{"id":239,"date":"2014-07-01T22:50:07","date_gmt":"2014-07-01T22:50:07","guid":{"rendered":"http:\/\/blogs.stthom.edu\/cameron\/?p=239"},"modified":"2017-04-13T20:54:49","modified_gmt":"2017-04-13T20:54:49","slug":"did-government-housing-policy-cause-the-financial-crisis","status":"publish","type":"post","link":"https:\/\/blogs.stthom.edu\/cameron\/did-government-housing-policy-cause-the-financial-crisis\/","title":{"rendered":"Did Government Housing Policy Cause the Financial Crisis?"},"content":{"rendered":"

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The financial meltdown of 2008 impacted the global economy on an unimaginable scale. Many economists\u00a0consider it\u00a0the worst financial crisis since the Great Depression of the 1930s. It resulted in the threat\u00a0of\u00a0a\u00a0total\u00a0collapse of\u00a0the global\u00a0financial system, the bailout of many major banks by national governments, and downturns in stock markets around the world. In many areas, the housing market also suffered, resulting in foreclosures and prolonged unemployment.\u00a0With the large collapse, naturally, the blame is being pointed in\u00a0many different directions, but\u00a0mostly towards the United States\u00a0Government\u2019s Housing Policy.\u00a0Some\u00a0critics believe misguided laws and over-grown sponsored agencies allowed unethical lending and directly caused the crisis.\u00a0This post will further reveal that the government housing policy did not cause the financial crisis. The cause of the crisis can be linked to\u00a0predatory mortgage products,\u00a0loosely regulated\u00a0securitization and derivatives markets, and the failure of government regulators to crack down on the massive risk being taken by our nation\u2019s financial institutes.<\/div>\n

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Predatory Subprime Lenders<\/strong><\/div>\n
Predatory subprime lenders contributed to the cause of the financial crisis by participating\u00a0in unethical and deceptive lending practices.\u00a0Many firms, such a Countrywide financial, took part in classic bait-and-switch methods, advertising low interest rates for home financing (Sanchez, 2013). Such loans were constructed into extensively detailed contracts, and swapped for more expensive loan products on the day of closing.\u00a0Over time, as rates started increasing rapidly, consumers\u00a0were unable to fulfill their loan obligations.\u00a0The Community Reinvestment Act, which requires banks and savings associations to meet the credit needs of all segments of the community, only\u00a0accounted for 6\u00a0percent of the\u00a0high-cost mortgages during the time of 2004-2006 (Sanchez, 2013) and therefore cannot be blamed for causing the\u00a0financial crisis.\u00a0Likewise,by the time Fannie Mae and Freddie Mac lowered their underwriting standards in 2006, they were too late to the game to cause the subprime frenzy (2013).<\/div>\n

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Securitization and Derivatives Market<\/strong><\/div>\n
\u200bNext, the unruly securitization and derivatives market heavily influenced the destruction of the financial industry.\u00a0Prior to the crisis, many financial institutions became highly leveraged, increasing their tolerance of risky investments and reducing their\u00a0recoil in\u00a0case of loses. A majority of this leverage was achieved through the use of\u00a0complex financial instruments such as off-balance sheet securitization and derivatives (Scott, 2010).\u00a0From 2004-2007, the top five U.S. investment banks each significantly increased their financial leverage which increased their vulnerability to a financial shock (2010). The changes in capital requirements allowed lower risk weightings for AAA securities.\u00a0This caused the risk contained in subprime mortgage-backed securities to spread throughout the entire financial system.<\/div>\n

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Financial Deregulation<\/strong><\/div>\n
\u200bLastly and perhaps the most significant cause of the financial crisis was financial deregulation.\u00a0The failure of government regulators to eliminate predatory lending and over-leverage by financial institutions greatly\u00a0impacted the crisis.\u00a0The 1999 repeal of the Glass-Steagall Act effectively removed the separation between investment banks and depositary banks in the United States.\u00a0The Gramm-Leach-Bliley Act<\/a>, also known as the\u00a0Financial Services Modernization Act of 1999, further\u00a0removed\u00a0barriers in the market among banking companies,\u00a0securities\u00a0companies,and\u00a0insurance\u00a0companies that prohibited any one institution from acting as any combination of an\u00a0investment bank, a\u00a0commercial bank, and an\u00a0insurance company.\u00a0Additionally, causing more risk, the Commodity Futures Modernization Act of 2000 allowed financial products such as credit default swaps to expand without oversight.<\/div>\n

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In conclusion, it is evident that the United State Government Housing Policy did not cause the financial crisis of 2008. The true cause of the crisis was due to predatory mortgageproducts, out of control securitization and derivatives markets, and the failure of government regulators to crack down on the massive risk being taken by our nation\u2019s financial institutes.\u00a0To eliminate future financial shock, our government should\u00a0effectively create a well regulated housing system\u00a0that serves families and strengthens\u00a0communities.<\/div>\n

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\n

Joyce Chartouni Denison<\/a>
\nUniversity of St. Thomas, MBA student<\/p>\n

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References<\/b><\/div>\n
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Kuttner, Robert. \u201cDon\u2019t Blame the Dream of Home Ownership\u201d.\u00a0The Huffington Post.<\/i>\u00a03 June, 2014. Web.<\/div>\n
Sanchez, David. \u201cNo, Lending to Poor People Did Not Cause The Financial Crisis\u201d. \u00a0Think Progress.\u00a0<\/i>15August, 2013. Web.<\/div>\n
\n

Scott, Kenneth. \u201cFixing the Financial System\u201d.\u00a0Journal of Applied Corporate Finance. Volume 22, Issue 3.\u00a0<\/i>Summer 2010. Web.<\/p>\n

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