The Financial Crisis: No End in Sight
This brief overview and assessment of the financial crisis was written in January, 2009, by Edith Rasell, a Ph.D. economist, who serves as Minister for Workplace Justice in Justice and Witness Ministries.
The financial crisis began when rising numbers of homeowners could not make payments on their sub-prime mortgages. By late 2007, major mortgage companies were failing and defaults were spreading into standard mortgages. Deception, fraud, and greed, as well as the simple desire to live the American dream, contributed to this painful personal and social catastrophe.
But during 2008 it became clear that mortgages were not the only problem. Bankers are typically viewed as conservative risk avoiders. But over the 2000s, they began acting more like gamblers. They increasingly invested in high-risk “derivatives,” for example, mortgage-backed securities and credit default swaps. Super-investor Warren Buffet calls derivatives “financial weapons of mass destruction.” But they were promoted by Alan Greenspan, then-chairman of the Federal Reserve and an important overseer of the banking industry.
Banks and investment firms made huge sums of money on derivatives. This is one possible outcome of high-risk investing. The other possible outcome – huge losses – is what banks are experiencing now and what threatens to bring down the whole economy. Both American International Group (AIG), which has needed tens of billions of dollars from the federal government in order to stay open, and Lehman Brothers, which failed in 2008, were victims of failed investments in derivatives.
Deregulation facilitated banks’ risky behavior. In recent years, Congress, a series of Treasury Secretaries, and the Federal Reserve all worked to relax banking regulations, some of which had been enacted in the 1930s to address the causes of the Great Depression. Unchecked “free market” forces coupled with a push for maximal profits have brought the banking system to its knees and threaten the U.S. and global economies.
The federal government’s $700 billion Troubled Asset Relief Program was designed to give banks additional cash to lend. But the legislation failed to provide for oversight of the program and put no conditions on the free money. So banks are using the tax payers’ cash to pay off debt, acquire other businesses, or invest for their future, not for new loans to get the economy going again.
When people and businesses cannot get loans, they buy less. Firms that sell less cut production, lay off workers, and buy fewer materials. Households cut their spending. Local retailers, restaurants, and service firms cut back and lay off workers, continuing the downward spiral. By late 2008, the U.S. was in a recession and in early 2009, the financial crisis is very far from over. In fact, it is still getting worse.
So what should be done?
1. Deregulation of the banking industry is a key cause of the crisis, along with banks’ increased use of risky, unregulated financial instruments (derivatives). The banking industry is too important, and its near demise too costly, for it to be governed by the whims of the “free market” and the self-interests of bankers. Carefully crafted regulations must prohibit excessively risky behavior. Policymakers who watched the crisis develop over the past decade, including some who now serve in the Obama Administration, should not have a role in trying to fix it.
Deregulation has not served the public well, whether in banking, product safety, the workplace, our food supply, or the environment. Throughout the economy and in our public life, a renewed system of regulation is needed to protect people, our institutions, and the environment.
2. Banks need to become solvent lending institutions once again. This cannot happen until the true values of their balance sheets are established. Assets must be re-valued to reflect current realities and shareholders must, rightly, bear the losses. Some banks will go under. The stronger but still fragile ones will need additional public money. It should be given conditional upon how it will be used, that is, for loans, with limits on executive pay, etc. The government (tax payers) should also receive an appropriate equity share in the banks that receive the money.
3. Fraud and negligence also played a role in the crisis, for example, in some subprime and “prime” mortgage companies, and in the rating agencies that gave low-risk marks to what were actually high-risk investments. These firms and individuals must be investigated and, if warranted, prosecuted.
4. Homeowners having difficulty paying their mortgages must have relief. But the cost of a program that would make a significant difference – the low tens of billions, far less than the hundreds of billions already given to the banks – is viewed by some policymakers as unaffordable. A plan to restructure mortgages, get payments and home prices more in line with current realities, and keep people in their homes should be a priority.