Financial Fiasco Paper
Financial Fiasco: How America’s Infatuation with Home Ownership and Easy Money Created the Economic Crisis is a book written by Swedish writer Johan Norberg, which traces the causes of the late-2000s financial crisis, showing the mistakes made in by the Federal Government in Washington D.C., politically connected finance institutions on Wall Street, and in communities across America that led to the economic meltdown. While many analysts have placed the blame solely on Wall Street, Norberg exposes the crucial role government regulation played in creating the opportunities and incentives that led to the financial collapse. (Cox, 2009).
In six concise ...view middle of the document...
- How Wall Street dove into the hunt for more risk with particular enthusiasm, creating exotic financial instruments to satisfy the voracious global appetite, including mortgage - backed securities and collateralized-debt obligations.
- How securities largely based on mortgages of inferior quality obtained excellent grades from the credit-rating agencies - convincing most people that the financial market had finally discovered the secret of alchemy - how to turn lead into gold.
- Why if we really want to make future financial storms less severe, we should start by abolishing bailout plans and deposit insurance, so that banks would be forced to think about what risks they can really bear.
Let’s now take a look at each chapter separately and analyze it more in detail.
The first chapter describes monetary policy of the U.S. during the early years of the 21st century. Johan Norberg contends that by keeping the interest rates very low the Federal-Reserve led by Alan Greenspan encouraged risky lending practices. This risky lending coupled with the surpluses from the emerging markets flowing into U.S. financial markets provided easy money to everyone. The major beneficiaries of this easy money were the real estate and the U.S. financial markets - for instance between 2000 and 2005 the value of the U.S. single-family homes increased by $8 trillion dollars. The low interest rates also discouraged savings and encouraged consumption expenditures financed by low-cost debt. According to Norberg, such monetary policy is unsustainable and results in depression.
The following chapter is an account of the U.S. housing policy of expanding home ownership practiced during the last few decades. These policies in essence resulted in lax credit standards and unscrupulous lending. Norberg blames many actors in this game of "building castles in the air (Norberg, 2009)": HUD, Fannie Mae and Freddie Mac, the 1995 tightening of the Community Retirement Act, architects of federal government housing policy, corporations compensation schemes, lenders, and the ordinary people. The policies and actions of these actors accentuated the lax lending of the easy money to even the subprime and other borrowers who did not have the real financial ability to own a house. This ultimately led to wide spread foreclosures across the United States.
In Chapter 3 the author postulates that innovative financial engineering/alchemy was also a major factor responsible for the Great Recession. The innovative financial instruments include the securitization of mortgage loans into Collateralized Debt Obligations (CDO). The CDO comprised various trenches based on their levels of risk; even the lowest trenches received mostly high ratings from the rating agencies which had now immense authority from the federal government. A related financial innovation was the very lucrative 'off-balance...