Posted by Rico K Setyo
By Harrison Hong
What a year! Lehman Brothers collapsed on Sept. 15th, 2008. The Dow Jones Industrial Average dropped by 43 percent. And since March 2009, the market has rallied and made up a significant fraction of its losses. The basic storyline for the financial crisis and recovery is familiar. The housing bubble deflated. Banks were caught holding over-valued exotic mortgage instruments bought using short-term debt. The Federal Reserve Bank and the Treasury bailed out finance firms both directly through giveaways and indirectly through the purchase of an array of assets. It’s anybody’s guess whether this crisis will return when the government withdraws its support.
What is clear is that this crisis reveals deep flaws in the financial system. In light of the millions of Americans out of work and the costly bailouts, many understandably believe one of these flaws to be bankers without principles who took excessive risks and endangered the economy. Reforms proposed by the Obama administration reflect this perspective. These proposals include a new consumer finance protection administration, attempts to link pay to longer-term stock performance and capital regulation to limit access to extreme leverage.
Some version of these proposals will likely be implemented, but its ability to prevent another crisis is far from clear. First, many of the subprime loans that are thought to be predatory and would presumably be forbidden by the new consumer finance administration actually gave many families free housing for some time. Second, these free homes ultimately came at the expense of sophisticated bankers (at least those who were not bailed out) who owned lots of shares of their company’s stock. And third, there have already been several attempts at improved capital regulation, known as the Basel Agreements.
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