As aforementioned, semi-independent organisations were established by the government to be a check on the banking system, and thus this section shall focus on the neoliberalist argument that they were virtually ineffective and acted as regulation that hindered the banking system, rather than providing a healthy check on it (Pelaez & Pelaez 2009 p235). Furthermore, neoliberals blame the Federal Reserve for not acting quick enough to save the banks, and as such place more blame on the government and its so-called semi-independent institutions, such as the FHA, who were responsible for providing a check upon the CRA legislation by promoting more credit to poor borrowers by offering low-deposit loans (Butler 2009 p54). However, instead of providing a check on the system, the FHA clearly helped add to the problem by offering even more ridiculous loans to people who could not afford to pay their mortgages. In contrast, the SEC were effectively made the supervisors of the five largest investment banks, and by doing so rebranded the investment banks to be Consolidated Supervised Entities (Taub 2011 p197). This form of regulation was largely ineffective due to the fact that the five investment banks under its watch were at the epicentre of the financial crisis. Bear Stearns and Merrill would have failed and defaulted without government-subsidised rescue, whereas Morgan Stanley and Goldman raised capital on their own to survive (Taub 2011 p197), but had to borrow out of the arguably ‘anaemic’ Federal Reserve (Taub 2011 p188, Gamble 2009 p55, Schwartz 2009 p45). Additionally, as will be seen in detail later, the Lehman Brothers filed for bankruptcy (Williams 2010 p165). To summarise, the neoliberalists believe that the government was largely at fault for what occurred before 2008. This is due to the damaging legislation signed into law, such as the CRA. It was this legislation that allowed the banks to commit to such terrible economic decisions, such as subprime loans. Also the semi-independent institutions were ineffective and should have in fact had stronger regulatory powers so that the financial crisis could have been stemmed from the beginning. Whilst the sentiment behind the legislation is admirable, it is impractical to assume that by allowing people to take out mortgages not dependent on their income could have resolved the home ownership problem of low-income families in the US, especially when dealing with banks that have such a global impact.
Despite this, there are a wide variety of critiques and schools of thought that would argue otherwise. Critics of neoliberalism argue that there were three main flaws of their theory that caused the financial crisis of 2008. These are the public interest view, the private interest view, and deregulation of the banks. The first, the public interest view, states that the government should have been more interventionist in economic affairs, implying that existing regulation, such as the institutions, were not strong enough, as they argue that an interventionist government are needed to attain the best efficiency and welfare when there are frictions or market failures (Pelaez & Pelaez 2009 p4). The public interest view first came about in Adam Smith’s “wealth of nations”, in which he proposed that individuals that seek their self interest promote the public good, thus legitimising government interventionism (Pelaez & Pelaez 2009 p5). Government intervention was an apparent consequence of the financial crisis in 2008 (Sheehan 2011 p135), in which the British government nationalised Northern Rock in order to save it (Augar 2011 p94), whilst the Federal Reserve in the US bailed out Freddie Mac and Fannie Mae (Butler 2009 p55). Booth supports the public interest view, by stating that the financial crisis of 2008 is comparable to the Wall Street Crash of 1929 and the Great Depression that followed, in that they were both caused due to the fact the government did not keep a tighter rein on finance (Booth 2009 p157). Moreover, Singer continues this argument by stating that due to the crisis, substantial debate has arose in which many leading economists are calling for governance of the markets (Singer 2010 p93). The public interest view is thus a major critique of the neoliberalist theory, in that they did not blame the government for too much regulation, and they effectively state the government should have taken control using the aforementioned methods in order to stem the impact of the global financial crisis. Secondly, the private interest view provides a further critique of neoliberlist theory, as this view states the possibility of government failure, and suggests that one could restrict collective action to improve social welfare (Pelaez and Pelaez 2009 p18). In other words, the private interest view raises doubts about the effectiveness of regulation, due to the power of the banks (Pelaez and Pelaez 2009 p18). This view is supported by Myddelton, as he states that the main cause of the financial crisis was defective regulation by governments (Myddelton 2009 p101). Furthermore, this view can also be seen as defective consumer protection procedures, rather than defective regulation. Thus it is implied that the government was responsible to pass more effective regulatory legislation to protect banking customers, and should not have given them a safety net which did not exist (Dewatripont, Rochet & Tirole 2010 p13). This viewpoint has demonstrated that there is a school of thought which supports this essays view that the governments existing regulation was not good enough to prevent the financial crisis, and as such demonstrates that the government should have had tighter control over the markets to prevent, or at the very least reduce, the effects of the financial crisis of 2008.
The final and strongest critique of the neoliberalist theory is the deregulation theory. This theory suggests that there had been too much deregulation in recent years, and as such the banks were allowed to be careless and reckless in regards to lending and borrowing, particularly as displayed by the subprime loan market that arose since 1995 (Butler 2009 p54). Kotz supports this view by stating that the rise of neoliberalist parties in the Western world is what contributed to the deregulation of “business and finance, both domestically and internationally” (Kotz 2009 p307). Furthermore, he also states that by 2000, the abuses by the financial sector had reached its peak and implies that they used incredibly reckless ways to make huge profits, usually via subprime mortgages (Kotz 2009 p313). Additionally, critics of the neoliberalist theory also state that the governments wrongly placed their trust in the financial sector. This due to the fact that they allowed the banks to self-regulate (Helleiner & Pagliari 2010 p74, Alexander 2009 p90, Dravis 2011 p163). Self-regulation was allowed in order to avoid accusations of political bias. This is in regards to politicians having too much power over finance to stop it being a completely ‘free’ market (Helleiner & Pagliari 2010 p76). Gamble supports Helleiner and Pagliari’s view, by stating that since Ronald Reagan all governments have been afraid to regulate the banks strongly due to the fact that it could be seen as dictatorial. It is due to this that Gamble suggests that both the Democrats and the Republicans were to blame for policies of financial deregulation (Gamble 2009 p103). In addition, Williams describes a further consequence of deregulation in that a Credit Default Swap (CDS) market grew under the Clinton administration, despite warnings from the Commodity Futures Trade Commission to regulate this market, which meant that a further money making policy could be introduced as a form of banking self-regulation. However, this would in fact cost major banks, such as the Lehman Brothers, a large amount of money when so many people asked to claim their CDS payments. Williams describes this policy as a “catastrophic mistake” (Williams 2010 p100). Deregulation was clearly the most important factor that has risen as a critique of the neoliberalist theory, due to the fact that if it had not occurred the government would have been in a better position to prevent the crisis. However, evidently the neoliberalist politics in the US was to blame for the lack of a government backbone to stop deregulation. Therefore, it was these governments that allowed the banks to self-regulate, and thus could maximise profit without considering the possibility of it all collapsing. Economists argue that banks believed they could continue in reckless abandon as they were such an integral part of the financial system, both domestically and internationally. This has been branded the “too big to fail” theory (Dewatripont, Rochet & Tirole 2010 p5, Duffie 2011 p5, Alexander 2009 p81). All of these theories and critiques will be under examination by using the Lehman Brothers as a case study to ensure the credibility of the essays conclusions.
This essay will now use the case study of the Lehman Brothers to examine the causes behind the defaulting of the bank. From this study it will be able to conclude which of the aforementioned arguments are correct. The defaulting of the Lehman Brothers was the biggest shock to come out of the 2008 financial crisis. The reasons behind this were simple, as aforementioned, the Lehman Brothers had the belief that they were “too big to fail” (Dewatripont, Rochet & Tirole 2010 p5, Duffie 2011 p5, Alexander 2009 p81). This means that they thought the trillions of dollars which were invested in the bank would be able to save it from any form of financial downturn or recession (Williams 2010 p165). Furthermore, the Lehman Brothers had traded for over 158 years, and had survived various other financial crises, such as the Wall Street Crash and the 1970s recession, however, they could not survive 2008 (Williams 2010 p7). The second, even more shocking point, is that the US government refused to save them from bankruptcy, this is despite the fact the US government had already bailed out Freddie Mac and Fannie Mae (Williams 2010 p167, Gamble 2009 p32). The fact that the government did not save the Lehman Brothers, and as a result forced one of the five largest investment banks in the world into bankruptcy, displays that the public interest view was correct in that government intervention would have prevented the extent of the fallout from the crisis. Additionally, Kotz supports this view as he argues that there should have been less limited interventions and more bailouts (Kotz 2009 p314). Moreover, one must first examine how Lehman Brothers managed to get into this mess before entirely placing the blame on the lack of government intervention. As aforementioned, since 1995 investment banks, such as the Lehman Brothers, were offering subprime loans to large numbers of low-income families, it was also from this reckless lending that many economists blame the blame the bankruptcy of the bank (Helleiner & Pagliari 2010 p77, Williams 2010 p103). From this two points become apparent, the first being that blame should be placed upon legislation passed by the US government, and in particular that of the CRA, as if this Act were not introduced the Lehman Brothers would not have followed the example of Freddie Mac and Fannie Mae by committing to these obtuse profit making business decisions (Williams 2010 p94). It was due to the CRA that the Lehman Brothers became one of the largest subprime lenders, “making more than $18 billion in loans and controlling 9 percent of the market” in 2003, and in 2006 Lehman Brothers became the “largest mortgage originator, churning out more than $4 billion” in mortgages every month (Williams 2010 p226). Secondly, regardless of the legislation passed, the government can be blamed for not having better regulation, thus the private interest view is correct in that with better regulation the financial crisis, and in particular the defaulting of the Lehman Brother would probably not have occurred to such a degree (Pelaez & Pelaez 2009 p18). However, it can be argued that the entire basis of the Lehman Brothers default was that of society itself, in which neoliberalist ideals were the norm, and thus it was expected that deregulation of the banks was to occur ever since Reagan placed the idea on the agenda (Cassidy 2009 p286). Additionally, further evidence of deregulation can be witnessed in the south regulatory processes that the Lehman Brothers used in order to make themselves richer and not necessarily more financially secure. The CDS market, which the Lehman Brothers were major actors in, is a major example of this and was contributing factor to the Lehman Brothers downfall (Williams 2010 p100). To summarise, it is evident that the public and private interest views, as well as that of deregulation, and even the neoliberalist anti-legislation argument, all have merit and thus proves, as expected, there were various reasons as to why the Lehman Brothers defaulted.
Conclusively, this essay has examined both the neoliberalist viewpoint and the critiques of neoliberalism in the examination of the causes of the financial crisis. By studying the Lehman Brothers in particular, it has enabled this essay to come to two major conclusions. Firstly, this essay has proven that deregulation should never have occurred, and the government should not have passed damaging legislation, such as the CRA, which forced the banks into this state. This is strongly linked to the second conclusion, in that the essay suggests that to prevent further financial calamities, strong regulation must be placed on the financial markets so that any financial crisis will be blamed on the government, and will not force the markets to be reliant on the economic recklessness of the bankers, whilst also preventing any further nationalisation and government intervention from needing to occur. Academics have now called for a restructuring of the capitalist system (Kotz 2009 p316, Kaletsky 2010 p54), and thus the proposed regulatory changes would allow a smooth operating restructured financial system, and will continue to make privatisation necessary in order to ensure that the government does not run the financial system, but instead just regulates it to a degree that no repeat of the financial crisis of 2008 will be able to happen again.
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