Financial Crisis of 2008 and Formulation of Economic Policies

Question: Discuss the reasons for policy formulation and implementation and policies formulated and their nature? Answer: Introduction The Great Recession roots back to 2004 when there was a sudden increase in interest rates in the housing sector. This increase resulted in increase in defaulters of subprime mortgages throughout America. Later in 2007, this came to be known as the Subprime Mortgage Crisis. As a result, biggest mortgage firms became insolvent. This crippled the secondary mortgage market and an increased unemployment. The real estate and the banking sector collapsed. Reasons for policy formulation and implementation The situation continued and by 2008 two of the housing giants in America; Fannie Mae and Freddie Mac filed bankruptcy and announced that they would not invest in risky RMBS or CMBS through securitization. This affected big hedge firms such as Bear Stearns, a large portion of whose capital base was tied up in subprime mortgages. Large business houses announced their inability to cope with the situation and wanted to revise their financial statements. International finance organizations closed doors for American firms as a fair valuation of the firms were unable to be arrived at. The stock market lost points rapidly as high interest rates discouraged the investment mentality of multinationals. In such a volatile investment scenario, credit rating of American securities and companies fell to a great extent as rating agencies downgraded them to lowest investment ratings. The banking sector suffered tremendously and there was gigantic increase in NPAs and they had no option to clear their balance sheets. Ultimately, the fall of Lehman Brothers market the beginning of the financial crisis. Economic growth came to a halt with an increase in the unemployment rate to almost 8% (Ncpa.org, 2015). Policies formulated and their nature The crisis made business environment in the country volatile with an acute unavailability of investment opportunities. Consolidated fiscal policies were required to be taken to counter the situation and bring about stability in price fluctuations. Thus, the following economic, fiscal and monetary policies were formulated and implemented by the administration: Dodd-Frank Act and Consumer Protection Act Objective of passing the act was to prevent the collapse of financial intermediaries such as banks, stockbrokers, insurance companies etc. Systemically important institutions and core investment companies availed a protection under this act in case they required a bailout by the government. Bailing out of money market mutual funds The Treasury department announced a financial assistance of $50 million for money market mutual funds to secure their investments. Short selling was terminated for a substantial number of stocks and changes in the required regulation were undertaken. Bailing out Fannie Mae Freddie Mac The Federal government utilized the $700 billion fund, Trouble Asset Relief Programme (TARP) to bail out the housing giants and buy other mortgage backed securities to stabilize the housing sector (2015). Other Legislations passed In an attempt to stabilize the market the following legislations were passed: Emergency Economic Stabilization Act, 2008 with a bailout corpus of $700 billion Stop Fraud Act which increased penalty for defaults in mortgage payments American Reinvestment and Recovery Act (ARRA) Other measures taken The following are the other major initiatives taken under the new economic policy: Creation of a stimulus of $787 which was later increased to $862 Tax reliefs in the form of cuts Government repurchases in tranches for two years Passing of agriculture and Housing Bills in 2007 Additional mortgage relief subsidies Lowering of interest rates to promote investment Debt reliefs to increase consumption Measures to increase employment opportunities Constitution of major commissions and boards to regulate and monitor the financial system and market Analysis and Conclusion Economists and scholars of political science describe the natures of the policies undertaken by the Obama administration to be similar to Keynesian theories as the policies deal with the acute problems of unemployment, tax structure and government expenditure. The government expenditure multiplier played a pivotal role in the policy formulation. The total expenditure during the period was estimated to be $4 trillion and the multiplier was calculated to be more than one which turned out to the most significant factor (2015). The policy measures somewhat were not up to the mark and the growth of the economy did not prove to be robust. The targets were missed by miles and the fragile situation of the regulatory environment proved disastrous. The inverse relationship of real GDP and unemployment was severe and the promise of price stability was not fulfilled by the administration. Though the choice of the policies seemed rational, but the politics of the elite was evidently visible. Big firms were bailed out without any inconvenience but the common people of the country had to face the wrath of the Stop Fraud Act. Due to the unfortunate fact of massive downsizing ratio of debt obligations and disposable income reached almost 135% (2015). The policies failed to repose the confidence of the investors and rising debt diminished consumption patterns. Thus, a number of political theories were evident in the economic policies. References (2015). Retrieved 12 July 2015, from https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf (2015). Retrieved 12 July 2015, from https://fas.org/sgp/crs/misc/RL34742.pdf (2015). Retrieved 12 July 2015, from https://www.atu.edu/jbao/Economic_Policy_and_the_Current_U_S_Recovery.pdf Ncpa.org,. (2015).Which Federal Policies Help or Hurt Economic Growth?. Retrieved 12 July 2015, from https://www.ncpa.org/sub/dpd/index.php?Article_ID=22419