Question

Over the short term, the financial crisis of 2008 affected the banking sector by causing banks to lose money on mortgage defaults, interbank lending to freeze, and credit to consumers and businesses to dry up. For the much longer term, the financial crisis impacted banking by spawning new regulatory actions. Furthermore, some believe that commercial banks where more fragile during the crisis which made them at more risk of a bank run. In your opinion, discuss whether you agree or not and why.

Answer 1

Over the short term, the financial crisis of 2008 affected the banking sector by causing banks to lose money on mortgage defaults, interbank lending to freeze, and credit to consumers and businesses to dry up. For the much longer term, the financial crisis impacted banking by spawning new regulatory actions internationally through Basel III and in the United States through the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Before the financial crisis hit in 2008, regulations passed in the U.S. had pressured the banking industry to allow more consumers to buy homes. Starting in 2004, Fannie Mae and Freddie Mac purchased huge numbers of mortgage assets including risky Alt-A mortgages. They charged large fees and received high margins from these subprime mortgages, also using the mortgages as collateral for obtaining private-label mortgage-based securities.

Many foreign banks bought collateralized U.S. debt as subprime mortgage loans were rebundled into collateralized debt obligations and sold to financial institutions around the world.

When increasing numbers of U.S. consumers defaulted on their mortgage loans, U.S. banks lost money on the loans, and so did banks in other countries. Banks stopped lending to each other, and it became tougher for consumers and businesses to get credit.

With the U.S. falling into a recession, the demand for imported goods plummeted, helping to spur a global recession.

Confidence in the economy took a nosedive and so did share prices on stock exchanges worldwide.

In hopes of averting another financial crisis, in December of 2009, the international Basel Committee introduced a set of proposals for new capital and liquidity standards for the global banking sector. The reforms, known as Basel III, were passed by the G-20 in November 2010, but the committee left it to member nations to implement the standards in their own countries.

In the U.S., the Dodd-Frank Act, passed in 2010, requires bank holding companies with more than $50 million in assets to abide by stringent capital and liquidity standards and it sets new restrictions on incentive compensation.

The legislation also created the Financial Stability Oversight Council, to include the Federal Reserve Bank and other agencies for the purpose of coordinating the regulation of larger, "systemically important" banks. The council can break up large banks that might present risk because of their sizes. A new Orderly Liquidation Fund was established to provide financial assistance for the liquidation of big financial institutions that fall into trouble.

Some critics charge, however, that the act passed by U.S. Congress in 2010 is a greatly weakened version of the bill originally envisioned by President Barack Obama, watered down during its development through legislative and lobbyist maneuvering.

Meanwhile, the ultimate impact of the financial crisis keeps unfolding. For example, the Act also contains more than 90 provisions that require rule-making by the U.S. Securities and Exchange Commission (SEC), along with dozens of other provisions where the SEC has been given discretionary rule-making authority. As of February 2019, the SEC has adopted final rules for 67 mandatory rule-making provisions of the Dodd-Frank Act.

Rules have been adopted to bring more transparency to the swap fund and hedge fund markets, to give investors say over executive compensation, and to set up a whistle-blowers program for securities law violations, for instance.