Financial Crisis of 2008: the Creator
Deregulation of the financial sector has been Greespan’s most noteworthy legacy, and deregulation has given these large corporations greater opportunity to commit fraud, take unnecessary shortcuts and risk, and ultimately become too big to fail.
2008 ended with the beginning of a global recession costing the world tens of trillions of dollars and millions of people their livelihoods, not to mention the doubled US national debt. As the financial sector has grown, it has caused more and more crises by created huge breakdowns, like the dot-com bubble and most recently the mortgage bubble. The people responsible for these bubbles are making billions in personal gains, leaving us and our economy in ruin.
After the Great Depression, the US government set strict regulations that kept the American people away from such financial crises for decades. Things were working well; some of the regulations were perhaps a little restrictive, but that was to keep the financial sector from gaining too much power over our economy. When Ronald Reagan became president, he and his administration claimed that these regulations had a stagnating effect on the economy, and that if we didn’t deregulate we would fall behind other countries. From then on there has been a constant onslaught of deregulation, and leading the deregulation campaign was none other than one Alan Greenspan.
Greenspan had so many faults attached to his name, especially through his failed predictions as an economist, yet he still managed to find his way to head of the Federal Reserve. One of these problems was his confidence in Charles Keating. He was hired by Keating to represent him against allegations of stealing, and Greenspan was compensated 140,000 dollars. He stated in a letter to Keating’s accusers that Keating had a sound business plan and managerial expertise, and that Greenspan saw no foreseeable risk in any of Keating’s endeavors. A few weeks later, Keating went to jail for looting his company out of millions of dollars.
Another mistake would be his testimony in front of Congress; he stated that the risk in derivatives was “negligible”. It was this key testimony that lead to the derivatives market being kept unregulated and would be a major cause of creating the tech bubble as well as the 2008 mortgage bubble.
A derivative is an agreement between two parties that is contingent on a future outcome. For instance, a bread company buys wheat from a farmer. Wheat is selling at three dollars a pound, but a year from now it could increase to 3.50. In order to protect themselves from the high prices, the bread company will sign a contract with the farmer to buy wheat a year from now for 3.20 cents. That way, if in a year price goes up to 3.50, the bread company saves money, but if the price only goes up to 3.15, the farmer makes money. It gives a sense of confidence to both sides in what is a very volatile market. These contacts can be sold on the open market.
But his most notable failures came in form of the scams he pulled as Chairmen of the Federal Reserve. One of these was the social security fraud. Since the baby boomers were in the middle of their earning years in the 80s, Washington was worried about paying out benefits when they retired. So Greenspan recommended a hike in social security taxes, which went from 9% to 15%. This way they would be able to build up enough funds that when the baby boomers retired, they would be able to pay out social security benefits without causing too much debt. But that’s not at all how it worked; the presidents since then (as suggested by Greenspan) have used the funds to pay off some current debts obligations, and in George W. Bush’s case, a massive tax cut for the wealthy. Now 30 year later, when the issue comes back into questions, Greenspan announces that the payouts cannot be afforded.
Greenspan also had a habit of flooding the market with obscene amounts of money after a crisis and constantly lowering interest rates. In 2004, he lowered the treasury interest rate to a record low one percent, and at the same time, he announced that this would be a great time to invest in the housing market. If you already owned a home, he encouraged you to refinance it and take out another mortgage on the equity you had built up and use it on improvements to your house or that new car you’ve always wanted. At a time when the housing market was relatively strong and the money spent wisely could essentially double the value of the home, most people took his suggestion.
He then went on to advise people that Adjustable Rate Mortgages (ARM) were much safer and a much more fiscally responsible alternative to Fixed Rate Mortgages, considering the fact that interest rates were at a record low. ARM work in a way that the first few set years, depending on the loan, you have a fixed interest rate, but after those years expire, the interest rate will adjust each year to whichever way the market is going. So essentially you could pay less or more than you did the first few set years. Still, the idea was not too bad, correct? He had lowered interest rates 17 consecutive times, and they were at the lowest they had ever been, so this also wasn’t bad advice. Well, here comes the kicker. From 2004 until 2006, when he left the Fed Reserve, he raised interest rates to 4.5 percent, basically quadrupling the amount of interest those poor saps would have to pay on their mortgages. Nice little gift for his friends at the bank, no?
Deregulation of the financial sector has been Greespan’s most noteworthy legacy, and deregulation has given these large corporations greater opportunity to commit fraud, take unnecessary shortcuts and risk, and ultimately become too big to fail. The Glass-Steagall Act is a prime example of a law that kept corporations from gaining too much strength but was over turned by the Gramm-Leach-Bliley Act, at the head of which was Greenspan. This act was put into law in order to get the City Corp and Travelers merger to be legalized. Since then, the firms have continued to grow larger. After the crisis, it is approximated that 77 percent of Americans’ bank assets are held by 10 banks. All of which are now considered too big to fail, so we have reached a point where our economy is too dependent on these firms that have by definition become an oligopoly.
Editor’s Note: This was the first part of a two-part series explaining the causes and outcomes of the 2008 financial crisis. The second half will appear in next week’s issue.