A Study of The Us Financial Crisis in 2008

Introduction

Investment banks went public in the 1980s, enabling them to acquire huge amounts of stockholder money. By the late 1990s, financial sectors merged into huge firms. These mergers could cause an economic collapse. In 1998, Citicorp and Travelers merged, forming Citigroup. Stock analysts gave high ratings to companies predicted to fail, leading to a case involving ten investment banks: Bear Stearns, Credit Suisse, Deutsche Bank, J.P. Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, UBS, Goldman Sachs, and Citigroup. Derivatives were created in the 1990s, making markets increasingly unstable, while banks claimed otherwise. By 2001, a securitization food chain was created. Lenders sold CDOs to investment banks, which led to investors purchasing CDOs from investment banks. This was popular among retirement funds because most CDOs received AAA ratings (Smith, 2010).

Subprime Loans and Market Instability

Borrowers were given subprime loans; the likelihood of repaying them was low due to high interest rates. Over a 10-year span, subprime lending increased from $30 billion to $600 billion annually in funding. AIG began selling Credit Default Swaps. If the Credit Default Swaps fell through, AIG would be bankrupt. Goldman Sachs bet against CDOs while encouraging customers to purchase them. After Fannie Mae and Freddie Mac were under government control, Lehman Brothers' stock collapsed. In September 2008, Bank of America acquired Merrill Lynch. AIG owed $13 billion to holders of Credit Default Swaps, yet had no money to pay them. The bubble burst, and chaos erupted. Banks began taking over each other, such as Bank of America acquiring Countrywide. Yet, after this crisis, lobbyists fought harder than ever to prevent reform, which still occurs today (Johnson, 2011).

Deregulation and Its Consequences

Ronald Reagan started the government’s 30-year deregulation period by appointing Donald Regan, who at the time was CEO of Merrill Lynch, to Treasury Secretary. In 1982, the Reagan Administration deregulated savings and loan companies, allowing them to make risky investments with depositors' money. By the end of the 1980s, many savings and loan companies failed, leaving people high and dry. Reagan appointed Alan Greenspan as the head of the Federal Reserve, even after Greenspan took a bribe from Keating to approve of his 'sound business plans.' Bill Clinton and George W. Bush also reappointed Greenspan. Deregulation continued under the Clinton Administration, which helped firms like Citigroup grow larger without the consequence of violating the Glass-Steagall Act. In 1999, Congress passed the Gramm-Leach-Bliley Act, overturning the Glass-Steagall Act. The Securities and Exchange Commission allowed investors to lose $5 trillion due to a lack of preparation. The CFTC proposed a bill to regulate derivatives, but the Clinton Administration denied the regulation. Due to Greenspan's ideology, he refused to use the Home Ownership and Equity Protection Act. Greenspan, Ben Bernanke, Summers, and Tim Geithner all received Raghuram G. Rajan's paper, "Has Financial Development Made the World Riskier?" with a conclusion of yes, but Summers accused Rajan of being a Luddite (Rajan, 2005).

The 2008 Financial Crisis

Henry Paulson was nominated head of the Treasury after being the highest-paid CEO on Wall Street. When the economy needed the Federal Reserve in 2008, Frederick Mishkin resigned, leaving three of the seven seats vacant. In 2008, Paulson and Geithner gathered Vikram Pandit, John J. Mack, Jamie Dimon, and Lloyd Blankfein in an attempt to rescue Lehman Brothers from total collapse. Lehman Brothers and the Federal Reserve didn’t plan for this possible bankruptcy. The Federal Reserve’s resolution was to deem it necessary for Lehman Brothers to go bankrupt to calm the markets. After taking over AIG in 2008, Paulson and Bernanke asked Congress for $700 billion, which would not be enough to fully stimulate the economy (Blinder, 2013).

Academic Influence and Economic Policy

Governor Mishkin resigned on August 31, 2008, to return to his teaching position during one of the worst financial crises, so he could 'revise a textbook.' Both Harvard University and Columbia University did not help in reforming or simply warning of what was to come if CDOs and derivative spending continued. Martin Feldstein, an economics professor at Harvard University and one of the world’s most prominent economists, was a major advocate for deregulation. Feldstein was once Reagan’s Chief Economic Advisor. He was also on the board for AIG and AIGFP. Banks such as LECG hired economic professors to write reports approving of their spending methods. Summers was the President of Harvard University in 2001. His income was between $16.5 million and $39.5 million. He made this much from being on financial institutions' boards and approving of their spending methods. An example would be Mishkin being paid $124,000 by the Icelandic Chamber of Commerce to write a report approving of their spending. Richard Portes, a professor at London’s Business School, was also paid to write a report praising the Icelandic financial sector (Ferguson, 2012).

Conclusion

The financial crisis of 2008 was a culmination of years of deregulation, risky financial practices, and inadequate oversight. The crisis highlighted the need for stronger regulatory frameworks to prevent future collapses. Despite the chaos, the reforms that were implemented have not been sufficient to prevent potential future crises, as lobbyists continue to fight against regulatory changes. The role of academic institutions and their influence on economic policy also underscores the complexity of addressing financial instability (Stiglitz, 2010).

• Blinder, A. S. (2013). After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead. Penguin Books.
• Ferguson, C. (2012). Inside Job: The Financiers Who Pulled Off the Heist of the Century. Oneworld Publications.
• Johnson, S. (2011). 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. Vintage.
• Rajan, R. G. (2005). Has Financial Development Made the World Riskier? National Bureau of Economic Research.
• Smith, A. (2010). The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It. Princeton University Press.
• Stiglitz, J. E. (2010). Freefall: America, Free Markets, and the Sinking of the World Economy. W. W. Norton & Company.