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“Evaluate decisions and impacts of key government leaders during the Blackberry Panic of 2008.
Provide an evaluation of those decisions and impacts in light of the model of statesmanship
introduced in this Module: Week’s presentation.”
Introduction
BlackBerry triggered a state of panic when in 2008, over 8 million of its subscribers went
out of signal for several hours. BlackBerry was not just a cellular gadget for call and alert but an
information-gathering device providing real-time information of financial and stock markets
worldwide investors, policy experts, and the US Government needed.
But there is much more to the network failure of BlackBerry and the frustration of
millions of subscribers. The “BlackBerry panic” has come to symbolize the Government’s failed
policy in addressing the 2008 economic recession (Stockman, 2013: 35). Although Stockman
recognizes the falling economy in 2008, he claims neither the banking sector nor the entire
economy of the US—from Wall Street to Main Street needed bailout (Stockman, 2013: 27).
Wallison (2009:365) agrees with Stockman and demonstrates how a well-intentioned
government policy can exacerbate the problems of the US economy.
This essay is charged with evaluating the impact of government decisions during the
Blackberry Panic of 2008 “in light of the model statesmanship introduced in this module.”
Economic Recession of 2008
Gwartney, et. al. (2018: 619-622) trace the origin of the Great Recession (2006-2008) to a
sudden drop in housing prices in 2006. To the economic planners, this was unexpected coming
from a long period of economic moderation (1980’s – 2007) that has enjoyed economic
expansion and stable housing industry. But a sudden drop in housing prices to -3% during the
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last quarter of 2006 followed by -19% in 2007 and -11% in 2008 delivered a massive shock to
the industry.
Economists consider the 2007 and 2008 recession exceptional in US’s 21-year economic
history, although a milder economic turbulence with a similar impact occurred from 1990 until
1992 that plunged housing prices (in 1990) to -3% with a meager recovery of less than 1% in
1991 and 1992. Economists recorded a devastating impact of the 1990-1992 price drop on the
housing industry, yet the economy quickly recovered beginning in 1993, achieving +3% increase
followed by incremental progress until 2005 at 15%. This rate soon declined to 12% in 2005,
sending signals to Wall Street, main street, and the Government.
The recession was not unique in US economic history, neither the indicators
unpredictable. Gwartney, et. al. (2018: 620) show the warning signs of an impending economic
freefall beginning in 2005 were evident until it plunged hard in the last quarter of 2006. Yet,
literature shows similar patterns of the 1990-1992 price oscillations.
Economists compare the triggers of price volatility in the housing industry during the
2007-2008 recession with the years prior, that is, 1987 until 2006 to test the consistency and
effect of government’s actions. They agree that prices were volatile during the years prior to the
2007-2008 recession as a result of shock. But this was not the case in the 2007-2008 recession.
Literature points to the structural change in economic policy as a significant trigger of price
volatility that worsened price inflation and prolonged the Great Recession (Clark, 2009).
Gwartney, et. al. (2018: 621) further analyzes housing prices against mortgage default
rate and housing foreclosures. Using data from S&P Housing Index and National Delinquency
Survey, they show that oscillation of market prices occurred simultaneously with a progressive
increase in housing market default and foreclosure rates. From 1979 until 1987 market default
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rate rose steadily from 0.8% to 2%, respectively, then oscillated within a narrow band between
1.6 to 2% from 1987 until 2001, then dropped sharply from 2006. Foreclosure rates show a
consistently rising trend from 0.8% in 1979 to 1.2% in 2008 regardless of increase and decrease
in housing prices. Gwartney and the team further analyzed the changes in stock prices. Using
data from S&P, they show 55% collapse in the stock price index during the period October 2007
and March 2009. The significant drop in stock price negatively impacted the retirement and long-
term savings of many Americans.
The Decision to Bailout AIG and Wall Street
Opinions about the moral uprightness of the Government’s decision to bail out the major
Wall Street institutions are varied. Literature and the media are quick to point to the ills of
capitalism and blame the big corporations and their cohorts for greediness. At this point, it will
be essential to step out of the Panic period and survey the events that took place within the home
financing industry prior to the Great Recession. Doing so gives a better understanding of the
Government’s decision to bailout the Wall Street institutions. Stockman (2013), Boyd (2011),
and Berger & Roman, (2020) supply most of the details.
During the 1980s the US received a sizeable amount of funds from Russia and Asia and
invested the funds into sub-prime mortgage—a type of mortgage that caters to the needs of low
income group as well borrowers with low credit scores. The Government required banks and
financing institutions facilitating the sub-prime funding to lower their lending standards to enroll
borrowers. Business tycoon Warren Buffet estimates that about 50 million out of 75 million
homeowners were on mortgage, roughly 40% (24 million) of the 50 million homes in the sub-
prime category (Buffet, 2016). Due to the sheer volume of prime borrowers, banks saw the
opportunity to make profits. They started selling prime mortgage mortgage—but since the
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mortgage were risky and unattractive, banks bundled them together into Collateralized Debt
Obligations (CDO). Since CDOs were mostly sub-primes, they are unattractive and too risky to
invest on.
Enter the American Insurance Group (AIG). The AIG sold CDOs and agreed to pay the
buyer if the borrower defaults payments. This was called Credit Default Swap (CDS). During the
first 5 years (around 2000-2006) of CDS operations, AIG made a windfall income. CDO sales
made an extraordinary 17.5% of its total revenue. Given the enormous success, AIG sold more
CDOs under its CDS facility more than the value of its assets and relied on optimistic market
predictions to convince its Board. But in 2007, the housing market was hit by a global crisis.
Sub-prime mortgage borrowers were unable to pay their obligations. Default and
foreclosure rates increased dramatically. AIG realized it insured more CDOs than it could pay.
AIG’s partners including Lehman Brothers were among the first Wall Street institutions to file a
bankruptcy. With fear that the contagion of financial failure will spread throughout the nation,
the Government took a hard stand to bailout AIG and other major Wall Street institutions since
they were “Too Big to Fail.”
Evaluation of Government Decisions
According to Wallison (2009) government-induced policies, provision of homeowner
options, reinforcing tax policies and the impact of certain bank-capital regulations contributed to
the Great Recession.
The depth of the recession in 2007 caused the market to slide deeply, raising a major
alarm in the Government. With soaring default rates and unabated mortgage foreclosures, the
Government led by Hank Paulson, Secretary of the Treasury, and Ben Bernanke, Chairman of the
Federal Reserve, launched a massive US$ 13 trillion Troubled Asset Relief Program (TARP) to
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bail out Wall Street. US$ 182 billion from the TARP went to AIG, of which $ 165 million went
to executive bonuses. Through the TARP, the Government bailed out AIG and took 80% equity
allowing the former to change the leadership and install a new management. In 2012, the
Government sold its share to AIG and made US$ 22 billion profit.
Stockman (2013) argues that there was only US$200 billion or 1.7% of the total
commercial banking assets of US$ 11.6 trillion considered “toxic” during the 4th quarter (peak of
recession) in 2008. The balance sheets should the loans were secure and the bank were never at
risk or showed a potential contagion.
The home mortgage bubble appears to have started during the 1980s when government
policy to accommodate sub-prime borrowers took effect to provide housing loans to borrowers
who did not qualify under normal lending standards. Additionally, the Government also
prioritized housing loans than other loan types. The effect of both policies was an increase in
non-qualified borrowers (under traditional rules of lending). A similar situation occurred with the
adoption of the Community Reinvestment Act (CRA) of 1977 to provide affordable housing to
low-income population, when Fannie Mae and Freddie Mac—two Government's Sponsored
Enterprises (GSE) that led the national mortgage system accepted loans from banks with little to
no equity that were unqualified under normal underwriting standards.
According to Wallison (2009:366), relegating the standards of borrowing did in fact
increased home ownership from 64-69%. In many cases, applicants meeting the usual lending
standard of creditworthiness lowered their financial condition to avail of the Government’s
relaxed lending policy. Private sector issuers of mortgages also followed the GSE’s “relaxed”
regulations for screening mortgage applications which accounted for an aggregate value of over
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US$ 3 trillion (Wallison 2009:371). It is essential to understand how government failed policies
of GSEs and private-label mortgages accounted for the highest defaults and foreclosure rates.
It is apparent that AIG took responsibility beyond its ability to meet its future obligations.
While no literature showing AIG violation solvency regulations, a responsible banking and
finance practice requires adequate assets to meet long term obligations.
According to Stockman (2013) 90% of AIG’s assets were high-quality assets while only
10% were CDS. This means only 10% were exposed to failure. An event of a loss is part of a risk
taken by an investing company. Companies that gambled beyond their means would have
absorbed part of the loss. Economists recommend spreading the loss by breaking up the banks’
intermediaries and underwriters and reducing taxpayers' cost. AIG’s intermediary institutions
would have absorbed part of the loss. Meanwhile, Government bailout increase speculation and
companies have had less incentive to raise quality leverage in their solvent assets.
The purpose of TARP to save companies with "significant financial distress or in danger
of failing" (Berger & Roman, 2020: 5). However, Government policies indiscriminately selected
applications with bad and good credit standing. Applicants with good credit rating can reduce
their asset information to avail the benefits accorded to low income group Wallison (2009:366).
This therefore reduced the overall integrity of the mortgage—when pay-able borrowers mix with
the less able ones to avail of loan moratorium and forgiveness policies thus contributing to a
distortion of the market. Additionally, as Stockman (2003: 19-34) exposes most of the bailout
funds went the fund managers and insiders of the Wall Street institutions who contributed to the
fiasco and benefitted themselves with revenues from short term money market account converted
from repossessed and unsecured loans.
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Government's tax policies increased problems of homeowners’ ability to produce equity.
As mortgage interests are tax-deductible, people prefer owning a home rather than renting, thus
increasing the rate of defaults. But if mortgage interest is non-deductible, there would be less
incentive to acquire a home and the problem of lack of housing remains (Sommer & Sullivan,
2018). Interest on consumer loans such as credit card, cars, etc. are non-tax deductible, as
compared to home-equity which are mortgage tax-deductible. Therefore, consumers are
encouraged to obtain home equity loans to pay off their car loans and credit cards that normally
are paid from consumer loans. The resulting misuse of loan reduces home equity and increase the
likelihood of mortgage default and foreclosure.
Conclusion
There is a point to make that the Fed's expansionary and restrictive monetary policy
caused interest rate to soar. Low-income borrowers became unable to pay their mortgage while
big loans with low income reached a 270% debt-income ratio in mid-1980s, indicating a deep
shortage of income to pay mortgage resulting in massive foreclosure. Gwartney, et. al. (2018:
619-622) points to the Fed-imposed regulations to force competitive lending institutions to lower
their mortgage lending standards such as lower interest rates and less scrutiny for
creditworthiness to make housing affordable for low-income groups. Literature supports this
claim.
Regulations providing meager interest rates created significant demand for high-interest-
bearing goods and increased artificially induced borrowings. Loan-facilitating banks reduced
their debt-to-capital ratio from 8% to 4% to accommodate more borrowers that exposed banks to
collapse. Providing housing loans with sustained low interest resulted in increased demand for
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interest-sensitive commodities such as cars and houses that fueled more borrowings to low-
mortgage capability, increasing the risk of loan default. Wall Street did not need a bailout.
Reflection
The government's action stifled the natural functioning of a free market, which is based
on fundamental exercise of freedom granted to human beings that scriptures established it as a
right to the freedom of choice (Deuteronomy 30:19, NIV). However, the Government also
established by God (Romans 13:1, NIV). Thus, the need to discern through the Holy Spirit
(Psalm 9:10; 111:10, NIV).
The economic recession of 2008 is test of “true” statesmanship. A leader must endeavor
to stand to the highest moral standard of leadership in every area of responsibility, always
consulting the Word of God in his decisions. Paul's letter to Titus instructs, "For an overseer, as
God's steward must be above reproach. He must not be arrogant... or greedy for gain, but... self-
controlled, upright, holy, and disciplined. He must hold firm to the trustworthy word as taught...
(Titus 1:7-14 NIV)." This essay has been another journey of learning inspired by God’s Word to
“Study to shew thyself approved unto God, a workman that needeth not to be ashamed, rightly
dividing the word of truth” (2 Timothy 2:15, NIV).
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References
2 Timothy 2:15, NIV, https://bit.ly/3jVVRxK
Berger, A. N., & Roman, R. A. (2020). TARP and other Bank Bailouts and Bail-ins around the
World: Connecting Wall Street, Main Street, and the Financial System. Academic Press.
Boyd, R. (2011). Fatal Risk: A Cautionary Tale of AIG’s Corporate Suicide. New Jersey: Wiley.
Buffet, W. 2016. Warren Buffett Explains the 2008 Financial Crisis. Wall Street Journal.
https://bit.ly/3AIGleE accessed July 6, 2020.
Clark, T. E. (2009). Is the Great Moderation over? An Empirical Analysis. Economic Review,
2009, Q4-5.
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