The President`s Role in the Financial Bailouts Of 2008

The President`s Role in the Financial Bailouts Of 2008
Many companies (including the public and private enterprises) undergo
financial troubles that subject them to the risk of fall during the
economic crisis. The financial bailout is perceived to be one of the
most effective strategies of rescuing these enterprises, which is
accomplished by giving them financial support during the crisis. The
Primary objective of the bailout process is to prevent potential
consequences that would result from the downfall of at-risk business by
giving them financial offers 1. The bailout process may take the forms
of loans, stock, cash, or bonus, which may or may not be reimbursed.
However, the bailout program is adopted at special circumstances where
the companies being rescued are perceived to have lost economic
viability and continues to sustain significant financial loss. In
addition, the bailout organizations are believed to make a substantial
contribution towards the national economy (such as employment of a large
number of people) such that their downfall would affect the entire
economy. In such circumstances, the financial bailout is the most
effective approach of rescuing not only, the companies at-risk, but also
the future of the national economy.
Statement of purpose
The global recession also referred to as economic crisis of 2008
affected many countries and exposed many financial institutions, motor
companies, and several other companies to the risk of liquidation. Since
its onset in 2007, may people have been blaming the government for
failure to detect and prevent the occurrence of the economic crisis that
increased unemployment rate, decreased the confidence of investors, and
endangered the going concern of business enterprises. The government
especially the president has been
1 Miron, Jeffrey. “Bailout or bankruptcy?”Cato Journal 29, no. 1
(2009): 1-17
blamed for adopting and implementing misguided policies to drive the
American economy. This is because many people believe that the president
has the role and powers to determine the policies and legislative
measures governing the financial sector. The purpose of this research is
to identify whether the president had the power to prevent the
occurrence of the crisis reduce the impact of the crisis after its
occurrence.
Research questions
The research questions that pushed the researcher to pursue this theme
include the following: How did the financial crises of 2007-2008 occur?
What schools of thought of theoretical concepts can be used to explain
the occurrence economic crisis? How did the policy and legislative
deregulations contribute towards the occurrence of the crisis? How did
misguided policies contribute towards the occurrence and the progress of
the crisis? Did the president have a duty or powers to prevent the
occurrence of the 2008 crisis? What influence did the interest groups
have on collapse of the financial sector? How was the bailout process
carried out and what impact (both positive and negative) did it have?
Are there alternative ways that the president could have used to prevent
collapsing of companies and the banking sector?
Outline
The structure of this paper consists of eight sections. The first part
addresses the historical background of the 2007-2008 crises. The
researcher identified and analyzed events (both legislative and public
policies) that accelerated the occurrence of crisis. The factor
considered include the reckless mortgage lending, housing bubble,
provision of easy credit condition by the federal government, and
irregularities in mortgage financing.
The second part is the research design where the researcher determines
the importance of qualitative design and review of literature to inform
the topic of research. The two theoretical concepts used to explain the
occurrence and prevention of economic crisis include efficient market
theory and Keynesian theory.
In the third part, the researcher addresses the contribution made by the
president of the United States towards the occurrence of the 2008
crisis. The research indicates the role and power of president in
controlling economic conditions by analyzing the deregulation mechanisms
and misguided policies made by federal government and culminate to the
crisis.
The third part of the paper seeks to answer the question of whether the
president had powers to control or prevent the occurrence of the 2008
crisis. The question has been answered by evaluating the roles played by
four presidents of the United States starting with Reagan, Bill Clinton,
George Bush, and Obama.
The fifth part addresses the influence made by special interest groups
towards collapsing of the financial sector. Lobbying that was
accomplished through financial contributions towards political campaigns
is well analyzed.
The sixth part addresses the bailout process by analyzing its execution
and the main objectives. The troubled Asset Relief program, which was
the guideline for execution of the bailout, has been discussed. The
researcher also considered the negative and the positive impacts of the
bailout program.
The next section considers alternatives that the president could have
used to save the distressed companies instead of using the bailout
program. The alternatives addressed include the restructuring, giving
the struggling companies` loans with distressed securities as
collateral.
Finally, the conclusion restates the main ideas addressed in other
parts. The researcher concludes that the bailout was an immediate and an
effective alternative for the president, but there were other options
that should have been considered for long-term stability of the national
economy.
Literature review
Historical background of the 2007-2008 financial crises
The global economic crisis of 2007-2008 is believed to have originated
from the United States and was caused by several factors. Research shows
that the United States had experienced several quarters of reasonable
economic performance just before September 2007 2. The country
experienced a period of an average GDP growth rate of about 2.73 %, the
unemployment rate of less than 5 %, and an insignificant rate of
inflation that was relatively stable. The onset of the global financial
crisis was marked by a sharp fall in stock prices, continued decline
housing prices, followed by financial difficulties among the formerly
established financial institutions. Although scholars, economists, and
other categories of researchers attributed the financial crisis to
varying causes, there are four major factors that had a direct
contribution towards financial crisis of 2007-2008.
The global financial crisis resulted from interplay of different factors
that the stakeholders especially in the United States failed to foresee
their implications in the national and the global economic conditions.
First, the controversial and unconsidered mortgage lending in the United
States, commonly known as the subprime lending marked the beginning of
the global economic downfall. The stiff competition between mortgage
lenders that began
2 Miron, Jeffrey. “Bailout or bankruptcy?”Cato Journal 29, no. 1
(2009): 1-17
in 2003 destabilized the lending rules and stands set by mortgage
companies, financial institutions, and the Government Sponsored
Enterprises (GSEs) 3. This resulted in the issues of riskier mortgage
loans to less creditworthy customers, which subjected lenders to high
risk of the defaulters. Research has shown that the combination of a
reduction in abundant credit, rising house prices, and low interest
rates triggered relaxation in lending standards, which allowed many
people to purchase houses they otherwise could not afford. However, the
unforeseen fall in prices and an increase in bad debts resulted in
severe shock within the financial system 4.
Bubble bursting is an economic condition that is difficult to predict,
and its impact on the national and global economy becomes evident after
the burst. The housing bubble that occurred in the United States
resulted in the rise of a typical house in America by 124 % by the year
between 1997 and 2006 an increase of between 80-90 % in 2004 and 2005
alone 5. The housing burst of the United States was characterized by a
rapid increase in the price of houses and the quantity of houses,
implying the boom was driven by the increase in housing demand. Most
importantly, the increase in house process resulted higher value of
houses, which tempted the house owners to finance their consumer
spending with price appreciation by taking extra mortgages or financing
their homes at lower interest rates. This scenario resulted mainly from
the imprudent monetary policies formulated through the Federal
3 Miron, Jeffrey. “Bailout or bankruptcy?”Cato Journal 29, no. 1
(2009): 1-17
4 Jickling, Mark. Causes of the financial crisis. Washington DC.
Congressional Research Services, 2010.
5 Ibid, 3.
Reserve, which led to rise in housing prices to unstable levels 6. The
sudden fall in prices of houses (by 20 %), which began in the mid of
2006 increased the default rate among borrowers with adjustable-rate
housing mortgages, subjecting financial lenders to an anticipated risk.
Research shows that about 9.2 % of the outstanding mortgages in the
United States were either foreclosure or delinquent by the year 2008 7.
The federal government also contributed to ultimate crisis by creating
easy or cheap credit conditions. The federal fund rate was lowered from
6.5 % in 2000 to 1.0 % by 2003 8. The primary objectives of this action
were to reduce the economic impacts of the dot-com bubble, buffer
perceived deflation risk, and economic impacts of the September 2001
terrorist attack. However, the reduced federal fund rates fueled
homeownership instead of projected business investment, which boosted
severity of the crisis. In addition, the high current account deposit of
the United Stated added pressure on the interest rates. This occurred
because the government of the United States had to borrow funds from
abroad, which resulted in high bids for bond prices and reducing
interest rates. This lead to global imbalances that were characterized
by the increase in the United States internal deficits in both the
government and household sectors, which created severe financial
disruptions since the United States borrowing could not proceed
indefinitely 9.
Reduced transparency and lack of accountability especially in the
mortgage financing
6 Jickling, Mark. Causes of the financial crisis. Washington DC.
Congressional Research Services, 2010.
7 Mortgage Bankers Association. Delinquencies and foreclosures
increase in latest MBA national delinquency. Washington DC: Mortgage
Bankers Association, 2008.
8 Boards of Governors of the Federal Reserve System. Open market
operations. Washington DC: Board of Governors of the Federal Reserve
System, 2013.
9 Jickling, Mark. Causes of the financial crisis. Washington DC.
Congressional Research Services, 2010.
worsened the impacts of the global financial crisis. During the eve of
high mortgage competition, the mortgage sector was characterized by
numerous irregular and fraudulent practices, which resulted from the
insensitivity of the stakeholders to the effects of the actions in the
national and global economy. The study shows that the value chain of
housing finance was faced with bad mortgages where participants sold bad
securities without being held accountable for their practices 10. During
this period financial lender could dispose exotic mortgage to house
owners without considering the failure of those mortgages while traders
could dispose toxic investment securities to other investors without
assessing the possibility of their failure. This implies that it was a
common practice for realtor, brokers, rating agencies, and other players
in the industry to pass on problems without taking personal
responsibility and accountability 11. Another significant malpractice
was fraudulent underwriting, which resulted in defective mortgages which
either missed the required policy documents or had not been underwritten
to policy.
Research design
The purpose of this research is to assess the role of president in
preventing the occurrence and reducing the impact of economic crisis.
The qualitative research design is the most appropriate approach to
pursue this goal. In addition, the scholarly articles on the topic will
be reviewed and analyzed with the objective of identifying the powers of
the president in stopping events that result from the occurrence of
crisis. Literature review helps the researcher to identify critical
points, substantive findings, and theoretical contributions on a
10 Jickling, Mark. Causes of the financial crisis. Washington DC.
Congressional Research Services, 2010.
11 Mishkin, Frederic, S. Over the cliff: From the subprime to the
global financial crisis. Journal of Economic Perspectives 25, no 1
(2011): 49-70.
given topic 12. This means that the present research will be based on
secondary sources that will be critically analyzed to address the topic
of study. Compared to systematic review, the present study will review
literature that is relevant to different subtopics. This implies that
the objective of the research is to provide sufficient and relevant
information that will answer different research questions that will be
organized in the form of subtopics.
Theoretical concepts and the 2008 economic crisis
Efficient market theory
Efficient market theory holds that the stock market reflects the
relevant information making it practically impossible for investors to
beat the market by earning more than the market average returns. The
theory assumes that investors cannot earn the excess on a risk adjusted
basis provided that all the relevant information is made at the time of
investment 13. In addition, the theory holds that market players with
rational expectations adjust their expectations whenever some more
relevant information becomes available. However, any reaction made by
investors should be random and adopt a normal distribution, which
ensures that the market prices are not exploited to gain abnormal
profits. This implies that investors cannot outperform the market
through timing or stock selection, but can only gain more by purchasing
riskier investments 14. Based on the weak form of efficiency, future
prices cannot be predicted by the look at the previous prices, implying
that the future prices will depend on relevant information that will
prevail at that time.
Some scholars have blamed the efficient market perspective for the
occurrence of
12 Curtis, Antony. The review of literature for research. North
Carolina: University of North Carolina, 2011.
13 Siegel, Jeremy, J. Efficient market theory and the crisis. Neither
the rating agencies’ mistakes nor the overleveraging by financial
firms was the fault of an academic hypothesis. New York: Dow Jones &
Company Incorporation, 2009.
14 Malkiel, Burton, G. The efficient market hypothesis and its critics.
Princeton: Princeton University, 2003.
economic crisis, but it was not the cause of the misfortune. The theory
holds that the price of securities is a reflection of known information
that has a direct impact on stock value, but it does not imply that
market price is always or perfectly right. The theory holds that prices
are wrong in most cases since the rational prices would differ if
investors are given the current and the future information. However, the
limited predictability of prices cannot be used as an excuse for the
negative impacts (including financial instability) caused subprime
mortgage. This is because the government regulators made a wrong
assumption that financial institutions would offset credit risks, but
they instead underestimated the real estate risk. Irregularities
practiced in the mortgage sector frustrated the application of market
efficiency theory and terminated the economic benefits that Americans
had enjoyed for many years.
Keynesian economics perspective
Keynesian perspective is a perspective that assumes that aggregate
demand has a strong influence economic output during recessions.
Aggregate demand is determined by decisions made by both the public and
private institutions, which include monetary and fiscal measures 15. The
theory assumes that any changes that occur in the aggregate demand
(anticipated or unanticipated) results in short-run impact on employment
and real output, but does not affect the price. This means that the
response of prices and wages to demand and supply are slow, a scenario
that creates surpluses and shortages that occur periodically. This
contradicts the microeconomic theory because real demand and supply
would not be expected to change on condition that all nominal prices
vary (fall and rise) proportionately. In addition, the theory puts more
emphasis on significance of the interest rate in the determination of
15 Blinder, Alan, S. Keynesian economics. Indianapolis, IN: Liberty Fund
Incorporation, 2000.
liquidity and money supply in the economy. Moreover, Keynesians assumes
that economic performance is determined by public confidence 16.
Two presidents (Bush and Obama) tried to apply Keynesian perspective in
rectifying economic mistakes that resulted in the global economic crisis
of 2008. The Bush administration went for cheap dollar in the belief
that it would, which was accomplished through federal policies that
aimed at regulating the impact of monetary excesses on the economy 17.
This resulted in the adoption of Keynesian stimulus package that was
also utilized by Obama’s administration. However, the Keynesian
perspective failed to revive the economy because of its outdated
assumptions. For example, the attempt by the government to boost the
public confidence with $ 150 billion fund used in the stimulus program
in 2008 worsened the impacts of crisis instead of reversing it. The
program was implemented to encourage investors through tax breaks and
onetime tax rebates. This was based on the misconceived Keynesian
assumption that holds that the government can raise people’s
confidence by providing them with more money, an effect that would be
expected to boost spending in the entire economy 18.
The contribution of the United States Presidents towards the 2007-2008
economic crises
Deregulation mechanisms
The presidency hand in economic crisis can be viewed from policy
formulation and political influence on legislatures. There are several
policy measures taken by different
16 Genetski, Robert. How Keynesian economic theory contributed to the
financial crisis. Chicago: The Heartland Institute, 2011.
17 Ferrara, Peter. How the government created a financial crisis. New
York: Forbes LLC, 2011.
18 Ibid, 1.
presidents of the United States that had a direct influence on the
crisis or accelerated its occurrence and impacts. The president of the
United States, as the head of the executive has the constitutional
mandate to regulate and deregulate the financial sector through policy
interventions. This implies that the president has a major role of
correcting the key factors underlying the crisis since most of them were
created by the former presidents through deregulation policies. For
example, the 1980 Depository Institutions Deregulation and Monetary
Control Act that was enacted during the rule of Jimmy Carter resulted in
the removal of restrictions on financial practices carried out by banks.
This broadened the banks’ lending power raised limits for deposit
insurance and allowed unions to provide checkable deposits 19. The
signing into law of the Garn St the German Depository Institutes Act
created an opportunity for adjustable rate mortgage loans, which marked
the beginning of major deregulations in the banking sector. Moreover,
the reduced separation between commercial banks and investment banks,
which boosted the risk taking culture.
The impact of federal misguided policies
Researchers and scholars have attributed the onset of economic crises of
2008 to extreme risk taking among the private investors, business
malpractices in the mortgage sector, and irresponsibility among the
rating agents. However, it is evident that misguided policies formulated
by federal government contributed towards the global economic crisis.
The president of the United States, being the head of the executive arm
of the government and the key player in the formulation and
implementation of public policies cannot avoid the blame. The first set
of policies and legislative enactments aimed at enhancing home ownership
among the people of the United States, which was the principle goal of
federal
19 Federal Deposit Insurance Corporation. The banking crisis of the
1980s and early 19901: Summary and implications. History of Eighties, 1
(1999): 2-86.
government. Federal government formulated several policies to increase
homeownership, which include the Federal Home Loan Banks, the Federal
Housing Administration, the deductibility of mortgage interest, Freddie
Mac, and tax-favored treatment of capital gains on housing 20. In
addition, the federal government enacted several acts (such as the HOPE
for homeowners Act) that targeted at assisting Americans to purchase and
own homes.
Although the pro-house policies initiated by the government did not show
negative impacts at their early stages of implementation, the change of
focus towards construction of affordable houses that targeted the low
income earners in 2003 marked the beginning of financial troubles 21.
This is because the low income earners were risky borrowers, which
resulted in the construction of a large number of assets that were based
on risky mortgages. The bailout policies undertaken by federal
government encouraged the private players in the mortgage industry to
continue with risky mortgage debts, which were highly profitable at the
beginning hoping that the government would cushion and fix any financial
crash in case it occurred. The misguided bailout policy encouraged
financial institutions and mortgagers to expand their investment in
low-income household in pursuit of gains from the increasing price of
households. This implies that much of the blame should be placed on
federal policies compared to other factors such as the Wall Street
greed, rating agencies, and improper regulations 22. The government
intervention in mortgage sector created perverse incentives that could
not yield long-term benefits.
Role of president in preventing the occurrence of the 2008 crisis
20 Miron, Jeffrey. “Bailout or bankruptcy?”Cato Journal 29, no. 1
(2009): 1-17.
21 Ibid, 10.
22 Dam, Lammertan and Koetter, Michael. Bank bailout, interventions, and
moral hazards. Frankfurt: Deutsche Bundesbank, 2011.
Since the most of the policies formulated to encourage and empower
Americans to own houses were initiated by federal government, the
president played a role in the occurrence and had the power to prevent
the 2008 crisis. The role of president in preventing the occurrence of
the 2008 crisis can be analyzed by reviewing economic priorities of
three presidents of the United States starting from the former president
Reagan. Reagan had set the pace the growth of the economy of the United
States using four drivers. First, Reagan aimed at enhancing savings,
investment, business startups, employment, and entrepreneurships through
a sharp reduction in taxes. Secondly, the president eliminated
unnecessary government spending. Third, Reagan formulated effective
anti-inflationary policies that resulted in a stable dollar for a period
after his term of service. Fourth, Reagan formulated deregulations that
aimed at reducing the cost of doing business and increasing efficiency
23. Based on the four economic goals pursued by President Reagan, it is
evident that he utilized efficiency perspective to empower the private
sector to participate in business while reduce a direct intervention by
the government, which would have otherwise destabilized the national
economy. This reduced the probability of occurrence of perverse
incentives, thus resulting in the most successive economic and financial
experiment in history 24. It was characterized by a long period of
(about 25 years) wealth creation, tamed inflation, and general economic
stability.
The two major legislative measures enacted by former president Bill
Clinton departed from efficiency perspective and the introduced era of
excessive governmental intervention in business operations. First, the
Bank Holding Company Act of 1956, which reduced the
23 Ferrara, Peter. How the government created a financial crisis. New
York: Forbes LLC, 2011.
24 Ibid, 1.
creation of huge banks was repealed through the support of Clinton 25.
This resulted in the formation of large size banks and growth of a
perception that these banks were too large to fail, which lead to
irresponsible risk taking. The Clinton’s thought process of cheap
money instead of an effective economic system allowed the growth of
financial institutions whose fall would have brought the entire economic
system to the ground. Secondly, the president had an opportunity to
prevent the occurrence of the crisis by regulating derivatives ($ 94
trillion), which had gone up almost three times the size of the world
GDP (31.6 trillion) by the year 2000 26. The former president Clinton
had been advised to regulate derivatives, but rejected the idea, a
decision that resulted in the downfall of several companies such as AIG
Insurance Company and Lehman Brothers cost 27. This implies that a
decision by the head of state can determine the fate of established
companies, employment, and economic conditions.
The Bush administration was an exemption because he made several
policies that contributed to the crisis. The mark-market accounting
rules, support for oligopoly credit rating agencies, and some incoherent
bailout policies were spearheaded by Bush 28. One of the measures that
Bush would have done to prevent the occurrence or reduce the impact of
the global economic crisis would be to reduce the government
expenditure, which is one of the policies adopted by President Reagan.
Research shows that government expenditure increased to one seventh of
the national GDP during the Bush administration. Adoption of the
25 Richman, M. Bill Clinton and the financial crisis of 2008.
Philadelphia: Temple University, 2012.
26 Ibid, 1.
27 Nanto, K., Weiss, A., Dolven, B., and Cooper, H. The U.S.
financial crisis: The global dimension with implications for U.S.
policy. Washington, DC: Congressional Research Service, 2008.
28 Ferrara, Peter. How the government created a financial crisis. New
York: Forbes LLC, 2011.
Keynesian stimulation package is another mistake that Bush did that
accelerated the crisis instead of reducing it. This was a further
departure from Reagan’s monetary policy, which had brought the
historic economic success that lasted for twenty five years. Similarly,
President Obama proceeded with Keynesian perspective, instead of
restoring the Reagan’s monetary policy. The actions of the four
presidents (Reagan, Clinton, Bus, and Obama) indicate the role of
president in the determination of the economic conditions prevailing in
the country and their power to regulate the outcome of the previous
misguided policies.
Influence of the interest groups on collapse of financial sector
The stakeholders in the economic sector (including the chairman of the
American Economic Association, Bernanke) have argued that supervision
and stronger regulations of underwriting practices and risk management
among finance lenders is the most effective way to constrain the housing
bubble 29. Since it is well known that regulations can work the question
is why these regulations were not put in place before and soon after the
onset of the global economic crisis. Research shows that formulation of
key policies and passing of legislative acts (such as American Housing
Rescue and Foreclosure Prevention Act) was strongly influenced by
interest groups, which included the financial institutions and mortgage
companies. In addition, large financial institutions lobbied against
proposed legal changes that would have tightened lending regulations,
thus continuing inattentive lending practices. The Ameriquest Mortgage
used political donations, lobbying activities, and campaign
contributions in 2007 to outdo the anti-predatory-lending legislation.
The two approaches used by interest groups lobby and influence the
process of policy formulation include campaign contributions (through
political action committees) and
28 Igan, Deniz, and Mishra, P. Lobbying and the financial crisis. New
York: Vox Organization.
lobbying federal agencies and members of Congress on certain
legislations. Research has established a positive association between
the amount of money spent on lobbying activities with the number of
proposed regulations that failed during the boom (from 2000-2006). Among
them sixteen proposals made by the federal government with the objective
of reckless lending failed to be enacted into laws, which gave the well
established and large financial institutions to proceed with reckless
lending that culminated in the global financial crisis and collapsed of
the financial system. These lobbying activities can be divided into two
namely lobbying associated with mortgage lending and securitization and
lobbying associate with lender associations as shown in Figure 1.
Figure 1: Lobbying by financial institutions between 1999-2006
Source: Igan, Deniz, and Mishra (2013)
Figure 1 shows that lobbying activities and expenditure increased
towards the onset of the global economic crisis.
The banking system bailout process and its impact
The federal government responded to economic impacts of the 2008
economic crisis through the formulation of the Troubled Asset Relief
Program (TARP) to protect the at-risk financial institutions from
collapsing. The bailout policy aimed at reduced the public misgiving by
convincing the public that the measure would take care of banking
regulations, fairness and equity, moral hazards, loss of employment
opportunities, executive pay, as well as the proper role of state 30.
The initial plan of TARP was to spend $ 700 billion in purchasing the
banks’ toxic assets. However, this was replaced with a proposal to
give $ 25 billion to each of the nine largest banks in exchange for
stock in order to enhance their capital reserve. Apart from financial
institutions, there were other companies (such as the General Motors)
that received capital infusion to rescue them from bankruptcy. The plan
was supported by President Bush and elect President Obama who requested
the Congress to release the remaining balance of TARP funds that
amounted to $ 350 for more capital infusion 31.
TARP was a successful program that cuts short collapsing the banking
system and other established companies as well as the probability of
occurrence of the second great economic depression. It was an
extraordinary measure to stabilize the entire economy with a focus on
the financial system. Research shows that the GDP growth would have
reduced by 4.7 % while unemployment would have increased by 4 % compared
per year in the absence of the TARP interventions that were coupled with
the Federal Reserve easing strategy 32. This would have intensified
recession and result in uncontrollable economic downfall of financial
and non-financial organizations.
30 Couch, F., Foster, D. Malone, K. and Black, L. An analysis of the
financial services bailout vote. Cato Journal 31, no 1 (2011): 119-128.
31 Yip, Jonathan. The bank bailout in perspective. Cambridge, MA:
Harvard Political Review, 2012.
32 Ibid, 1.
The cash infusion of about $ 356 billion improved the bank performance
in more than expected extents and resulted in an effective treasury
management. In addition, the diligent management of TARP assets resulted
in cost reduction and successful restructuring of companies such as AIG
and the General Motors. The TARP program and the general bailout program
facilitated an orderly bankruptcy of at-risk companies that would have
otherwise ended up in liquidation to pay creditors. The liquidation
would have been a devastating alternative that would result in the loss
of millions of employment opportunities. Currently, the affected
companies (including the General Motors and Chrysler) are on the
recovery track and have acquired the capacity to pay back their funds in
as scheduled.
Although TARP proved its success in reducing costs and deterioration of
economic crisis, it failed in accomplishing some of predetermined
objectives. Prevention of foreclosure is one of the goals that the TARP
program failed to accomplish and part of cost reduction has been
attributed to this failure. Research shows that the Home Affordable
Modification Program (HAMP) that was supposed to cost $ 50 billion was
reduced to 1.5 million 33. This contributed to its failure to prevent at
least 4 million foreclosures as projected at the onset of its
implementation. Consequently, over 7 million people or home owners have
issued with foreclosure notices since the authorization of the TARP
program. The HAMP program that aimed at rescuing mortgages through a
temporary reduction in monthly rates and interest rates, but the
majority of homeowners were highly affected and remained at risk of
default.
The TARP program also failed to rebuild the confidence of the general
public and investors because of its rushed implementation that resulted
in failure to provide accountability in the policymaking process. The
general perception among the members of
33 Richman, M. Bill Clinton and the financial crisis of 2008.
Philadelphia: Temple University, 2012.
the public was that TARP was a massive bailout program that targeted
undeserving bankers that undermined the public confidence in regulations
and policymaking in the financial system. Although the program managed
to prevent further loss of jobs by reducing chances for liquidation, the
rate of unemployment remained high and this created a perception that
the TARP program assisted the rich more than the poor.
Alternatives that the president should have used to prevent the collapse
Several alternatives have been suggested to restore the credit market
and save the entire financial system. Provision of unlimited liquidity
to financial institutions that are comfortably solvent is one of the
most viable alternatives. This should be followed with the set-up of a
new administration regime to oversee their recovery 34. The bonds of
insolvent of nearly insolvent banks that have sound business models with
capacity to generate value should be converted into equity. This should
act as a form of recapitalization or restructuring where the new equity
shares should be placed in the hand of new owners, thus overthrowing the
order of claims under insolvency law. This can be accomplished through a
legislative act. The state shares in the solved banks whose large
proportion is owned by the state should have been wiped out entirely to
release the entanglement of state with such banks.
The special administration in the banking sector should then allow
depositors to withdraw either all of up to 80 % of their deposits from
solvent banks. These deposits should be treated as loans from a Deposit
Access Fund, a special fund created that will be supplied with money
from the central bank or bond purchases. However, the government should
avoid recapitalizing the banks or purchasing shares from these banks.
The government should only
34 Brunnermeier, K. Deciphering the liquidity and credit crunch
2007-2008. Journal of Economic Perspectives 23, no. 1 (2009): 77-100.
keep ready to provide additional easing if crisis cascade 35.
Alternatively, the government should provide loans to the at-risk or
struggling organizations, taking their distressed securities or mortgage
as collateral instead of purchasing them. This is based on the notion
that the distressed companies will retain the ownership of their assets
instead of transferring their risks to taxpayers. This will help the
companies get back to their feet repay the loans and recover their
assets.
Conclusion
During economic crisis that result in collapsing of large company
financial bailout is the most effective approach of rescuing not only,
the companies at-risk, but also the future of the national economy. The
president, as the head of the executive arm of government has both the
role and power to influence the policy making process, which means that
the president cannot avoid the blame for the occurrence of the global
economic crisis. In addition, the economic crisis of 2007-2008 resulted
mainly from the implementation of misguided policies and could be
rectified through the implementation of policies that are free from
political interest or the interests of special groups. Although the two
schools of thought analyzed in the present study suggest that the
prediction of the crisis was difficult, it is clear that there were some
deliberate actions (such as lobbying) and unfounded policies taken by
the stakeholders that could have been avoided in pursuance of national
interest. Although the bailout produced some positive results in the
short-run, the government considers the monetary approach adopted by the
former president Reagan because it may help in restoring the period of
economic growth and rectifies the mistakes of other presidents
(including Clinton
35 Lilico, Andrew. What’s the alternative to another bank bailout?
Ontario: Telegraph Media Group Limited, 2013.
and Bush) who departed from Reagan’s perspective.
Recommendations
Based on the literature reviewed in the present study, there are two
recommendations that help the stakeholder and policy makers in
preventing the future occurrence of economic crisis. First, the
government should conduct a direct and on budget low-income
homeownership program in order to monitor its impacts on the economy.
This will require the removal of existing low-income housing policies,
which include Freddie Mac, Fannie Mae, and the Federal Housing
Administration among others. Although this may be difficult to implement
due to political influence, it will help the government to take charge
and control over all expenditures and determine the risks at an early
stage.
Secondly, the government should conduct policy adjustments to reduce the
occurrence of moral hazards that result from bailing out. There are
several ways of accomplishing this goal, but stakeholders should first
determine the long-term cost of the bailout. The most appropriate means
of avoiding the moral hazards of the bailout include the use of
alternative methods (such as issuing loans with toxic assets as
collateral security and reconstruction) of saving the at-risk companies.
Bibliography
Blinder, Alan, S. Keynesian economics. Indianapolis, IN: Liberty Fund
Incorporation, 2000.
Board of Governors of the Federal Reserve System. Open market
operations. Washington DC: Board of Governors of the Federal Reserve
System, 2013.
Brunnermeier, K. Deciphering the liquidity and credit crunch 2007-2008.
Journal of Economic Perspectives 23, no. 1 (2009): 77-100.
Couch, F., Foster, D. Malone, K. and Black, L. An analysis of the
financial services bailout vote. Cato Journal 31, no 1 (2011): 119-128.
Curtis, Antony. The review of literature for research. North Carolina:
University of North Carolina, 2011.
Dam, Lammertan and Koetter, Michael. Bank bailout, interventions, and
moral hazards. Frankfurt: Deutsche Bundesbank, 2011.
Federal Deposit Insurance Corporation. The banking crisis of the 1980s
and early 19901: Summary and implications. History of Eighties, 1
(1999): 2-86.
Ferrara, Peter. How the government created a financial crisis. New York:
Forbes LLC, 2011.
Genetski, Robert. How Keynesian economic theory contributed to the
financial crisis. Chicago: The Heartland Institute, 2011.
Igan, Deniz, and Mishra, P. Lobbying and the financial crisis. New York:
Vox Organization, 2013.
Jickling, Mark. Causes of the financial crisis. Washington DC.
Congressional Research Services, 2010.
Lilico, Andrew. What’s the alternative to another bank bailout?
Ontario: Telegraph Media Group Limited, 2013.
Malkiel, Burton, G. The efficient market hypothesis and its critics.
Princeton: Princeton University, 2003.
Miron, Jeffrey. “Bailout or bankruptcy?”Cato Journal 29, no. 1
(2009): 1-17.
Mishkin, Frederic, S. Over the cliff: From the subprime to the global
financial crisis. Journal of Economic Perspectives 25, no 1 (2011):
49-70.
Mortgage Bankers Association. Delinquencies and foreclosures increase in
latest MBA national delinquency. Washington DC: Mortgage Bankers
Association, 2008.
Nanto, K., Weiss, A., Dolven, B., and Cooper, H. The U.S. financial
crisis: The global dimension with implications for U.S. policy.
Washington, DC: Congressional Research Service, 2008.
Richman, M. Bill Clinton and the financial crisis of 2008. Philadelphia:
Temple University, 2012.
Siegel, Jeremy, J. Efficient market theory and the crisis. Neither the
rating agencies’ mistakes nor the overleveraging by financial firms
was the fault of an academic hypothesis. New York: Dow Jones & Company
Incorporation, 2009.
Yip, Jonathan. The bank bailout in perspective. Cambridge, MA: Harvard
Political Review, 2012.
PAGE * MERGEFORMAT 9

Close Menu