Cause_of_Crisis

Ethan Williams The Financial Crisis: Failure of Capitalism' In 2008 our economy was hit by the most powerful financial crisis this country has seen since the great depression. The popular diagnosis has been focused on the deregulatory policies and free market capitalism. The greedy risks that large corporations took to turn a profit received most of the blame for the massive downturn. However, when one looks more closely at the underlying issues, this doesn’t appear to be the case. Capitalism did not fail, primarily because in the States we have a mixed economy, not a free market. Preceding the crisis, large corporations such as AIG, JP Morgan, and commercial banks would trade credit default swaps (CDS), which is basically an insurance policy paid by the consumer to the seller that will hold the seller responsible if the credit defaults. These corporations assumed these investments were sound and did not expect the underlying loans and mortgages to fail. Suddenly many consumers began to default, leaving the companies unable to pay the fees. The underlying question is this: what caused so many consumers to default on their loans' The government had been pushing for an increase in home ownership through a process of subprime loans. Two highly regulated government sponsored enterprises, Fannie Mae and Freddie Mac, bought loans from banks and repackaged them into secondary mortgage securities to sell. In an attempt to meet the Urban Housing and Development goals, regulators increased the required percentage of low-income loans, reaching 56% of Fannie and Freddie’s total business. With Fannie and Freddie’s federal backing, they held a monopoly on the secondary mortgage market. Before these government mandates and monopolies, corporations rarely granted subprime loans because of the high risk involved. These risky actions would not be seen in a free market. These loans, in part, resulted in the widespread defaults. Another method used to increase home ownership was the Fed’s lowering of interest rates. Individuals, who otherwise could not afford these homes, believed these low interest rates were an opportunity to buy a nice home. As housing demand increased and interest rates remained artificially low, prices went up. This increase in prices did not reflect the actual value of the homes being sold, resulting in a housing-market bubble that eventually burst. As the housing market returned to realistic values, many homeowners were forced into default on their loans. Preceding the crisis, the government intervened and manipulated the free market through various means. This makes it difficult to pin the blame directly on the use of the free market. In such a market, corporations that make unnecessary risky decisions will be forced to endure the consequences through profit loss or bankruptcy. Corporations would not have the option to defer their own risk through government sponsored enterprises and receive massive taxpayer bailouts for their failures. It becomes obvious that our mixed economy has caused many of the issues seen in the crisis through its government manipulation of the free market. Only through the removal of these government sponsored enterprises and a move towards real free market capitalism can the nation expect to see real economic growth. This will allow for businesses to succeed or fail based on the merits of their own decisions and not provide a safety net over which corporations can seek to maximize their profit with the security that the federal government is covering for their mistakes.