The 2008 Financial Crisis Regulations – Are They Enough?

The aftermath of the 2008 financial crisis featured an environment of uncertainty. The government and other financial regulatory organizations were working overtime to correct the effects of the financial crisis as they unfolded. The nature of the regulations that came about as a result of the 2008 financial crisis mostly resembled ‘patchwork’ because the extent of the problem was mostly unknown to regulators during the initial stages of the crisis. On the other hand, the 2008 quagmire can be compared to some recent financial crises of equal magnitude including the United States Savings and Loans (S&L) crisis and the Great Depression. These crises and many others were in one way or another responsible for shaping the existing financial laws in the country. The fact that the 2008 crisis is not the first incidence of man-made financial anomaly indicates that regulations are not enough to safeguard the populous against these types of events. Furthermore, the intensity of financial crises appears to have increased since the 1980s. These developments have also brought about the possibility of the post-2008 financial regulations being ineffective in the long run.

Consequently, questions have been raised whether the latest financial regulations have what it takes to prevent future financial crises. Incidentally, the post-2008 financial crisis laws are aligned with the specific events that unfolded between 2007 and 2009. The regulatory policies that were borne from the 2008 crisis touch on specifics such as capital, conditional convertible debts, criminal liability definitions, banking, and higher liquidity requirements, among others. The solutions to the 2008 financial crisis aimed at regulating credit availability, the chief contributing factor to the problem. In addition, the crisis revealed that regulations could be manipulated for them to accommodate stakeholders’ vested interests. The crisis was also blamed on various stakeholders including politicians, mortgage providers, credit rating agencies, and credit seekers among others. This paper argues that even though the genesis of the 2008 financial crisis can be blamed on various laxities in regulatory policies, the laws that were created to protect the consumer against similar events may not be enough.

The 2008 crisis was first witnessed through the collapse of the real estate market as a result of falling prices. The low real estate prices were occasioned by increased instances of underwritten sub-prime mortgages. This development created a subsequent panic whose climax occurred between September and October of 2008 thereby creating a recession environment. To combat the effects of the recession, the United States Government increased overall liquidity by providing more capital for the money markets, bailing out the major financial institutions, bringing down interest rates, and increasing its spending, among other measures.

In the run-up to the 2007 real estate collapse, “some investors started shorting real estate markets…the leveraged credit market dried up and billions of dollars of pending buy-out deals collapsed…billions more in mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) were written down” (Kim, Koo, and Park 662). Nevertheless, the real estate prices kept dropping throughout the year 2008 and this led to more CDO markdowns. In addition, the Federal Reserve reacted to the situation by bringing down the interest rates “and flooding the market with money…the value of the dollar plummeted relative to other currencies” (Young and Ho Park 562). The result of this move was that the prices of various commodities including oil and foodstuffs increased significantly.

The next event in the financial crisis was the collapse of various financial institutions including Fannie Mae and Freddie Mac. The collapse of these two institutions was particularly significant because of the vital role they played in the US real estate market. The government resolved to bail out these two organizations mostly because the public was under the impression that the institutions were acting on behalf of the government. Furthermore, Congress argued that injecting unlimited capital into the rescue of Fannie Mae and Fannie Mac would lessen panic among citizens and subsequently bring economic stability. However, the bailout of Fannie and Freddie only exacerbated the situation and increased global panic. Some of the events that followed this bailout include the collapse of financial services providers AIG, Lehman Brothers, and Merrill Lynch. In response, “the Federal Reserve exercised its emergency powers under section 13(3) of the Federal Reserve Act to rescue AIG, but the Government allowed Lehman Brothers to fail” (Ivashina and Scharfstein 323). Later on, AIG collapsed leading the Congress and the Treasury to implement a Troubled Asset Relief Program (TARP). After the collapse of the AIG, various financial institutions appealed to the government for bailout money. Some of the institutions that were rescued by the US government include Citigroup and Bank of America (BOA). Other institutions continued to acquire government assistance throughout 2009 when the effects of the crisis began to decline.

One of the most notable effects of the 2008 financial crisis is that “the economic uncertainty created by various US Government actions taken or feared subsequently, have resulted in the worst recession since the Great Depression” (Chodorow-Reich 7). The aftermath of the crisis was an economic environment that was worse than the one that happened between the late 1980s and the early 1990s. The crisis also led to higher levels of unemployment. The financial services industry also suffered immensely and in the end, “the FDIC resolved over 25 failed institutions in 2008, 140 in 2009 and more than 100 as of July 2010…as of 31st March 2010, the FDIC had nearly 780 insured institutions on its ‘problem list’” (Ivashina and Scharfstein 327). Furthermore, the Deposit Insurance Fund proved to be insufficient due to the magnitude of the financial crisis.

The actions of stakeholders during the financial crisis of 2008 resulted in various regulatory policies. First, there was the TARP implementation of the Treasury under the Economic Stabilization Act of 2008 (EESA), which was later amended to the Emergency Economic Stabilization Act of 2009 (ARRA). The other regulatory adjustment involved the discount authority window to benefit commercial banks under Section 13(3) of the Federal Reserve Act. In the course of the crisis, the FDIC used the Deposit Insurance Fund to bail out various players in the banking industry such as commercial banks and thrifts. On one occasion, the fund was increased to cover “US$250,000 per person per institution under the Temporary Liquidity Guarantee Program (TLGP)” (Armantier 324). The crisis also led to the creation of the Housing Economic Recovery ACT of 2008 (HERA). This law was particularly meant to facilitate the rescue of Fannie Mae and Freddie Mac.

This section of the essay investigates the effectiveness of the regulations that were born from the financial crisis about the events outlined above as well as their capability to curb another disaster. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act in short) was enacted in 2010 and it sought to minimize the effects of a financial panic. The Act is quite significant because its magnitude is similar to “the Federal Deposit Insurance Act, the Securities Act of 1933, the Glass-Steagall Act, the Securities Exchange Act of 1934 and the Investment Company Act of 1940” (Chodorow-Reich 14). This law seeks to put large financial institutions under closer scrutiny whilst continuing to regulate the smaller ones.

The stakeholders who support this legislation claim it can reduce the impact of a financial crisis, eliminate the need to use taxpayers’ money to bail out private institutions, and protect consumers. However, there are fears that the legislation is too weak in its current institution for it to achieve any significant impacts. In addition, there are concerns that these rules do not impact Wall Street directly. For instance, stakeholders in Wall Street are often pointed out as the main contributors to the 2008 crisis. Furthermore, there is concern that the Dodd-Frank Act only gives the government power to control a panic without necessarily addressing its causes. The involvement of the government through the Act also fails to address the moral shortcomings that were the main contributing factors in the 2008 crisis. The regime that was created by the Dodd-Frank Act is also likely to fail because it does not align itself with internationally accepted standards and subjects the entire financial system to the risk of incompetent regulatory decisions (Shedd et al. 3).

Another new component of the post-2008 financial regulatory legislation is the Orderly Liquidation Authority and it serves as a replacement for the Bankruptcy Code. The Liquidation Authority gives the “Treasury Secretary the authority to appoint the FDIC as receiver of any financial company if certain conditions are satisfied” (Kim, Koo, and Park 667). This regulatory practice resembles the Federal Deposit Insurance Act but it seeks to straighten the rules that apply to creditors. This rule also puts most of its focus on eliminating financial-based panic without focusing on its causes. In the future, the regulatory authority might attempt to use ‘old’ tactics to combat a ‘new’ problem thereby exacerbating the situation.

The Volker Rule is another regulatory policy that seeks to compel banks to diversify their proprietary assets with the view of cushioning them against risks. This regulatory policy only applies to the United States’ domestic banking environment. In addition, the regulation seeks to compel other financial institutions other than banks to have capital thresholds. Although this rule creates extensions on the existing policies, its anatomy goes against international standards. Therefore, the rule is customer-centric but not industry-oriented. The evolution of the banking industry might make the Volker rule outdated in the future.

The financial crisis of 2008 caused a valid shock on the financial services industry, the housing industry, and consequently the economies of various countries around the world. In response to the crisis, the US took a series of measures to mitigate the impending financial disaster. Most of these measures are aptly designed to cater for the events that transpired during the crises. Some of these measures were short-term while the others were long-term. The Dodd-Frank Act was the most prominent and extensive post-financial crisis legislation. Nevertheless, most of these legislations fail to comply with the international environment, reign in the Wall Street factor or encapsulate the evolutional nature of the banking industry. A crisis that might occur fifty years from now might not be prevented by these new legislations.

Works Cited

Armantier, Olivier. “Discount Window Stigma during the 2007–2008 Financial Crisis.” Journal of Financial Economics 118.2 (2015): 317-335. Print.

Chodorow-Reich, Gabriel. “The Employment Effects of Credit Market Disruptions: Firm-Level Evidence from the 2008–9 Financial Crisis.” The Quarterly Journal of Economics 129.1 (2014): 1-59. Print.

Ivashina, Victoria, and David Scharfstein. “Bank Lending during the Financial Crisis of 2008.” Journal of Financial economics 97.3 (2010): 319-338. Print.

Kim, Teakdong, Bonwoo Koo, and Minsoo Park. “Role of Financial Regulation and Innovation in the Financial Crisis.” Journal of Financial Stability 9.4 (2013): 662-672. Print.

Shedd, Peter J., et al. The Legal and Regulatory Environment of Business, New York, NY: McGraw-Hill/Irwin, 2005. Print.

Young, Kevin L., and Sung Ho Park. “Regulatory Opportunism: Cross‐National Patterns in National Banking Regulatory Responses Following the Global Financial Crisis.” Public Administration 91.3 (2013): 561-581. Print.