5. Fundamental reason for the failure of the financial systems and economic recession a. Specific government actions & intervention – Excessive money policy Current monetary policy contributed in a certain extent to the failure of financial systems and economic recession. For example, U.S. monetary policy since 2002 was too expansionary (Taylor 2009) and was a major culprit to the crisis (Jeroen 2010). The policy makers was also lack of accountability that fail to encourage optimism about the reforming the policy process itself (Adrian & Atkinson 2009). The decision by the U.S. Treasury and the Fed to let a major bank (Lehman Brothers) fail led to a system-wide loss of confidence that exacerbated the crisis. The failure of policy makers to deal with the crisis should be seen as a factor in aggravating the crisis. (1) Housing market failure - An Economics professor Taylor conducted a research in 2009 and suggested that the financial crisis was due to government policy and intervention that leaded to excessive money and contributed to housing boom and bust (Taylor 2009). By using the information given in The Economist (October 18, 2007), Taylor indicated that the federal funds interest rate was deviated from the suggested rate based on Taylor Rule – Fed interest rate should be adjusted according to economic situations such as the inflation & employment level. The actual rate was far below the suggested rate from 2001 to 2006 (Please refer to Figure 2), so it suggested that the monetary policy was too loose. In order to prove that abnormal interest rate contributed to housing marketing failure, Taylor decided to implement the following model to indicate that if the suggested rate (counterfactual) was applied, fluctuations of hou... ... middle of paper ... ...? Harvard Business Review (November): 85-92. 22. Scott, I.E. (2009), “Fair Value Accounting Friends or Foe?” http://www.law.harvard.edu/programs/about/pifs/llm/select-papers-from-the-seminar-in-international-finance/llm-papers-2008_2009/scott.pdf, accessed February 4, 2011. 23. Sorrnette, D. and R. Woodard 2010. Financial Bubbles, Real Estate Bubbles, Derivative Bubbles, and the Financial and Economic Crisis. Econophysics Approaches to Large-Scale Business Data and Financial Crisis. Retrieved 5 March 2011 from SpringerLink 24. Taub, S. (2009). Survey: Boards are Often Blind to Major Risks, CFO Magazine. Available at http://www.cfo.com/article.cfm/12454618?f=search, accessed August 5, 2009. 25. Taylor, J.B. 2009. The Financial Crisis and the policy Responses: An Empirical Analysis of What Went Wrong. NBER Working Paper 14631. http://www.nber.org/papers/w14631.pdf
Just as the great depression, a booming economy had been experienced before the global financial crisis. The economy was growing at a faster rtae bwteen 2001 and 2007 than in any other period in the last 30 years (wade 2008 p23). An vast amount of subprime mortgages were the backbone to the financial collapse, among several other underlying issues. As with the great depression, there would be a number of factors that caused such a devastating economic
Taylor, J. B. (2009). The financial crisis and the policy responses: An empirical analysis of what
Vernon L. Smith, a Nobel Prize Laureate in economics and a graduate from Harvard talked about the housing bubble and the bank balance sheets as important issues in the Great Recession. Here are some notes of what he proposed:
We feel that the latter is on the radical side of thinking, and that overall the Federal Reserve has the best interest of the nation and international economy in all their decisions regarding the increases in interest rates, etc. Since the onset of the Federal Reserve, we have not gone into a major depression, and over the course of time there will be times when our economy will peak and boom and the Fed will feel that it is time to slow the economy by raising the rates. Bibliography FED 101 Hosted by the Federal Reserve Bank of Kansas City. http://www.kc.frb.org/fed101 Friedman, Milton and Jacobson Schwartz, Anna. A Monetary History of the United States, 1867-1960.
It can be argued that the economic hardships of the great recession began when interest rates were lowered by the Federal Reserve. This caused a bubble in the housing market. Housing prices plummeted, home prices plummeted, then thousands of borrowers could no longer afford to pay on their loans (Koba, 2011). The bubble forced banks to give out homes loans with unreasonably high risk rates. The response of the banks caused a decline in the amount of houses purchased and “a crisis involving mortgage loans and the financial securities built on them” (McConnell, 2012 p.479). The effect on the economy was catastrophic and caused a “pandemic” of foreclosures that effected tens of thousands home owners across the U.S. (Scaliger, 2013). The debt burden eventually became unsustainable and the U.S. crisis deepened as the long-term effect on bank loans would affect not only the housing market, but also the job market.
The causes of the Great Recession all started as hundreds of billions of dollars was given to the United States abroad and financiers conceiving were to make a profit and what better way but the real estate market. Since the Community Reinvestment Act of 1977 and an expansion made in 1995 the than President Bush endorsed the program that created Option adjustable rate mortgages (nick-named “Pick-A-Pay”) to allow for bank to sell these options even though they were high risk (Conservapedia, 2013). The Community Reinvestment Act of 1977/95 is defined as to framework financial institutions, state and local governments, and community organizations to jointly promote banking services in the community” (Office of the Comptroller of the Currency, n.d.). That being said, there were three individuals, and firms that contributed the most to the recession including Senator Charles Schumer D-NY, Fannie Mae, American Ins...
Cabral, R. (2013). A perspective on the symptoms and causes of the financial crisis. Journal of Banking & Finance, 37, 103-117
There is perhaps no other political issue in our contemporary society that is more pertinent, pervasive, and encompassing than a nation’s economy. From the first coins used in Greece and the Asia Minor in the 7th century BCE, to the earliest uses of paper money, history has proven time and time again that the control of a region’s economy is absolutely crucial to maintaining social stability and prosperity. Yet, for over a century scholars have continued to speculate why the United States, one of the world’s strongest and most influential countries, has one of the most unstable economies. Although the causes of this economic instability can be attributed to multiple factors, nearly all economists agree that they have a common ancestor: the Federal Reserve Bank – the official central bank of the United States. Throughout the course of this paper, I will attempt to determine whether or not there is a causal relationship between the Federal Reserve Bank’s monetary policies and the decline of the U.S. economy. I will do this through a brief analysis of the history and role of this institution, in addition to the central banking system in general. In turn, I will argue that the reckless and intentional manipulation of the economy by the Federal Reserve Bank, through inflation and the abolishment of the gold standard, has led to the current economic crisis in the United States.
The monetary policies that caused the financial crisis were that the Federal bank reserves provided banks with new funds that enabled them to make loans and investments. The process led to increase in money supply which in due course increased the rate of spending (Flores, Leigh & Clements, 2009). Eventually, the increase in spending over and beyond the capacity the economy to produce goods and services led to inflation.
In economics, a recession occurs when there is a slowdown in the spending of goods and services in the market. A recession causes a drop in employment, GDP growth, investment, as well as societal well-being. All recessions are caused by a specific cause, but the Great Recession of 2007-2009 was caused by a crash in the housing market. This crash was triggered by a steep decline in housing prices. All of a sudden, people bought houses because there was an excessive amount of money in the economy and they thought the price of houses would only increase. (Amadeo, 2012). There was a financial frenzy as the growing desire for homes expanded. People held a lot of faith in the economy and began spending irrationally on houses that they couldn’t afford. This led to overvalued estate and unsustainable mortgage debt. (McConnell, Brue, Flynn, 2012).
(Murphy, 2008) The US banking sector was first hit with a crisis amongst liquidity and declining world stock markets as well. The subprime mortgage crisis was characterized by a decrease within the housing market due to excessive individuals and corporate debt along with risky lending and borrowing practices. Over time, the market apparently began displaying more weaknesses as the global financial system was being affected. With this being said, this brings into question who is actually to blame for this financial fiasco.
Keeping in mind that the main reason for the mortgage crisis is the high number of defaulted home loans, which triggered foreclosures and sell offs. The other four contributing factors include high-risk loans, the bust in the housing market, mortgage fraud, and speculation. High-risk loans are loans that are over leveraged, where the financing is done more than the suggested values to be given. (Greenspan) This can result in immediate sell off when the property falls below that loan amount and to avoid further loss the banks start raising the installment. The housing market has seen pressure as a result of the over pressure on most homeowners by increasing rates. This affects people ability to make the payments, resulting in defaults. This is the problem with the burst in the housing market. The third major factor that is causing the mortgage crisis is, mortgage fraud.
The PBS Frontline documentary, Money, Power, and Wall Street gives the audience a little history about the causes of the Great Recession. Frontline some of the major people from Giorogs Papakonstaniou, the Former Greek Financial Minister; Sheila Biar, chair member of the FDIC during the crisis, and Robert Wolf the chairmen of UBS Americans to name a few. The crisis of 2008 not only made about 8 and half million Americans unemployed, but also a loss of about $11 trillion in net worth. On top of that, the nation was divided with radical movements from the left and right like Occupy Wall St. and the Tea Party forming as a result of the crisis in 2008. Some may say that this was just a result of capitalism and not enough government regulation on Wall St.
Firstly, the main reason for the systematic failure, according to the report was the expansion of the property bubble financed by the banks. Between 2002 and 2008 bankers demonstrated high levels of greed combined with disregard for the risks and gross misjudgement which few bankers’ could disagree with. This was evident from the surge in lending between sectors which was very uneven. Residential mortgage lending and lending to the construction and property sector considerably out-paced growth in all the other sectors combined (see Fig1 15). For instance, lending to this sector increased at an annual rate of almost 45%. This effectively created a property bubble and like all bubbles, they burst, and this heavily influenced Irelands’ financial crisis. This tied with the world- wide economic crisis heavily increased the rate of the crisis.
Warwick J. McKibbin, and Andrew Stoeckel. “The Global Financial Crisis: Causes and Consequences.” Lowy Institute for International Policy 2.09 (2009): 1. PDF file.