The Role Of Financial Deregulation in the 2008 Crisis

The 2008 financial crisis, also known as the Global Financial Crisis, was a severe worldwide
economic downturn that began in the United States and quickly spread across the globe. Its
roots can be traced to the housing bubble in the U.S., which was fueled by an excessive
availability of low-interest mortgages and lax lending standards. Banks and financial
institutions began issuing subprime loans to borrowers with poor credit histories, which
increased home ownership but also led to a risky accumulation of bad debt.

As the housing market boomed, many financial institutions packaged these mortgages into
complex financial products called mortgage-backed securities (MBS) and collateralized debt
obligations (CDOs), which were sold to investors including other banks, insurance
companies, and pension funds, under the assumption that they were low-risk because they
were backed by real estate. However, the true risk of these securities was grossly
underestimated.

When housing prices began to decline in 2006 and 2007, many borrowers began to realise
that they had negative equity or in other words, they owed more on their homes than the
house was actually worth. The crisis intensified in September 2008 which aggravated a rapid
rise in mortgage defaults especially among subprime borrowers. These defaults led to a
sinking in the value of MBS and CDOs which led to immense losses through institutions
holding these securities.

The breakdown came to world prominence in September 2008 when Lehman Brothers, a
major investment bank in the U.S. declared bankruptcy. This event shocked the global
financial markets, leading to panic and a universal loss of confidence. Financial markets
tumbled, financial institutions proved shy to lend to other institutions resulting in credit
crunch.

Governments and central banks around the world responded with emergency measures,
including massive stimulus packages, interest rate cuts, and bailout programs to stabilise the
financial system. In the U.S., the Troubled Asset Relief Program (TARP) was introduced to
purchase toxic assets from banks, while the Federal Reserve slashed interest rates to near
zero. Other nations, including the U.K. and some European countries, also came up with the
same measures to avert bank failure.

The 2008 financial crisis had a profound impact on the global economy, triggering a severe
recession and leading to significant GDP contractions in many countries. Unemployment
rates surged resulting in millions of job losses. With the collapse in housing markets, home
values plummeted resulting in a surge in foreclosures on account of higher defaults. The
financial crisis saw many banks, insurance companies, and any investment related firms
across the world reporting significant losses. In the United States, Citigroup and AIG
required government bailouts in order to avert an even bigger systemic collapse while in
Europe Northern Rock faced near total collapse along with major intuitions in Ireland and
Iceland they also had to be rescued. With the substantial bailouts and stimulus packages
being handed over by the Governments to stabilise the situation, the overall debt burden
increased significantly impacting the fiscal policy for years ahead.

The crisis led to significant regulatory changes aimed at increasing oversight and reducing
systemic risk.The credit crisis and financial regulation reform in the United States was
introduced in 2010 under the name of Dodd-Frank Wall Street Reform and Consumer
Protection Act. It decided with the Volcker Rule which acts as part of Dodd-Frank that
prohibited such self-financing trades. In Europe, measures to enhance the operations of
financial markets and minimise the risks were implemented.

The public reaction to the financial Crisis was marked by widespread anger, fear, and
distrust toward financial institutions and government entities with many individuals feeling
betrayed after losing their homes, jobs, and savings. People were outraged by the
recklessness with which the financial institutions engaged in risky lending and created
complex financial products that contributed to the crisis. The massive bailouts to these
institutions, funded by taxpayer money, further fueled public resentment, leading to
movements such as Occupy Wall Street.

The 2008 financial crisis also changed the way central banks approached economic policy.
To stimulate growth, the Federal Reserve along with other central banks began using
unconventional tools like quantitative easing—buying financial assets to inject money into
the economy and keep interest rates low. These measures have since become standard
tools to combat economic downturns.

To summarise, the 2008 financial crisis was a result of risky lending practices, poor
regulatory oversight, and the widespread use of complex financial products. It led to a global
recession, prompted massive government intervention, and sparked a wave of regulatory
reforms to safeguard the financial system against future crisis.
 Analysis
The 2008 Global Financial Crisis was a departing point of the present day global financial
system and from my perspective, it was a wake-up call for the over-extended greed, lack of
regulation and highly risky financial much more than markets but of confidence among
international organisations.
This analysis will review the causes of this crisis, regulatory breakdowns, responses and
some critical lessons that are still useful in developing a more stable future economy.

The key events that contributed to the 2008 financial crisis:

● Lack of oversight and Deregulation: The seeds of the crisis were planted in the
late 1990s with financial deregulation. The repeal of the Glass-Steagall Act in 1999
allowed banks to combine commercial and investment banking operations, while the
Commodity Futures Modernization Act of 2000 permitted unregulated trading of
complex derivatives, like Credit Default Swaps, increasing unchecked risks through
the financial system.
● Low Interest Rates and New Investment Avenues for Investors: When the
dot.com bubble burst in the year 2000, the Federal Reserve lowered the interest
rates to spur growth. This led to the availability of cheap credit that investors seeked
to exploit for investments in real estate which later fueled a speculative bubble in the
housing sector.
● Role of Banks in aggravating the asset bubble: Banks, in order to gain from the
housing boom, aggressively issued subprime mortgages to borrowers with poor
credit histories. This allowed borrowers to take on more debt than they could afford.
Such lax lending standards created a vicious cycle in the housing market further
fueling the bubble.
● Securitization: Banks developed Mortgage-Backed Securities (MBS) and
Collateralized Debt Obligations (CDOs), bundling subprime loans into investment
vehicles. These securities attracted substantial global investments, incentivizing
lenders to issue more subprime mortgages. Trading of financial derivatives such as
Credit Default Swaps, created additional layers of risk.
● Failure of Credit Rating Agencies: Credit rating agencies significantly contributed
to the crisis through their overrating of MBS and CDOs, which contained a significant
portion of subprime mortgages. This misled investors into believing these securities
were low-risk, despite the underlying assets being questionable.
● Housing Bubble Burst and Immediate Impact on Markets: Housing prices peaked
in 2006, and then began to decline. Many borrowers, for whom their mortgages
became larger than what the home was worth, simply defaulted causing MBS and
CDOs to collapse.
● Financial Collapse and Credit Crunch: In September 2008, bankruptcy of Lehman
Brothers sent shockwaves through global markets, exposing the gravity of the
situation creating a domino effect in the markets, leading to severe contraction in
economic activity and resulting in a global recession This was followed by credit
crunch as banks became more risk-averse and reluctant to lend. The inability to
refinance or obtain new mortgages led to a spike in home foreclosures, further
depressing the housing market and contributing to the downward spiral of the
 economy.

Executive and Legislative Response of the U.S. Government

The collapse of the U.S. housing market triggered global repercussions, leading to massive
losses for firms invested in mortgage-backed securities. While Lehman Brothers and Bear
Stearns went bankrupt, the government intervened to bail out systemically important
companies like AIG and Citigroup which were considered ‘Too big to fail’.

To prevent a financial system collapse, the U.S. government initiated the Troubled Asset
Relief Program (TARP), to purchase the distressed assets of banks. The Federal Reserve
deployed Quantitative Easing apart from lowering the interest rates to near zero, in order to
get the economy moving.

The 2008 crisis led to significant regulatory reforms, including the 2010 Dodd-Frank Act and
Consumer Protection Act, aimed at increasing financial transparency and oversight. It
tightened mortgage lending rules, created the Consumer Financial Protection Bureau
(CFPB) to rein in exploitative practices that was the chief stimulus for the huge housing
bubble. The act established the Financial Stability Oversight Council to address systemic
risks in the financial system. The Act mandated greater transparency and regulation of the
derivatives market. It also established higher capital adequacy requirements for large banks
and financial institutions.

Impact of the Crisis on India

India's limited exposure to US mortgage-backed securities and strong regulations shielding
against reckless lending minimised the impact of the 2008 crisis. With an economy driven by
domestic consumption, proactive government measures like fiscal stimulus and RBI rate
cuts stabilised growth. While exports declined and GDP slowed to 9%, India's solid
foundation helped it weather the global downturn better than most other economies.

Lessons Learned
The 2008 crisis merits stronger regulation, oversight, transparency and accountability
standards in the financial markets. Continuous learning involves adapting regulations to the
changing markets, keeping an eye on risky financial innovations and maintaining
international financial stability. An increasingly complex and interconnected financial system
demands it, so as to prevent or minimise the impact of future crises.