economy would likely behave over the next several months and years (Horner 33). This allowed for the current situation to continue to extend itself for approximately another 2 years time before the final result of such a failure in oversight and monetary policy was noted by the stock market in the painful round of shocks that exhibited themselves throughout the stock market and economy during 2008 and 2009. Ultimately, the Federal Reserve felt that even though the drop in applications was something of an “anomaly”, the strong employment figures that the economy was continuing to generate were indicative of the fact that increased consumer spending, and low inflation would help to cover and shortfalls that such an externality may have on the economic system as a whole. Unfortunately, this was not the only sign of distress that the economy exhibited prior to 2008. Economists today point to what is collectively known as an inverted yield curve; utilized to predict the recessions of 1981, 1991, as well as 2000. This inverted yield curve is ultimately something that can be understood from the way that Treasury notes are higher than their long term yields. In a typical situation, long term yields are higher as a result of the fact that investors demand and expect a higher return for investing money for such a long period of time within a certain economic mechanism. Yet, as individuals believe the economy is cooling, the rate at which they will seek to invest in long-term investments as a means of hedging bets with regards to the rigidity of the system exponentially increases. Again, the Federal Reserve ignored this implication and assumed that due to the fact that interest rates were low that there was a very large amount of liquidity left to continue to provide for high levels of growth. However, as would soon be seen, liquidity exhibited itself to be the fundamental shortcoming of the entire system. As a direct result of the fact that more and more money was being tied up in long-term investments that were hedging themselves against a very difficult path ahead for the economy, the overall level of liquidity that economists and the Federal Reserve expected was not there to back up anticipation. Another fundamental oversight involved the fact that the Federal Reserve and shareholders within the banks and financial institutions had an over-reliance on the rapid change that a change in the Federal funds rate could achieve. Whereas many times previously slight manipulations in the Federal funds rate had effected an overnight change in the way that the economy operated and integrated with the news, there remained a diminishing return and an eventual point at which further reduction of the Federal funds rate could affect little if anything to stem to overall loss of confidence and lack of liquidity that was extant within the system. Although the issues that have thus far been discussed tangentially revolve around an understanding of the economy and the way in which the Federal government seeks to integrate with its role of stimulating and forecasting economic development and growth, the next section of this essay will focus upon the role that an unregulated mortgage and banking sector played in adding to an already perfect storm that had been brewing within the market for a period of several years. As such, it cannot be understood that any one single culprit is ultimately responsible for the financial collapse of 2008-2009; rather, a litany of factors, many compounding one another, continued to stack up until the point that they were not only providing a definitive strain upon the system, they also served to coalesce and combine in order to send shock waves throughout the global financial system (Death and Resurrection on Wall Street 6). One of the ways in which this lack of regulation played into creating, sustaining, and developing the crisis was the sub-prime mortgage market and its general lack of oversight. Many on the far right have blamed the Dodd Frank Act for the crisis; however, seeking to blame the Dodd Frank Act for the economic collapse of 2008 is a gross oversimplification due to the fact that it was both the government itself as well as the financial institutions that failed entirely to uphold any rigid form of oversight into how these loans were dispersed, backed, repackaged, and sold within the market (Freeman 171). Perhaps most importantly of all the aspects that have thus far been discussed is the role that MBS (mortgage backed securities) played with regards to the financial crash. MBS were ultimately bundled and sold as a means of generating income by leveraging assets. These high risk bundles were snapped up by willing investors when the market was booming; however, once it began to crumble, few if anyone truly understood what percentage of “bad mortgages” were constituted within the MBSs that were being bought and sold; thereby leading to a fundamental breakdown and/or lack of trust within the system. Just as was the case during the Great Depression, the lack of trust further served to rob the system of integrity and trust. As a function of the fact that the MBS transactions were spread so evenly throughout the economy, both intra bank as well as personal investment tools, they commanded a heavy price when trust in such a tool began to fail. Moreover, due to the very nature of these transactions, the SEC was not involved whatsoever in regulating their sale. Ultimately, the breakdown in the financial system can be defined as the responsibility of the mortgage brokers who made the bad loans as well as the hedge funds who too heavily leveraged the financial instruments that were derivatives of these loans. Moreover, a third culpable party remains the federal government as it ultimately and completely failed in its mission of oversight and regulation of key financial transactions and markets. Ultimately, an ounce of prevention would have been worth a ton of cure and the painful period that the United States and the world economy has faced in the intervening 5 years since the crash may well have been partially averted or lessened. As a function of understanding the way in which the crash was ultimately precipitated, it is the hope of this author that the reader will be more able to provide thoughtful insight into both explaining the key causal factors as well as seeking to prevent such an incident from occurring again. Works Cited "Death And Resurrection On Wall Street." Trends Magazine 67 (2008): 4-7. Business Source Premier. Web. 5 Mar. 2013. FREEMAN, Richard B. "It's Financialization!." International Labour Review 149.2 (2010): 163-183. Business Source Premier. Web. 5 Mar. 2013. Horner, Jennifer R. "Clogged Systems And Toxic Assets: News Metaphors, Neoliberal Ideology, And The United States “Wall Street Bailout” Of 2008." Journal Of Language & Politics 10.1 (2011): 29-49. Communication & Mass Media Complete. Web. 5 Mar. 2013. "The Banking Crisis." The Banking Crisis. Ed. Dedria Bryfonski. Detroit: Greenhaven Press, 2010. Opposing Viewpoints. Opposing Viewpoints In Context. Web. 5 Mar. 2013. Read More