How government’s policies led to the Financial Crisis of 2008
The Financial crisis of 2008 is the worst financial crisis since the Great Depression, which started with crisis in subprime mortgage market in the USA and developed into a global economic downturn, the Great Recession. In this picture, two men are carrying away a “Lehman Brothers” bank sign. This bank was founded in 1850 and collapsed after 158 years of operating in September 2008. This was the fourth-largest investment bank in the United States, so its bankruptcy led to huge new losses for the economy. The crisis affected everyone, reducing the living standards of every family. The atmosphere of harsh conditions and loss of confidence is vividly expressed by men’s mimics and poses on the photo. While the consequences of this recession are pretty obvious, it is not the same with the causes. Economists all around the world argue whether free market or government regulations were the primary cause and how to prevent next economic downturns.
In this artictle I assert that there was no free market economics in this time period in the US, and therefore,
enormous government intervention and regulation of the economy caused the financial crisis of 2008 and the Great Recession.
Most of the politicians and mainstream economists claim that the government should be given more power to regulate the economy. They think that the main cause of the financial crisis were
“the Wall Street executives whose greed and irresponsibility got us into this mess”
— Barack Obama.
The immorality and selfishness of “greedy entrepreneurs, taking advantage of the de-regulations and low interest rates, involved in excessive lending and with support of inaccurate rating securitized and sold their loans” in particular led to the Great Recession according to Dr. Necati Aydin, Associate Professor of Economics.
For decades government has increased its role, and switched it main role from protecting individual rights to providing lots of services to the people.
In the end of the 19th century, the government started to increase its power and intervene into economics. Firstly it has been through government grants, f.e. railroad grants. Later it started to bust big businesses and pass lots of legislation. The most significant turning point was the era of the Great Depression and FDR’s New Deal. It was the first time during peace when the United States government was directly ruling the economy. For most modern politicians and economists the New Deal is the role model. Paul Krugman, winner of Nobel Prize in economics and NYT columnist, wrote in his book “The Return of Depression Economics and the Crisis of 2008” that the way to prevent future recessions is to create a new regulatory regime based on principle that
“anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn’t a crisis so that it doesn’t take excessive risks”.
— Paul Krugman
Even though many people claim that markets were the cause of the crisis and the recession, there is evidence that the primary cause for this economic downturn were the policies of the US government. Yes, people and markets massively misinvested into the consumption (buying home is consumption, not investment), but in such highly-regulated economy
“it is impossible to have a systemic failure of the financial markets without mistakes by government policy makers being the primary cause”
— John Allison, ex-CEO of BB&T Bank
There were several mistakes in government policies. The most crucial of them were made by the Federal Reserve. Federal Reserve, or the Fed, is a central bank of the United States, created in 1913. According to John A. Allison, CEO of BB&T Corp. from 1989 to 2008,
“the ‘success’ of the Fed’s efforts to prevent significant market corrections from early 1990s to 2007, which was achieved at the expense of a massive misallocation of capital (especially to the housing market), laid the groundwork for the Great Recession”.
Federal Reserve’s policies of printing money in order to prevent deflation, because it was to the advantage of the U.S. Treasury which could pay back debt in inflated (cheaper) currency, of lowering short–term interest rates
— Lawrence White
There is another example of government action that led to the financial crisis.
Dr. Aydin in his work claims that greedy entrepreneurs “offered credit to individuals who could not afford to pay them back. They did so because they invented intelligent means to pass on their risk to a third party. Since they did not have to worry about the risk factor, it was in their best interest to offer as much credit as they could”, but that is not true. Of course, some of the businessmen could have used this scheme, but that wasn’t the primary reason why banks gave credits to people who couldn’t afford to pay it back. Banks were required by the government regulatory agencies, i.e. the Fair Housing Act of 1968, the Community Reinvestment Act of 1977 and the Equal Credit Opportunity Act of 1974 coupled with
“a totally misleading study by the Boston Federal Reserve bank. Even the Fed currently acknowledges that this study was fundamentally flawed”
— John Allison
led to “energizing the affordable-housing/subprime-lending efforts that subsequently destroyed the residential real estate market”. Under these laws, especially under the CRA “banks had a legal duty to make high-risk home loans to low-income borrowers”. Even giant sponsored enterprises (GSEs) were forced by the Clinton administration to have “at least 50 percent of their loan portfolios in affordable housing (subprime) loans”, which was incredibly risky and subsequently led to their failure. And these are only some of the examples how government agencies which were supposed to prevent the crisis led directly to its creation.
Even though recessions are considered to be bad for the economy, panics in pre-Fed era didn’t have a major impact (look at “Log of Industrial Production, 1790–1915”, Davis (2004)). Recessions are normal for the economy, no government can protect society from downturns. As Mr. Allison stated, “Unfortunately, if all the regulatory standards were fully enforced to the maximum, the U.S. economic system would grind to a halt. Banks must take risk for there to be economic growth. Driving risk to zero would destroy our economy”. Furthermore, the existence of government regulations massively increases the impact of recessions on the economy and exposes the market to negative consequences.
Works cited:
Allison, John A. “The Financial Crisis and the Market Cure: Why Pure Capitalism is the World Economy’s Only Hope”
Aydin, Necati “The 2008 Financial Crisis: A Moral Crisis of Capitalism”, African Journal of Business Management, vol. 5, no. 22, 2011, pp. 8697–8706
Krugman, Paul “The Return of Depression Economics and the Crisis of 2008”
Obama, Barack Speech at Reno, Nevada on Sep. 30, 2008.
White, Lawrence H. “How Did We Get Into This Financial Mess?”, Cato Institute, 2008
