Question 1: Discuss the boom years (1987-2007) and the events that led up to the financial crisis of 2008-09.
Allan Greenspan, chairman of the Federal Reserve Bank for 18 years, oversaw great prosperity in the US economy. London stock market suffered a 25 percent dip after major weather setbacks. Prosperity began in 1987 after the fall of the Berlin wall, collapse of Soviet Union, and globalization of the market. Allan Greenspan linked prosperity to globalization which he claimed had lifted Americans “out of abject poverty…” World leaders embraced the open market policy, with London as the financial capital. Ageing financial players were quickly replaced by young and aggressive traders according to Prof Robert Reich, Secretary of Labor. The contribution of the financial sector to GDP rose from £31 billion to £95 billion. Construction industry boomed in London and America. One Mike Osinski, programmer, wrote a program to help traders convert mortgage loans into convertible mortgage bonds. By 1993, the US had high levels of public debt, 33 million people without medical insurance, low government spending on education, and shortage of home ownership. The US had to cut spending, reduce debt, and conform to global market forces (Reich). In Britain the Labor Party adopted and expanded Thatcher’s free-market policies by encouraging investors to create wealth and embrace globalization. The economy grew and stock bonuses multiplied threefold. The government at London created three financial service regulatory bodies, namely, central bank or Bank of England, Treasury, and Financial Services Authority (FSA), which were encouraged to come up with innovative services while protecting public interest at the same time. Investors were show the benefits of globalization and wealth creation.
By 2000, the GDPs of both the US and Britain had grown by 33 percent. the governments used minimal or “light touch” regulations to manage the markets. The financial sector created new products, notably the Credit Default Swaps, which allowed institutions to trade in uninsured credit. The Credit Default Swaps market was risky business yet it grew rapidly to a whopping $62 trillion by 2007. The bomb attack on World Trade Centre in September 2001 caused the New York Stock Exchange to close for six days, but it quickly recovered and operational within six days.
Banks were awash with money for lending to customers. As part of economic stimulus, the Clinton administration created much liquidity, lowered tax, and reduced interest rate to one percent. China came to the global market with a lot of excess reserve money and invested it in London and US banks according to Mervyn King. The banks lent to mortgage companies at very low interest rates. Mortgage companies sold houses at low interests. Sub-prime or high-risk borrowers were encouraged to apply for mortgage on a “teaser mortgage rate” scheme, in which the initial loan rate was low but after two years it rose sharply. Loans were offered with no background check or collateral, while speculators and employees of mortgage companies like Ameriquest, bought houses on speculation. The mortgage companies bundled the mortgages and sold them to banks in what was called securitization. The banks in turn enjoyed high interest rates from the borrowers. The debts, called Credit Default Swaps, were traded locally and globally through London. International lenders were therefore unwittingly buying back their own debts (Hector Santa). Banks knew about the risk but they were making large profits from the sub-prime sector, considered the sector insignificant to influence Credit Default Swaps, and they thought they could easily absorb any shocks from that sector. Warnings from experts like Nouriel Roubini were ignored, states Reich.
The financial bubble eventually burst in 2007 shortly after a merry summer. According to Robert Gnaizer, Gresinling Instiitute, American mortgage-takers started to lose confidence in the mortgage because of high interest rates, and sell their homes cheaply, while banks repossessed others. A glut of houses for sale followed, prices tumbled, and banks stopped trading Credit Default Swaps among themselves. The government initially ignored the problem, until it became a global financial meltdown.
Question 2: Discuss how politicians across the globe reacted after the collapse of Lehman Brothers in September 2008.
Due to the initial indifference of politicians, the financial crisis developed into the worst recession since 1929. Different camps of experts and politicians blamed each other for either not seeing the warnings or misinterpreting the signs. In the view of Robert Gnaizda, Allan Greenspan was to blame because it was during his tenure that deregulation was done, and he completely opposed any form of regulation after issues were raised about the Credit Default Swaps operations. Tetsuya Ishikawa questioned the sustainability of banking behavior and lone rangers like Roubini were not given a chance to explain their views properly.
When Lehmann Brothers collapsed, government was forced to intervene and regulate the market, however, pressure to rescue Lehmann Brothers failed, and many Americans lost their life savings and homes. 49 state governments sued Ameriquest and forced it settle lawsuits. In London the Bank of England blamed Financial Securities Authority for failure to exercise oversite on banking and trading behavior, according to Mervyn King. Overall, the crush was caused by excessive financial risking when banks bundled risky mortgage credit with the more secure credit, and caused loss of confidence. According to experts the government’s hands were tied and they had no authority to intervene until the banking system collapsed. Sub-prime mortgaging was blamed for exposing the Credit Default Swaps market, while the companies were blamed for encouraging “teaser loans” but hiding vital information from ignorant customers. Some people argued that Lehmann Brothers knew the risk they were taking when dealing with “teaser rates”, and therefore should not blame the economy for its troubles. As noted by Al Hubbard, the Director of National Economic Council, government and its leaders had initially dismissed the Lehmann Brother issue along with the mortgage market issues as business regulatory issues, and yet they affected many citizens. By the time government acted to rein in the banks, the mess at Lehmann Brothers was beyond salvation and spiraled into a global recession.
Question 3: What did you find most interesting and/or beneficial to you when you watched the video?
I found the issues of market dynamics quite intriguing and complicated. It is not easy to predict the outcome of actions of the sector players in the market. I learned that markets do not respond easily to warnings because there are too many interest groups involved and they do not necessarily serve public interest. Economy and politics are inseparable, and politics drives the economy to serve the desired political interests. Even local economic difficulties require a global solution because the market is globalized. The source of a crisis according to AG is unpredictable. When the deal is too good, step back and analyze it first before taking action. There is no such thing as complete deregulation in the manner advocated by Greenspan. All sectors must be controlled in a way as to safeguard public interest. Greenspan the expert admitted to making a fundamental error of judgement, which is a positive attitude to copy.
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