The aim of this essay is to try to examine who was responsible for the financial crisis of the recent years, which hit the whole world’s economy. It is reasonable to blame both the government and the banks, which together contributed to create a speculative financial system, but also the mortgage holders, who asked for loans they were not able to pay. The government lacked enough control and regulation, while the banks focused on making the biggest short-term profits they could, taking excessive risks and keeping it hidden from the investors.
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The other main characters of the financial system-Mathematicians, Central Banks, Regulators and Rating Agencies-contributed to the crisis too, directly or indirectly, but to a smaller extent. Many words will be spent especially on the subprime crisis of 2007, which started in the US, the first of a series of successive and related crises throughout the world, which all together culminated in the so called “Credit Crunch”. Each country worldwide tried to find a solution to the problems created by the crisis, sustaining the economy, in order to avoid recession. A particular focus will be on the United Kingdom, one of the countries which suffered most the bad consequences of the crisis. This recently pushed the British government to introduce a package of austerity, one of the most severe plans of the last 30 years.
Most people around the world have lost their trust in bankers, and they are considered guilty by the majority. People should also think about what the governments did and what the governments did not do, during that period. US government lost control over the regulation of the banking system, trying to stimulate the economy and the overall consumption. During the boom of the housing market it focused on liquidity rather than on risk. It encouraged bankers to grant loans to almost everyone, even to people with low income and poor credit, without any security for banks to regain the money. The government prolonged the crisis by increasing the interest rate on borrowing, due to the increasing inflation of 2007. People who were finishing their introductory period of mortgage faced an even higher interest rate, being unable to pay their debt towards the bankers. It made the situation worse by providing support to certain financial institutions and their creditors but not for others in an ad hoc fashion, acting too late, without a clear framework. This increased uncertainty and panic in the market. Furthermore government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor. Regulators had ample power in many arenas and they chose not to use it. The Securities and Exchange Commission (SEC) for instance could have required more capital and stopped risky practices at the big investment banks, but it did not. In case after case after case, regulators continued to rate the institutions as safe even in the face of troubles, often downgrading them just before their collapse. Even households played their role: they borrowed excessively, leaving them vulnerable to financial distress or ruin if the value of their investments declined even modestly. From 2001 to 2007, US national mortgage debt almost doubled, and the amount of mortgage debt per household rose more than 63% from $91,500 to $149,500, even while wages were essentially stagnant. It is this combination of structural conditions that investment bankers were able to exploit.
On their side, bankers tried to make the biggest profit they could from the boom of the housing market. They were also encouraged by the government to lend money as much as they could, apparently without limits. This lack of control pushed bankers to give mortgages even if they were too expensive and with a high chance of default. In order to be able to sell more mortgages, mortgage companies bundled the debt into consolidation packages and sold the debt on to other finance companies, like banks. In practice they borrowed money to be able in turn to lend mortgages. Bankers sold these mortgage debts to financial intermediaries, in order to spread the risk; as a consequence rating agencies gave these mortgages a low risk rating, being unable to really understand the level of risk they carried, since the bundles passed from lenders to lenders. To make it worse, many mortgages had an introductory period of one or two years of very low interest rates, at the end of which, interest rates increased a lot. People, who were initially able to pay, found themselves no more able to, defaulting. The 2007 economic scenario was not helpful at all: inflation was increasing and the government had to persuade the bankers to increase the interest rates because of it. Householders faced lower income because of rising health care costs, rising oil prices and rising food prices. As a consequence there was a rise in mortgage defaults, since many householders could not afford to pay. This situation signalled the end of the housing boom in the US and house prices started to fall; the increasing number of defaults caused many US mortgage companies to go bankrupt. Also many banks in Europe and UK lost billions of pounds in the bad mortgage debt they had bought off US mortgage companies. Banks wrote off large losses and this made them reluctant to make further lending available. As a result it became very difficult to raise funds and borrow money worldwide; the cost of interbank lending increased a lot and the market dried up. The situation was slightly different in the UK. The mortgage lending had more controls than in the US, but the crisis hit a lot of English banks. The reason is that many banks, like Northern Rock which was the first to go bankrupt, had a high percentage of loans financed through reselling in the capital markets; when the subprime crisis hit the economy, they were unable to raise funds from it. In addition, many UK banks bought the bundles of the bad mortgages debt from US companies, directly or indirectly. Therefore when US mortgage defaults rose, many UK banks lost money. Many banks were left with a shortfall and had to ask the Bank of England for emergency funds, causing customers to worry and start withdrawing their savings. Banks tried to write off bad debts improving their balance sheets by lending less and encouraging customers to save more. As a result even UK mortgages became more expensive and lots of them, especially the riskiest, were removed from the market. At the same time, world stock markets continued to fall in value; investors rushed to sell so-called “toxic” assets, moving their money into safe areas such as commodities and bonds. This contributed to make the credit less easily available and more expensive; as a result consumer spending declined further, resulting in increasing unemployment as companies became unable to sustain their payrolls.
What started as a problem of private-sector debt has become a problem of public-sector debt; we have to look at the financial conditions that preceded the crisis, which is a result of the credit-driven growth: abundance and excess of cheap money that was being lent without regards to borrower’s ability to repay. The banks have since become more conservative; in order to get a loan you need proof of your income and you need to have a deposit. Politicians are now attacking the banks for not lending enough: the custodians of capital are much more careful about where they use their money, and this is going to be very awkward for the economy. Looking in particular to the British government’s reaction, the measures it is going to take have few precedents in the latter half of the last century: a budget which focuses on cutting 82 billion pounds in this legislature possibly before 2015. The fear is to fall in the same situation Greece and Ireland are experiencing, but many economists worry that this excessive austerity could lead to recession. The government’s plan is to cut on an average of 19% the public expenditure. The outlook is a reduction of 500,000 jobs in the public sector, the rise of the pensionable age, the trim of credit allowances for well-off families, the incentive for the unemployed to find a job. The effect of this will downsize the British welfare, which would be intolerable to sustain. As a consequence many economists think that, since many families are going to experience a reduction in their income, these will bear on the consumption. Data from September 2010 show that British people have drastically reduced their spending, aware that they will need to save more. New banking regulations are being introduced at different speeds in the main economies. UK is among the quickest countries introducing bank levy, while crucial changes are being demanded by international banking regulators (based in Basle), which require banks to hold more capital in order to prevent losses, increase transparency and defer bonuses. Nowadays two key issues remain to be addressed: first the structure of banking-especially investment banking-and secondly international cooperation: the 2007-2008 crisis was an international one. Even those European banks which did not have any direct exposure to the US sub-prime mortgage crisis were caught-up in its effects on the global financing market; there is a need to coordinate policy, both macro and regulatory.
To sum up, both the government and the bankers contributed to create a speculative financial system which worked as a framework for the crisis. This was the result of human action and inaction: lack of control, regulation and severe parameters to follow ended up creating a bubble that burst as the overall system allowed it to happen. On one hand the government insisted on pervasive permissiveness, inducing banks to give loans to everyone, in order to make the economy work well; on the other bankers wanted to get the highest possible profits, hiding the bundles of debt and contributing for instance to confusing rating agencies. Firms and investors blindly relied on them as their arbiters of risk. As a consequence these agencies helped the market soar and then fall down. Without their active partecipation, the market for mortgages could not have been what it became. Bankers also ignored and failed to question, manage and understand the evolving risks in the system. There were warning signs of the crisis, despite many people said that it was unpredictable, but they were ignored and discounted: financial institutions made, bought, and sold mortgage securities they never did care to examine, or knew to be defective. Last but not least, ordinary people played their crucial role, integral to the consumer society. Since we love to own all the products we like, which make our life easier and give us satisfaction, many investors borrowed money without a clear limit in mind, consciousness about not being able to pay back the whole loan, or part of it; in this way we contributed to the spread of the risk and to the worsening of the situation.
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