Deregulation: a Major Cause for the Financial Crisis of 2008

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INTERNATIONAL FINANCE
Deregulation: A major cause for the financial crisis of 2008? Professor E. Slavai

Geoffrey Delbaere
August 2013

“When you can create something out of nothing, it is very difficult to resist” Lee Hsien Loong (Prime Minister of Singapore)

Introduction
On September 15th 2008 the investment bank Lehman Brothers was declared bankrupt. That same month AIG, the world’s largest insurance company, also collapsed. These two events led to a global financial crisis which cost 30 million people their jobs and doubled the national debt of the USA. It also caused to largest single point drop on the stock market in history. Today we can realize that this crisis was not an accident, it was caused by an out of control industry. Since the start of the 1980’s the financial sector of the USA has risen through the skies. This has led to a series of increasingly severe crises which have caused more and more damage. But this has also led to the fact that the industry has made more and more money. The question that a lot of experts have asked themselves is: ‘What was the impact of deregulation on this latest financial crisis?’ Along with the boom of the financial sector since the 1980’s, a lot of measures have been taken to deregulate the financial markets. In my paper I wish to analyze the impact of those measures. A lot of people see this deregulation as the major cause, but a deep study also shows other causes that are more hidden for the public. First I will explain the chain of events that led to this deregulation. After that I will discuss how big the impact was of this deregulation on the financial crisis in 2008.

1) The process leading up to deregulation
After the crash of 1929, the US economy experienced 40 years of growth without a single crisis. This was due to a lot of regulation. In 1933 Congress approved the Glass-Steagall Act, or the Banking act, which prohibited commercial banks to speculate with investors’ money. This act arranged a limitation in the affiliation between commercial and investment banks. Until the 1980’s investments banks were very small partnerships. In 1972 the investment bank Morgan Stanley had 110 employees, 1 office and a capital of 12 million dollars. Today, this same bank has 50000 employees, offices around the world and a capital of several billions. In the beginning of the 1980’s, the financial industry exploded because these investment banks went public. The capital and profits of these banks went way up and people on Wall Street were getting very rich. In 1981 President Reagan set the first step in bringing the politic and economic powers too close together. He choose the former CEO of Meryll Linch, Donald Regan, as his treasury secretary. This set Wall Street and the president in an eye to eye position, which is a very dangerous liaison. This can be seen as the start of a 30 year period of massive financial deregulation. In 1982 Reagan approved the deregulation of savings and loans companies. This allowed these companies to make risky investments with their depositors money. At the end of the decade this decision led to a crisis which cost 124 billion dollars and a lot of people their life savings. A lot of these savings and loans companies had to declare bankruptcy. Because of this crisis, a lot of people went to jail for fraud and mismanagement of their companies. One of these people was Charles Keating. Before he went to jail, in 1985, he started realizing that federal regulators were starting to investigate him. He decided to hire Alan Greenspan, a skilled economist. Greenspan publicly said that he supported the methods that Keating was using. This same Greenspan later became the Chairman of the US Central Bank during the Reagan, Clinton and Bush administration. This can be seen as the second step in bringing Wall Street en politics in the eye to eye position. Alan Greenspan made sure that these three presidents continued to support this upcoming...
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