The Key Financial Crashes of the US in 1929 and 2008
Today, the 2008 financial crisis is known as one of the worst economic disasters in the history of the United States of America, since the Great Depression of 1929. To exacerbate the issue, this disaster expanded globally; simultaneously affecting most of the world’s financial markets, resulting in an economic crisis for many countries. According to the OECD, “the crisis was triggered by the proliferation of mortgage loans – the famous subprime loans – granted to low-income households”. This is known as the subprime crisis, which was the deflation of the housing market bubble, that commenced in 2006. During this time, housing prices decreased, appearing to relators that the housing market was returning to a more sustainable level. However, mortgage dealers, for example, banks, were supplying consumers, such as families, with mortgages for ordinary home loans that they did not qualify for. In the beginning, interest rates were lowered to attract clients, then began to increase significantly after a few years. Resultantly, nearly six million US low-income households were on the receiving end of these loans.
The subprime loans were converted into securities and banks were able to trade profitable derivatives, that were then sold to investors in the financial markets. These securities were mortgage-backed and required home loans as collateral, increasing the demand for mortgages. This was very profitable for banks, due to the credit risk of the mortgage being reduced and dispersed throughout the financial system. However, as banks increasingly obtained these short-term financial operations for profit, volume and trading of the securities rose. This resulted in consumers holding subprime loans to default because they were unable to meet the unreasonably inflated monthly repayments. Subsequently, the subprime loans began to lose their value and banks no longer continued with the transactions in the market. This resulted in banks finding themselves in or near bankruptcy. Financial institutions were either purchased by others, like Bear Stearns by JP Morgan Chase, nationalized like Freddie Mac and Fanny Mae, placed under US Treasury guardianship or fully bankrupt. Lehman Brothers, an investment bank at the time, filed for bankruptcy. In its petition, it urged the government to intervene, in order to prevent the same fate of other institutions. If no intervention was made, this would have resulted in an even more catastrophic repercussion for the economy. This is because these institutions were “too big to fail”, an expression used to describe institutions that were connected to the overall economy, resulting in the government being forced to bail them out of bankruptcy. Based on the results of the Great Depression, government policy makers learnt that the government must intervene to relieve the crisis. Having high taxes, money constraints and restricted government spending would only worsen the situation. Nonetheless, although the Treasury and Federal Reserve interceded on behalf of the institutions, the financial crisis continued to have a disastrous effect on the economy.
Dodd-Frank Wall Street Reform Act
After the 1929 stock market crash, which preceded the Great Depression, the Glass-Steagall Act regulated financial institutions such as banks. One of the regulations of the act kept a separation between commercial and investment banks, to avoid commercial banks from engaging in risky investments, to boost their profits. Nevertheless, in 1999 the act was repealed by the Gramm-Leach-Bliley Act, which allowed banks to once again invest depositors’ funds in unregulated derivatives. Resultantly, this deregulation abetted to the 2008 financial crisis.
Consequently, the country was left in turmoil; millions lost their jobs and banks and other financial institutions were continuing to fall. Moreover, with this disaster spreading like wild fire on a global scale, changes had to be put in place immediately. The Dodd-Frank Wall Street Reform and Consumer Protection Act was implemented to alleviate some of the repercussions of the financial crisis. History.com notes “the law places strict regulations on lenders and banks in an effort to protect consumers and prevent another all-out economic recession”. This massive piece of financial reform legislation was first proposed in 2009 by the Obama administration. In 2010, the act was passed with little support from the Republicans. Named after sponsors Sen. Christopher J. Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.), it contained numerous provisions that were to be implemented over a period of several years.
The act was designed to prevent the crisis from occurring again, through implementing new regulations for the financial industry. Dodd-Frank established a new council made of new government agencies that were tasked with managing various components of the act and aspects of the financial system. The main objective of the act is to keep banks, hedge funds and companies from becoming “too big to fail”, due to its failure having a grave impact on the U.S economy. For example, the Financial Stability Oversight Council identifies these companies and turns them over to the Federal Reserve for closer supervision. The Fed can then compel the bank to increase its reserve requirements to have enough cash on hand to prevent bankruptcy. Additionally, the council was given the power to dissolve companies that posed a threat to financial stability. Moreover, the council requires firms to now have an assessable amount of money reserved at all times for the firm to employ in case of emergency. Nevertheless, Dodd-Frank is comprised of a number of components aimed to protect consumers at large from financial institutions. The act regulates credit-rating agencies, establishing the Office of Credit Ratings at the SEC.
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