Question

Please answer the following questions on the 2008 financial crisis please answer 1-2 paragraphs each.

• What was the financial situation that consumed Wall Street and the Federal government in 2008?

• Which government officials played critical roles in addressing the financial crisis, and how did they address it?

• How would you critique the ethical culture of Wall Street and those insiders on Wall Street who triggered the financial crisis?

   4. Who is to blame? Are there any good guys here?

Answer 1

1) Financial Situation that consumed Wall Street and the Federal government in 2008

Banks allowed people to take out loans for 100 percent or more of the value of their new homes. While Community Reinvestment Act directed banks to make investments in subprime areas, Gramm Rudman Act allowed banks to engage in trading profitable derivatives that they sold to investors. These mortgage-backed securities needed home loans as collateral. The derivatives created an insatiable demand for more and more mortgages. Hedge funds, options, etc were based on the houses. Now, in the zeal of making money , credit agencies did not do the complete due diligence. When low credit worthy borrowers defaulted, it created panic in the whole banking system. The mortgages value came down and whole system collapsed. Banks refused to give loans and intra bank loans also evaporated. Libor rates shot up. This was the harbinger of the financial crisis.a big secondary market for originating and distributing subprime loans developed.

In October 2004, the Securities Exchange Commission (SEC) relaxed the net capital requirement for five investment banks - Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley - which freed them to leverage up to 30-times or even 40-times their initial investment. This whole secondary market was based on sub prime housing loans. When people started to default, the whole building of derivatives, options, swaps and other financial assets came crashing down.The period leading to the financial crisis was marked not only by an unprecedented increase in the amount of leverage, but also by an increasing concentration of sectoral and counterparty risk, and an expanding reliance on short-term indebtedness to finance long-term assets.

Critical Roles played

By September 2008, the Bush administration had abandoned its previous concerns about the risks of government intervention and embraced the roles of the U.S. Treasury and the Federal Reserve Bank of New York as “lenders of last resort” through the adoption of a multifacted series of monetary and fiscal rescue efforts. Following the further loss of market confidence that accompanied the collapse of Lehman Brothers, the Bush administration deployed an ever increasing arsenal of monetary and fiscal tools to prevent the collapse of
the money market system and avert further damage to the economy, including the provision of temporary money market insurance, the rescue of AIG, and the adoption of the Troubled Asset Relief Program (TARP), the Emergency Economic Stabilization Act (EESA), and the Term Asset-Backed Securities Loan Facility (TALF). At the same time, the Federal Reserve undertook a stunningly massive and diverse set of initiatives to ease monetary conditions, offering an array of liquidity facilities and dramatically expanding its balance sheet through the purchase of Treasuries, agency debt, mortgage backed securities, and other assets.While most of the credit provided through the Federal Reserve liquidity facilities during the height of the crisis has been reduced as the financial system stabilized, the breadth of emergency measures taken by the Fed as a result of the crisis expanded its balance sheet dramatically into assets and liabilities
that differed significantly from those in its traditional portfolio, which the Fed continues to hold to this day. Following the change in administrations in January 2009, the Obama administration continued to introduce a number of significant new measures designed to stimulate the economy and restore the functioning of the financial system. These included the passage in February 2009 of $787 billion in additional stimulus included in the American Recovery and Reinvestment Act, and the announcement of the administration’s Financial Stability Plan, which included a series of measures intended to address various aspects of the crisis. In addition to efforts
to improve access to consumer finance (the Consumer Business Lending Initiative), reduce the wave of residential foreclosures (the Home Affordable Modification Program, HAMP), and stimulate the market for “toxic” assets (the Public/Private Investment Program, PPIP), this initiative also involved the imposition of bank “stress tests,” followed by required capital increases for those banks found to have insufficient capital.By giving lenders, investors, depositors, and other transacting parties additional comfort in the solvency of their financial institution counterparties, the bank stress tests (subsequently
conducted in Europe in July 2010) played a critical role in restoring confidence in U.S. financial institutions, analogous to that played by the banking “holiday” unilaterally imposed by FDR following his inauguration. Although the plans differed in their details and scope
of coverage, the broad outlines of Obama’s Capital Assistance Program, which subjected U.S. financial institutions with more than $100 billion in assets to stress tests and mandatory capital increases where needed, are remarkably similar to the process deployed in FDR’s Bank Holiday, under which the U.S. Treasury examined banks, which were then subjected to Reconstruction Finance Corporation (RFC) conservatorship or made eligible for RFC capital investment. Like FDR’s Bank Holiday, although the Obama administration’s stress tests were initially criticized as lacking in rigor, they succeeded in restoring confidence in, and the
normal functioning of the U.S. financial system.

Ethical culture

(1) Overeager and Financial Institutions Searching for Yield - Debt, however, requires the participation of both a borrower and lender. While ultimately a borrower always has the freedom (and thus the responsibility) to choose whether to incur debt, in the absence of easy credit, in the form of low interest rates and reduced underwrit-
ing standards, U.S. individual borrowers would not have had the opportunity to indulge in the excessive leverage that supported the unprecedented issuance of asset-backed securities between 2000 and 2008. Thus, while borrowers bear a share of the responsibility for the crisis, we cannot ignore the corresponding role played by their enthusiastic lenders, who competed for access to the fees and income made available by the expanding borrower universe, and
the central bankers and other government officials who made borrowing artificially accessible and affordable.

(2) Governments throughout the world contributed in a variety of ways to the expansion of lever-age. As we have seen, central banks played a significant role through their control of interest rates (at least at the short end of the yield curve). However, governments contributed to the
crisis at the legislative, executive, and regulatory levels, as well. By holding interest rates at abnormally low levels during the extended period between 2000 and 2008, central banks encouraged the massive glut in worldwide liquidity and the corresponding asset price inflation.

(3) The credit rating agencies played a critical role in facilitating the leverage boom. Their AAA ratings were necessary in order for many financial institutions to invest in (and, under Basel II, receive preferential capital treatment for) the complex subprime mortgage-backed securi-
ties they reviewed. Even where investors did not require the agencies’ AAA ratings, many derived comfort that the high ratings meant they could earn a premium to U.S. Treasuries at a similarly negligible risk of default by investing in subprime debt.Thus, the rating agencies
served as the final gatekeeper that could have prevented, but instead facilitated, the dramatic increase in risky indebtedness in the years leading to 2008. In so doing, they were shockingly cavalier in issuing their coveted AAA ratings.