In 2007, the world faced a financial crisis that was even worse than the Great Depression that happened in the 1930s. This crisis went on until 2009, and it led to many people losing their jobs and means of living. Housing prices also dropped precariously during this time, leading to the Great Recession. By this time, the global financial system was at the brink of collapsing, with stock prices declining sharply and uninsured financial institutions bailing out to save themselves from bankruptcy.
A study done by Atkinson, et. al in 2013 revealed that this crisis cost the U.S. an estimated 6 trillion to 14 trillion dollars, which is 40 to 90% of its output in a year.
What Caused the Crisis?
Several factors were believed to have caused the great financial crisis. One contributing factor that was believed to have triggered it was the U.S. housing market. The first signs of the problem began to be visible in 2007 when New Century Financial Corporation filed for bankruptcy. The company was a provider of housing loans to risky borrowers. At about the same time, Freddie Mac, a public enterprise sponsored by the government to provide affordable homes to the masses, announced that it would stop purchasing high-risk mortgages. In the same year, many borrowers also defaulted on their housing loans and credit default insurance. August 2007 saw massive withdrawals of short-term funds in markets that were considered to be safe, and this was believed to have been caused by the sharp decline in housing rates.
The massive decline in the credit and financial market worsened in early 2008, with lending institutions reporting losses and giving in to the problem. Even the major mortgage lenders in the U.S. collapsed during that time, and they had to be taken over by the government. The crisis dragged on until 2009, with more institutions filing for bankruptcy one after the other.
Several systems were put in place to solve the 2007-2008 economic problem. These include the Troubled Relief Asset Program and the Economic Stimulus Package proposed by Obama in 2009. In 2010, a comprehensive financial reform legislation was also passed. This was the Dodd-Frank Wall Street Reform and Consumer Protection Act or the Dodd-Frank Act. The primary purpose of the Act was to improve the accountability and transparency in the United States’ financial system and to protect the consumers widely. The Act was named after its makers: Senator Chris Dodd and Congressman Barney Frank.
Many reform provisions were included in the Dodd-Frank Act. These include standards for residential housing loans, requirements for banks to have contingency plans if they ever run of out funds or if they are approaching bankruptcy, identifying risks that affect the financial industry, protection of consumers against the abusive business practices of banks, encouraging agencies to give reliable credit ratings to applicants, and requiring financial institutions to increase the amount of funds they must hold to protect them against future economic slumps. With these provisions, government agencies were created, such as the Financial Stability Oversight Council (FSOC), the Consumer Financial Protection Bureau (CFPB), the Office of Credit Ratings, and the Federal Insurance Office.
The FSOC was tasked to oversee the stability of the financial system. Part of its primary responsibility was to identify risks that were likely to affect the financial system of the US. The CFPB, on the other hand, was tasked to alleviate the abusive practices that banks and other financial institutions have against consumers. The Office of Credit Ratings was tasked to make sure that institutions evaluate credit applicants appropriately. The Federal Insurance Office was established to collect and analyze data regarding insurance.
The Dodd-Frank Act also placed restrictions on the ways banks can invest. It removed propriety trading to reduce the possibility of conflicts of interest. Additionally, the Dodd-Frank Act also encouraged people to report any violations of the Act to the government. Whistleblowers are given a reward for each information they provide.
Since then, a massive change has been made. Refinancing and loan modification systems have helped millions of homeowners who are struggling with their loans and are facing potential foreclosure. Federal programs, such as those provided by the Federal Home Association, the Department of Veterans Affairs, the Department of Agriculture, and many others, continue to help people obtain new homes with lower interest rates.
Despite this, the Dodd-Frank Act still has many critics. Many think that the regulations and provisions of the Act are too stringent and may hinder economic growth. They also think that the provisions of the Act may only make it hard for the US to compete in the international markets.