We Cannot Grow Without Accepting Our Weaknesses: The Economic Meltdown of 2008

I recently sat in on a Q&A with Federal Reserve Chairman, Ben Bernanke. It was aimed to answer questions that rose from our recent economic crisis and to help students of all ages understand the importance of personal financial literacy. Some key lessons/ideas I will seek to grow from:

Greatest Success and Greatest Failure of The Federal Reserve

During the Great Depression, the Federal Reserve failed to boost the money supply and stabilize the financial system. Consequently, in 2008-2009, the Fed took this lesson to heart—they prevented deflation and kept the banking industry from collapsing. A great achievement was in the 1970’s. The Fed brought down inflation, conquered it and achieved great prosperity. He urged the importance of students needing to understand the elements of stability and crisis management from the past and present.

 

Role of the Media in Consumer Confidence

The media controls a large portion of consumer and business confidence. We should keep a healthy amount of skepticism and decide for ourselves before placing too much or too little confidence in our economic health. We need to think for ourselves with a wide variety of sources (newspapers, channels, politicians and economists). Those who have prospered have always kept this in mind.

Monetary vs. Fiscal Policy

It is importance to know the difference because the Fed only deals with monetary policy. The Fed works independently from Congress its Fiscal Policy therefore, maintaining their nonpartisanship. Although we’re in a recovery, we are still struggling. According to Bernanke, we cannot cut taxes while increasing spending all at once. However, we need to be expansive in the short run and frugal in the long run. It’s a challenge. We need to somehow persuade the public that we need to tackle our long run debt and will in turn give us more space to be expansive.

Banks: Raise or Lower Risks?

Raising risks brought on the recession but not taking any risks has slowed down our growth. Should banks seek to build capital and stabilize or make more loans? Bernanke proclaims that banks should make loans to good borrowers to build capital—great for both businesses and our economy. However, we should now take a “balanced and appropriate” approach: healthy risks and lots of help for small businesses (85% of our economy).

The recession ended in June 2009. Why is there still slow growth?

Bernanke states, “It is not uncommon for recovery to be slow after such a financial crisis.” He mentions that banks were reluctant to make loans and cater to household finances. Consumers are saving (finally!) but spending has decreased. Ultimately, even though our labor market is expanding, we still feel little growth. Bernanke concludes that the suffering is diminishing and we should continue being hopeful.

What if the Fed didn’t collaborate with the Government?

Its true: we basically bailed out Wall Street. A combination of subprime mortgages, greedy business executives, and the lack of business regulations was the root of the bailouts.

This Frontline video is one of my favorites and it thoroughly explains the financial crisis of 2008.

Basically, loans were given to homebuyers despite investment banks being aware of its high risk. Insurance companies, like AIG, backed these loans with phenomenal ratings, entrusting them to attract other investors. Keep in mind that these insurance agencies maintain peoples pension and hedge funds. Companies like Goldman Sachs allegedly sold these loans, aware that they would fail, and bet against them (synthetic collateralized debt obligations).

In the end, the burden is left on the taxpayers.

So in 2008, the Fed had no choice but to step in. They tried to prevent a collapse of our economy, not to save Wall Street. They knew from history that the financial system is too important…its collapse would have been beyond devastating. Bernanke reiterates, “Although it was distasteful, it was necessary.” In September-October 2008, we came very close to a global financial system collapse. Actually, a couple of nations did have their economy collapse but most nations began issuing bailouts to prevent a deeper, greater meltdown. If the Fed did not collaborate with the Government, people would lose investments, retirement, and the wounds from this recession would be far from healing years later. It was all a successful attempt. The Feds actions were necessary because it affected every single American. In retrospect, we prevented being in a graver state like other nations. Many companies are also paying back their bailouts with interest. Bernanke concludes that, “as an economic historian, we really had to keep it from being worse.”

The toughest situations have the least popular policies. Patience and trust has never been so important, even beyond our economy.

Dodd-Frank Wall Street Reform and Consumer Protection Act

I’m a business major but even I cannot ignore the need for reform. The Dodd-Frank/Consumer Protection Act passed in July and was comprehensive enough to mend our errors. It makes fundamental changes in our financial system: creates a stability oversight council and brings together the heads of all financial agencies. This reform greatly strengthens the provisions for regulators to oversee individual as well as the general whole of the various institutions. It closes many existing gaps in our system (there were previously no legal requirements for investment banks to be regulated).

It also creates a consumer protection agency. It has provisions that make bailouts unnecessary and illegal. We will have an agency to oversee it in the case that an institution is collapsing and the government will “size it down with no tax dollars spent…this legislation is, by far, the most sweeping since 1930”. The Great Depression lead to the creation of the FDIC and The Meltdown of 2008 lead to the Dodd-Frank/Consumer Protection Act.

So what’s an important lesson for our future generation: the students?

At the macro-level we can take note of how damaging financial instability can be on our society as a whole. Contrary to what I felt before, I’ve realized the enormous importance of Wall Street. Its near collapse jumpstarted a series of bailouts that were, regretfully, necessary. At the micro-level, we can learn a lesson in personal financial literacy. The basics of saving and budgeting as an individual have never seemed more crucial.

Note: I really do appreciate all the support, praise, and constructive criticism I receive. I don’t know why more people don’t question my thoughts and ideas because I’m pretty debatable. I cannot hope to improve my style or rhetoric without criticism.