A Study of The Us Financial Crisis in 2008

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. The merges could cause an economical collapse. In 1998 Citicorp and Travelers merged, which formed Citigroup. Stock Analysis’s gave high ratings to companies predicted to fail. This lead to a case involving 10 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. Markets became increasingly unstable, while banks claimed otherwise. By 2001, a securitization food chain was created. Lenders sold CDO’s to investment banks, which lead to investors purchasing CDO’s from investment banks. This was popular among retirement funds because most CDO’s received AAA ratings.

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

Ronald Reagan started the government 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. Continuation of deregulation continued under the Clinton Administration. The Clinton Administration helped firms, like Citigroup, grow larger without 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 because of lack of preparation. The CFTC proposed a bill to regulate derivatives, however 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. 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 3 of the 7 seats vacant. In 2008, Paulson and Geithner gathered Vikram Pandit, John J. Mack, Jamie Dimon, and Lloy Blankfein in an attempt to rescue Lehmann 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. This would not be enough to fully stimulate the economy.

Governor Mishkin resigned on August 31, 2008 to return to his teaching position during one of the worst financial crisis, so he could ‘revise a text book’. Both Harvard University and Columbia University did not help in reforming or simply warning of what was to come if CDO’s 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 Feldsteine was once Reagan’s Chief Economic Advisor. He was also on the board for AIG and AIGFP. Banks such as LECG hire(d) 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-$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, whom is a professor at London’s Business School, was too paid to write a report praising the Icelandic financial sector.