Introduction
Economics is one of the key areas of public policy. In order to enact change, you need
money to fund initiatives. Over the centuries there has been many financial and economic
recessions. Some say recessions are just another part of the the cycle of business. While they all
may differ in cause, they all are troublesome to societies’ businesses and workers. Even though
there have been multiple recessions, not many have been serious enough to be called a “panic”.
In 2008, many investors were able to keep up with the stock market through real time
updates on their Blackberry devices. The Blackberry Panic of 2008 became known as the
governments inability to create policies to address the economic recession.Stockman claimed
that neither the banking sector nor the entire economy of the United States—from Wall Street to
Main Street needed bailout (Stockman, 2013) The Recession caused high rates of unemployment
and home foreclosures in the United Statesm but also impacted the entire world. This paper will
analyze the impact of the governments decisionsand impacts of key government leaders during
the “Blackberry Panic of 2008”, in light of the model of statesmanship introduced in this weeks
presentation.
Firstly, from a biblical perspective, God grants inaliable rights to us including; life,
liberty, and property. The free market supports these rights as long as the businesses are honest
and caring for the customers. The free market also limits economic planning from the
government because God is all knowing and answers come from him. With that being said, it
would not be wise for policy makers to assume that their policies, alone, can affect economic
change for society. “Rather, the governments purpose is to protect justice in the legal order and
maximize freedom within the economic arena.” (Fischer, 2022) Understanding this perspective
will help analyze how the government and its decisions actually may have made the crisis even
worse.
Decline of the Housing Market
“ The headlines of 2008 were dominated by falling house prices, rising default and
foreclosure rates, failure of large investment banks and huge bailouts arranged by both the
Federal Reserve and the United States Treasury.” (Gwartney, et al., 2017) The Recession of 2008
was one of the largest economic crises in history. It is important to understand why and how the
recession happened. By doing this, we can learn from this incident. The housing boom and bust
during the first seven years of this century are central to understanding the economic events of
2008.” (Gwartney, et al., 2017) During the 1990’s, the housing market was stable and began to
rise toward the end of the decade.
By the beginning of the 2000s, the housing market was up 87 percent. However, by the
end of 2006, the market began to decline which continued throughout 2007 and 2008. “ By year
end 2008, housing prices were approximately 30% below their 2006 peak.” (Gwartney, et al.,
2017) The housing market was declining, there was an increase in defaults and to make matters
worse, oil prices were increasing rapidly to almost four dollars a gallon. This caused consumers
and investors to lose confidence in the market. This led to many people pulling out, which was a
big hit to the market.
The cause for the fluctuation in the housing market can be linked to multiple factors such
as, “ changes in mortgage lending standards, prolonged low interest rate policy of the Fed, the
increase in debt to capital ratio of investment banks and high debt to income ratio. (Gwartney, et
al., 2017)Whiles these issues alone did not cause the recession, this was the beginning of a
downward spiral. One theory is that the housing market fell because lenders of subprime
mortgages had the intiative to combine and give away risky mortgage-backed securities to other
investors and make a profit from the origination fees. This means that the banks were lending
money to borrowers that, most likely, would not be able to keep up with the payments. It also
implies that the banks did not care whether or not the borrowers could repay the loan because
they would not have ownership of the mortgage very long.
“Goldstein and Fligstein challenge this understanding. They find that financial
institutions actually sought out risky mortgage loans in pursuit of profits from high-yielding
securities (such as an MBS or CDO), and to do so, held onto high-risk investments while
engaging in multiple sectors of the mortgage securitization industry.” (Coghlan, 2019) Financial
institutions were now maintaining all aspects of the mortgage securitization process, instead of
allowing multiple entities to each play a separate role. This meant that the financial institutions
could charge more and gain more profit. Another way that financial institutions werre cutting
corners was that they were commiting fraud, “ such as overstating a borrower’s income and
over-promising investors on the safety of the MBS products they were being sold.” (Reserve
Bank of Australia, 2022)
Over the years, the Federal Reserve policy focused on keeping the inflation rate down
and consistent. However, the Fed policy began to become unpredictable around the early 2000s.
“The Fed’s artificially low short-term rates substantially increased the attractiveness of
adjustable rate mortgages (ARMs) to both borrowers and lenders. Adjustable rate mortgages
jumped from 10 percent of the total outstanding mortgages in 2000 to 21 percent in 2005. The
low initial interest rates on adjustable rate mortgages made it possible for homebuyers to afford
the monthly payments for larger, more expensive homes” (Gwartney, et al., 2017) This is what
caused the housing market to rise. However, when interest on these loans began to increase, so
did the payments of the borrowers, which led to defaults and foreclosures. “The combination of
the mortgage lending regulations and the Fed’s artificially low interest rate policies encouraged
decision-makers to borrow more money and make unwise and inefficient investments.”
(Gwartney, et al., 2017)
The increased debt to capital ratio encouraged the fall of investment banks and the crisis
of the recession. “Essentially, the SEC applied regulations known as Basel I to investment
banking. These regulations, which have been adopted by most of the industrial countries, require
banks to maintain at least 8 percent capital against assets like loans to commercial businesses.
This implies a leverage ratio of approximately 12 to 1.” (Gwartney, et al., 2017) This method
was more so geared to residential loans. Some banking leaders encouraged the SEC to have this
ratio to include investment banks. “When the global financial system was melting down in 2008,
Ben Bernanke was head of the Federal Reserve. Henry Paulson Jr. was Treasury secretary. Tim
Geithner was president of the Federal Reserve Bank of New York and later became Treasury
secretary as the crisis went on.” (NPR, 2019) These people and institutions were important to the
response of the crisis.
Bailing Out Wall Street and the AIG
“Financial distress at several large financial firms in 2008 played a prominent role in the
2007-09 financial crisis.” (Weinberg, 2022) Alan Greenspan was another important person durng
the resession. Greenspan was an American economist who was chairman of the United States
Federal Reserve. “Ccritics believe that he “encouraged the bubble in housing prices by keeping
interest rates too low for too long and that he failed to rein in the explosive growth of risky and
often fraudulent mortgage lending” (Andrews, 2008). Greenspan figured that in order to avoid
the econony going in to a deflation, it was best “to push interest rates even lower to ignite a
housing boom” (Madrick, 2011). The idea behind this theory was that if the housing market was
supported than more people would be more open to spending money. This plan, clearly, did not
pan out as expected which cause many financial institions to go bankrupt and merge. This
created what was called a dot-com bubble. Greenspans desicions ended up doing more harm than
good, From a statesmanship view, this desicion was very poor.
Bear Stearns, one of the biggest securities firms in the United States, contacted the
Federal Reserve to let them know that they did not have sufficient funding to last another day. “
On Friday, March 14, 2008, the Board of Governors of the Federal Reserve System authorized
the Federal Reserve Bank of NY(FRBNY) to extend credit to Bear Stearns through JP Morgan
Chace & Co (JPMC). The loan from the FRBNY was for $12.9 billion and was secured by assets
valued at $13.8 billion; it was extended under the authority of Sections 10B and 13(3) of the
Federal Reserve Act.” (Weinberg, 2022) Even though Bear Stearns received funding, they
continued to be impacted negatively by the market. This led to Bear Stearns merging with JPMC,
which was made possible with the help of the FRBNY. Bailong out Bear Stearns set expectations
for the rest of the institutions that were going through the same issues.
“The American Insurance Group (AIG) is a worldwide financial company entered into
credit default swaps in which it insured counterparties against losses on particular debt
instruments, many of them mortgage-related.” (Weinburg, 2022) This was called the Credit
Default Swap. The program made a sufficient income in the first few years of operation. Because
of this, the AIG ended up selling more than their value. This means that they were relying on the
market to continue to rise, but it did the opposite. During the decline of the housing market, the
AIG was getting pressured to provide security to ensure that the market would hae something to
fall back on. However, the AIG could not support the market alone. “On September 16, 2008, the
FRBNY extended credit to AIG, as authorized by the Board of Governors under Section 13(3) of
the Federal Reserve Act.” (Weinburg, 2022)
Harold Stanley and Henry Morgan were the founders the investment bank, Morgan
Stanley. They were a company that relied on theses low interest mortgage loans and sold credit
default swaps. They took advantage of these interest rates and shorted the market. With the help
of investors, Morgan Stanley was selling useless mortgages that were inevitanly going to fail. By
doing this, Morgan Stanley ended up losing billions of dollars that relied on taxpayer dollars to
fix.
The Lehman Brothers bankruptcy differed from Bear Stearns and AIG. “During the
weekend prior to the bankruptcy, the Federal Reserve, the US Treasury, and the Securities and
Exchange Commission brought together leaders of the major financial firms to attempt to devise
a private-sector solution to Lehman’s situation. They were unsuccessful, and early Monday,
September 15, Lehman formally filed for bankruptcy.” (Weinburg, 2022)
Lehman Brithers did not have any specific institution to support them like Bear Stearns
and AIG. In September a very important money market fund stated it that it would no longer be
able to continue to cash in their shares as normal because of losses Lehman had encountered with
commercial paper. Once the word started to circulate, many investors withdrew their mone from
the market. To stem these outflows, the Department of the Treasury subsequently announced that
it would establish a temporary guarantee program for US money market funds and the Federal
Reserve established the Asset-backed Commercial Paper Money Market Mutual Fund Liquidity
Facility.(Weinburg, 2022)
“The days before Lehman’s bankruptcy filing on September 15, 2008, saw frantic efforts
by Treasury Secretary Henry Paulson and other regulators to arrange a sale or rescue for
Lehman.” (Weinburg, 2022) Many people thought that because a small institution like Bear
Sterns has received help, then surley a larger institution would also recive help. However, this
was not possible and Lehman was advised to file for bankruptcy. Paulson was influential in
creating programs that helped the economy through the crisis. “The day after Lehman’s
bankruptcy filing, the Fed bailed out AIG, and a few weeks later, Congress passed the Troubled
Asset Relief Program (“TARP”), which allocated $700 billion to stabilizing the financial
system.” (Weinburg, 2022)
The goal of TARP was for the government to buy mortgage-backed securities and bank
stocks. TARP was distibuted as follows; Approximately $250 billion was committed in programs
to stabilize banking institutions; Approximately $27 billion was committed through programs to
restart credit markets;Approximately $82 billion was committed to stabilize the U.S. auto
industry; Approximately $70 billion was committed to stabilize American International Group;
Approximately $46 billion was committed for programs to help struggling families avoid
foreclosure, with these expenditures being made over time” (Department if Treasury, 2021)
There are a few things that can be evaluated and learn from this financial crisis in order to
respond to an inevitable next financial crisis. The first would be to enact policies that would
consider the overview of the financial market before a crisis in order to be prepared. This would
require “more capital and liquidity in the financial system, stress-testing financial institutions,
and strengthening regulatory vigilance, particularly over large institutions and rapidly growing
parts of the system”. (Blinder & Zandi, 2015) While it can not be predicted exactly when a
financial crisis will ensue, it will help to be prepared. Another response would be for the
government and regulators to be more consitent when it comes to how they respond to the crisis.
For example, there was a very different response to the Lehman Brothers and the Bear Sterns
financial crisis. By being more consistent, this would ensure that creditors knew where their
injvestments stood and not panic. That way, these creditors would not be so quick to pull their
money and cause such a rapid crash and make matters worse.
“Furthermore, it seems to us that the first step in fighting a crisis is to stabilize the
financial system. Without credit, the real economy will suffocate regardless of almost any other
policy response.” (Blinder & Zandi, 2015) This means that it is necessary for the Federal Reserve
to be unlimited in the amount of lending in emergency loans needed to stablize the economy.
“Bailouts of companies—whether financial or not—should be avoided if at all possible” (Blinder
& Zandi, 2015) Company shareholders would ve responsible for any losses, which is a risk that
you take when investing. Creditors should also be punished in order to reduce the moral hazard.
Taxpayers should not be financially punished for these types of situations.
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really-caused-the-great-recession/
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