Financial Crisis
The WILD DERIVATIVES was the first error towards the financial meltdown. It appears like Brooksley Born, the then chairperson of Commodity Futures Trading Commission had foreseen the danger posed by deregulation of derivatives. The idea to extend the regulation mandate as proposed by Brooksley was rebuffed by the officials of the Securities and Exchange Commission, the Federal Reserve, and the Treasury Department. While it remains debatable whether the regulation could prevent or alter the financial trend, few dispute the idea that such control would have slowed the emergence of the problem. Financial analysts believe if this was introduced 10 years or earlier, the control would have mitigated the rise of the problem (Blinder, 1).
Blinder has observed that the alarm bells signaling the financial credit crunch went long ago and individuals in positions of influence refused to act rather preferring to protect huge business interests. The innermost government sanctums were basically to blame as they chose to protect few businesses at the expense of the common good (Blinder, 1).
Brooksley, while serving at CFTC made it clear to congress that controlling the financial markets was necessary. The financial instruments commonly known as derivatives were the focus point. It is little surprise that ultimately the collapse of the derivatives market served as a trigger towards the 2008 financial crisis. Brooksley was overly concerned about the swaps unregulated trading (Blinder, 1).
On the basis of Blinder.s observation, the second error, SKY-HIGH LEVERAGE, rose in 2004 (1). During this period, the S.E.C allowed securities firms to up their leverage to levels unmatched before. Prior to this instance, leverage stood at 12 to 1. After this event, the leverage sky rocketed to 31 to 1 (Blinder, 1). This is a pointer to madness on the side of the S.E.C and firms heads. It is known that at 33 to 1 leverage, a small decline, for example a three percent decline in assets valuation can lead to a wiping out of a business company. If the authorities had ensured that the leverage was kept at 12 to 1, then the firms would have remained stable as they would not have grown that big or exposed to vulnerability.
Treasury Curve Steepening Bet Blows Sky High INCLUDEPICTURE http3.bp.blogspot.com_nSTO-vZpSgcSE2VMlxZvVIAAAAAAAACukuIPut7X8FGYs400treasury-spreads-2008-06-09.png MERGEFORMATINET
This chart is obtained courtesy of Bloomberg.
It show how the treasury curves steepened unusually as a result of leverage manipulation. An over leveraged economy requires higher interest rates (Blinder, 1). However, individuals and businesses appear to be on the steepened meaning that funds would bet that treasury yields were to rise more in the long run as opposed to short term.
Thirdly, the SUBPRIME SURGE presented the other serious mistake preceding the financial crisis (Blinder, 1). This is believed to have taken place between 2004 and 2007. At this time, subprime lending expanded from a small scale mortgage market to a dangerously big scale. This witnessed an unmatched fall in the lending standards while at the same time dubious transactions became a commonality. This continued unabated as it emerged that bank regulators were sleeping on the job. Enthralled by the laissez fairer mode of leadership, the authorities ignored credible warnings like the one issued by Edward Gramlich. This former federal governor had seen the problem brew years earlier.
It should be noted however that many of the adverse subprime mortgages had their origin outside the banking industry (Blinder, 1). This indicates that such origins could not be regulated as they fell out of the federal mandate of regulation. This presents another regulatory loophole which needs to be put into check, however it wasnt.
The creation of the housing bubble in 2005 and the subprime mortgage of 2007 and 2008 played a he role in plunging the globe into recession (Blinder, 1). The enactment of laws and regulations by government in regards to the private sector operations would have prevented this eventuality.
Important issues like takeovers and bankruptcies could have also been altered to stem the crisis.
The fourth error as identified by Blinder, (1) centers on the FIDDLING ON FORECLOSURES. The government continued in its failure to do anything of note in a bid to arrest the situation. If the government could have taken steps to check the foreclosures and limit them, the crunch may have been countered at an earlier stage. Apparently, the signs depicting foreclosures were clearly discernable more than a year before the credit crunch, (Blinder, 1). Representatives such as the Massachusetts democrat, Barney Frank, and the chairwoman of the Federal Deposit Insurance Corporation had sensed a problem and sounded the alarm bells. Surprisingly, the Congress and the Treasury fiddled as homes burned (Blinder, 1). The idea of the free market economy may have played a role in the stance taken by the congress and the Federal Treasury though this indicates denial on their part as they were unwilling to commit taxpayers money.
The real trigger came when the Federal Reserve responded to the crisis by cutting the Federal funds rate. This appeared to plunge the economy into further uncertainty as interest rates tumbled by 75 percent. The Dow Jones was down by around five hundred points though this was before the move by the Federal Reserve department. This did not save the situation as anxiety remained high in the financial markets. However, in the end, this proved to be a good move by the authority.
LETTING LEHMAN GO was the next big mistake committed en-route to the financial meltdown (Blinder, 1). Unlike in the case of Bear Stearns, the Lehman group was let to collapse. This is a pointer to the inability of the authorities to correctly make judgments. The officials in a position to save the company either thought the Lehman group was too ensnared with other financial players to be saved or too big to fail. It is difficult to understand the thinking of the authorities regarding the Lehman group but it is realizable that after the collapse of the company, everything went wrong the credit crisis was heightened (Blinder, 1).
Serious questions are asked here, one rests on the wisdom behind saving the Bears group on the pretext of bigness since the Lehman group was twice as big. This shows inconsistencies in handling the crisis. Equally posed is the question regarding the issue of entanglement if Lehman was too entangled in a way that it could not be rescued, how come Bears entanglements were not factored in towards its rescue After the collapse of the Lehman group no financial group seemed safe from the crunch. It is at this point where lending was frozen triggering an economic slowdown and literary put, the economy sank. This was a monumental error that had huge effects on the direction of the economy (Blinder, 1).
Based on Blinders observation, the TARPS DETOUR, presented the final serious mistake surrounding the financial meltdown (1). The mismanagement of the seven hundred billion dollars meant for the bail out scheme at the Troubled Asset Relief Program is testament to the mistake. According to Blinder, (1), the decision by Henry Paulson, the then treasury secretary to use the first 350 billion dollars was a mess that reflected inconsistencies. It was expected that these funds could be used to carry out the intended purposes however, the funds were used as capital injection into banks. Even the injection of capital into banks was poorly done. These funds would have played a significant role if they had been used to buy troubled businesses and mitigating foreclosures.
Conclusion
As examined and presented above, Blinder perceives and rather rightly that the six decisions on the various aspects were made wrongly. If the decisions had been made rightly, then the world would not have witnessed the vulnerabilities seen in the financial markets. In a nutshell, Blinder argues that if the derivatives were exchanged under good organization, if leveraging was controlled, if subprime lending was done responsibly, if right decisions were taken to check foreclosures, if Lehman was saved, and if TARP resources were used as anticipated, then the credit crunch could have been averted.