Engineering the Financial Crisis

Posted: August 27th, 2021

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Engineering the Financial Crisis

The financial crisis experienced in 2008 is considered one of the worst in economic history after the Great Depression. Thus, this paper focuses on engineering the financial crisis, assessing views by various authors and scholars about the causes and effects of the crisis in the subsequent discussion.

Conventional Reasons Behind the Financial Crisis and Authors Argument Against Each

The first reason is that low-interest rates caused the financial crisis. According to the authors, the low-interest rates led to a housing bubble. This happened in the United States and in the European Union, where the authors demonstrate a correlation between low interest rates and the housing boom in the first half of the decade (Friedman and Kraus 6). From 2001 and 2004, the European Central Bank and the Fed lowered their interest rates to about 1% from 6.4% in 2001. The interest rate remained at this level until 2006 before it began rising to 5.25%. Irrespective of the intention, mortgage rates followed suit downward, leading to increasing borrowed and the subsequent inflation.

            The second reason is the limited role of Fannie Mae and Freddie Mac, which were the central government-sponsored enterprises. These agencies stimulated the housing market, thereby causing an overall upturn such that investment in other avenues such as equipment and software reduced as investors focused on the housing market. According to the authors, money resources were misallocated mainly to the housing sector. Therefore, this contributed to the anemic growth of the economy.

 The third conventional reason is the economic depression, which was illustrated through declining bank lending. As the authors claimed, this was particularly eminent in the third quarter of 2007, and before the mid – 2008 panic began. The depression also characterizes a stop in the rise of housing prices that subsequent increase in mortgage defaults. Thus, the mortgage market began suffering from default with the potential of experiencing bad debts.

 The fourth reason is financial deregulation and the “shadow banking system.” The non-regulation of the financial system led to increased shadow banking systems characterized by financial entities instead of commercial banks. As such, this led to a flawed banking system, thus undermining proper regulation of financial assets.

The fifth reason is the non-regulation of derivatives, where most senior economists misadvised their influence in the financial markets. Therefore, most derivatives were allowed to be traded over the counter rather than through a centralized exchange. Hence, limiting their control.

The sixth reason is the “repeal “of Glass – Steagall that tremendously led to the failure of stand-alone investment banks such as the Lehman Brothers and Bear Stearns. However, the authors argue against the repeal since it had little or no impact on the investment banks to the extent of resulting in recessions. Therefore, in any case, the repeal would be of more impact on commercial banks than investment banks.

Reasons Behind the Financial Crisis

According to the authors, the financial crisis’s primary reason is the housing bubble contributed by a fall in the housing prices. The authors gave the authors that the realtors failed to consider that many homeowners were running questionable credits (85). This was worsened by the Community Reinvestment Act that encouraged investments in commercial banks’ sub-prime areas (98). Therefore, this significantly affected the overall housing market with an oversupply coupled with inadequate financial regulations.

Works Cited

Friedman, Jeffrey, and Wladimir Kraus. Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation. University of Pennsylvania P, 2011.