Through the years, most nations around the world have been working tirelessly towards the creation of a unified global market. This means that there has been a major pool of resources at work and as such, measures have to be taken to instill balance in the markets financial or otherwise in order to avoid any form of economic conflicts and crisis. In response to this, regulatory and deregulatory measures have been implemented globally in order to monitor and manage the effects that some institutions and trading markets may have on the overall financial environment. The effectiveness of the regulation and deregulation measures put in play has recently been questioned in relation to the current financial crisis. This paper shall therefore provide a detailed insight as to how the current regulatory and deregulatory measures contributed to the recent financial crisis. Also, recommendations shall be made as to how the scenario can be salvaged and the repetition of the same avoided.
Regulations refer to rules and statutes put in place by the government of a particular country in order to maintain and monitor the demand and supply of a given economy/ market. These regulations are often implemented in order to protect the public from economic exploitation through high prices and questionable qualities of goods and services. Deregulation on the other hand is the removal of some restrictions in a bid to encourage investments and also to create a free market with fewer government interventions. In the United States, the first regulations took place in the early 1900s in order to encourage private investors to produce public goods and services such as communication, energy, and water. This was because most investors naturally aimed at profit maximization and therefore neglected the production of public goods due to their inability to raise the same. During the same era, regulations were used to discourage and eventually ban monopolies, improve working conditions, wages, working hours, and living conditions of most workers. These regulations were slowly adopted by neighboring countries and eventually globally.
However, these regulations were hindering the true progression in economics terms and as a result, major deregulatory initiatives were taken from the 1970s to 2000. The first deregulation was in the transport sector during President Nixon’s era in 1971 whereby the government wanted to encourage private investors to have a share in the bus, rail and truck business. After this, many more deregulations have been implemented ever since up to date in almost all sectors of the economy.
Leading economists acclaim that the 2007 to date financial crisis is by far the worst since the 1930’s great depression. According to Snyder (38), the current financial crisis has to a large extent been brought about by failed capitalism and the inability of the US government to prevent this capitalism through proper and effective regulation of the financial systems. In addition to this, there have been other possible economic reasons that have led to the same. Factors such as economic policies, global business interactions, inflation, and income inequality are just among some of the causes of the current global crisis. This is so because the monetary value of any currency determines the wealth maximization or lack thereof for that particular country and the US dollar has in the past decade been in a depreciative state and this has led to failures of businesses and consequently low effective demand and wealth creation in most countries.
Regulatory causes of the financial crisis
The immediate cause of the crisis is believed to be the United States housing bubble which peaked between 2005 and 2006. This was brought about by the reduction of the borrowing rates whereby the federal reserves lowered the rates from 6.5% to a record low of 1.0%. This encouraged people to borrow loans and most of them reinvested the money in the real estate market which after 2005 seemed lucrative due to some changes in policy. Due to low-interest rates and large inflows of foreign currency, the housing industry in America attracted many investors into this sector and as a result, the amount of mortgage-backed securities (MBS) and collateralized debt obligations (CDO) increased significantly. These financial agreements get their value from house prices and mortgage payments.
Horowitz acclaims that as the housing prices declined many financial institutions and investors who had borrowed to capitalize on the opportunity recorded high losses to an extent where other institutions had to close down (56). In addition to this, most houses were worth less than the mortgage loans attached to them, and as such this consumed much wealth from the consumers and the banking institutions that gave out these loans. Total losses in this sector are estimated to reach trillions of dollars throughout the world. If regulatory measures were taken in relation to awarding loans and restricted investment in the housing sector, then the supply of houses would have been controlled and as the law of supply states, the lower the supply, the higher the prices, and this would have minimized the chances of the financial crisis taking such devastating toll in our economies.
Another factor that led to the crisis was the increase in debt burden that ensued before the crisis. Statistics reveal that the amount of household borrowing in relation to their annual disposable income was at 127% in 2007 as compared to 77% in 1999. This was brought about by high inflation rates and high costs of living in most countries around the world. In addition to this, most banks in a bid to have a competitive edge had lowered the collateral requirement attached to the loans. Many banks up to date offer loans with amounts higher than the collateral provided as such if the clients cannot pay off their debts the banks are left with hefty debts which after accumulating leads to their foreclosures.
To action this, the debts owned by private investors and households the n US were at 123% of the GDP in 1981 and constantly rose up to 290% in august 2008 yet there were regulations set to monitor this level within a specific limit. This left people with less disposable income as much of their money goes into servicing these loans. Consequently, the investments level went down and so did the GDP leaving the government with inadequate financial resources to improve and facilitate key economic changes. Also, some of the top investment banks in the US had increased their financial leverage significantly. This made them more susceptible to a financial shock and as the depression set in, it left most of them put under receivership, closed or in need of government support. This reduced the number of investments in the US and also lowered the GDP level even further.
There has also been a problem in cross border/ cross functional regulations in the financial sector globally. These regulations were put in place to ensure that there was sharing of information between international and regional financial institutions. As a result most financial institutions did not show effectiveness of this sharing before the financial crisis which would have otherwise provided valuable information about the vulnerability of some financial and marketing policies to such crisis. This information would have been useful in formulating measures that would have helped avert this crisis.
The global economic crisis resource center states that the regulatory changes made in the Gramm-Leach-Bliley act in 1999 which removed all barriers to competition between the various types of banking institutions had a hand in the financial crisis (27). This act allowed financial institutions to take part in the three financial markets; banking, investment and insurance. As a result the competition between these firms became unhealthy leading to development of financial products such as the shadow banking system that intentionally went around the set regulations and contributed highly to the US financial crisis.
Deregulation of the transport and communication sectors also contributed to the financial crisis. Due to the right to privacy, the government never foresaw the terrorist attacks that happened in America and other countries. As a result of this, many investors hesitated to invest in the states due to fears of loosing their investments in such attacks. Also before the attacks there was free entry and exit in the states which increased the number of investments from foreigners. After the attacks the government put in place heavy trade policies and bans to countries they suspected to have terrorist links and also deported many people who were suspected to be terrorists’ affiliates. This reduced the GDP and the amount of money received from international trade.
Remedies and recommendations to the crisis
With the above insight in mind, there is need to reconfigure and redesign the regulatory systems in place in the financial industry. According to Horowitz it is always important to have some sort of financial forecast report which would help analyze the financial situations of the various economies (120). But for this to work, retraining programs have to be initiated so that financial supervisors are equipped with the knowledge of how to avoid and solve financial issues that may lead to a yet another financial crisis.
In the future, the world should work on a plan to get a single global currency. This is because financial crisis was partly caused by the depreciation of the US dollar in comparison to other currencies. The use of one currency would efficiently make use of price legislation and consequently the effects of inflation and deflation to the economy. In addition to this, there is dire need to change the banking principals that regulate the granting of loans to investors, financial institutions and households. The Federal Reserve should increase the credit ratio and bank rates to ensure those banks and other financial institutions do not give loans as easily as they are currently doing. Herigstad literates that strict lending policies are the only remedy towards the high inflation and debt burden that are being experienced in all countries around the world. He insists that high financial discipline needs to be exercised by all if the world wants to recover fully from this crisis and as such it is the duty of everyone to change their saving and spending for the better of the whole economy. However, new regulations and deregulations ought to be drafted and made public so that everyone understands what they are supposed to do and the consequences of deviating from the set rules and regulations to their future (99).
It is also evident that the regulatory boards have been compromised and focus mainly on the institutions rather than the consumers. Therefore there is need to create laws that safeguard against such actions. Such tendencies fall under the corrupt and fraudulent category and the perpetrators and the companies they represent should be shut down before they cause more instability in the global economy.
Another future remedy would be the change in the education system as regards to the preparation of model self-sustaining citizens. The world is currently characterized by inequalities, unemployment, and lack of resources. Many of the people experiencing these difficulties are well learned but lack the opportunities to better themselves. This is because most of them have the mindset that they are learning to get jobs which is what the current education system is teaching. Due to the changes, the education systems should concentrate more on equipping the students with entrepreneurial skills which will enable them to be self employed and give them an equal chance to fight for resources. In addition to this, these skills have been known to enhance innovativeness and creativity in people which consequently improves productivity and the financial status of an economy through increased GDP.
Jansen et al (17) acclaims that the subprime mortgages contributed highly to the US financial crisis. In their book they insist that this crisis was due to loose monetary policies and regulations governing the banking systems and housing sector in the US. To curb this, the government should try and control the number of investments that are in the various sectors in order to avoid oversupply of such commodities and also the prices of the same. They should also ensure equal regional development and distribution of resources in order to promote equality.
From the above discussion we have seen the impact that regulations and deregulation had in the financial industry. Also an insight has been provided as to how laxity in policies and regulations can damage an economy and eventually the whole world. Recommendations have also been made as to how best a similar situation can be avoided in the future. If these adjustments are made in the global financial industry, then everyone is bound to enjoy some financial freedom within this important road to recovery.
Global Economics Crisis Resource Center. “Global Economic Crisis: Impact on Finance.” Cengage Learning, 2009
Herigstad, S. “Help! I Can’t Pay My Bills: Surviving a Financial Crisis.” St. Martin’s Press, 2006.
Horowitz, S, A. “The political economy of international financial crisis: interest groups, ideologies, and institutions”. Institute of Southeast Asian Studies, 2001.
Jansen, L, H, et al. “US Subprime and Financial Crisis – To what Extent Can You Safeguard Financial System Risks?” GRIN Verlag, 2009.
Snyder, F, G. “Regional and global regulation of international trade Studies in European law and integration”. Hart Publishing, 2002.