Sept. 26 (UPI) — Ten years ago the Dow Jones industrial average experienced a historic decline as the United States faced its worst financial crisis since the Great Depression.
The Dow Jones fell 777 points on Sept. 29, 2008, as members of the U.S. House of Representatives voted down a $700 billion bailout bill for banks that took excessive risks in the subprime mortgage market.
The collapse spread into global markets as well, as markets in Japan and Australia fell about 4 percent each and markets in London, South Korea, France and Germany were also affected by the crisis.
At the center of the meltdown, which was part of a larger recession, were a number of major investment banks, insurance companies and government loaning entities that collapsed or required government bailouts after dealing in subprime mortgage loans.
The federal government responded by bailing out most of the largest banks, deeming them “too big to fail,” and becoming more involved in investing and trading by placing tighter regulations on banks — an effort aimed at making the economy more resistant to similar collapses in the future.
A decade later, the market has shifted and another new administration has sought to roll back those regulations.
The Collapse
While the factors driving the crisis and the larger recession had been in motion for years, the issues began to rise to the surface in early 2008 as some of the largest banks in the United States found themselves on the verge of collapse.
“One of the first characteristics of this crisis was that it was very surprising for many, many people,” Lorenzo Naranjo, assistant professor of professional practice for finance at the University of Miami, told UPI. “You read now that there were some people out there that were betting against the crisis that foresaw it was going to happen, but there were very few of them and it took a long time anyway for this to unfold the way it did.”
One of the first major dominoes to fall came in March 2008 when Bear Stearns was unable to meet obligations until J.P. Morgan Chase borrowed money from the New York Federal Reserve and lent it to Bear Stearns before eventually acquiring the bank.
In July, the U.S. Treasury and Federal Reserve sought congressional approval of a temporary increase in a Treasury line of credit for government-sponsered enterprises Fannie Mae and Freddie Mac. In September the U.S. government decided to take over the giant mortgage firms that owned or backed $5.3 trillion in mortgages.
Later in September, more financial institutions and insurance companies began to collapse as Lehman Brothers investment bank filed for bankruptcy, Merrill Lynch was purchased by Bank of America and the he Federal Reserve took over AIG for $85 billion.
On Sept. 29, as the government looked to find a way to stop the bleeding, the House voted down the historic $700 billion bailout bill for the U.S. financial markets on a 205-228 vote and sent the stock market tumbling.
The bill was ultimately passed by Congress days later, but the massive bailout left some questioning why Lehman Brothers was allowed to fail and set a precedent that still has lasting effects today, Naranjo noted.
“In retrospect I think nobody knew exactly what to do and even today one of the lessons of the crisis is that we still need to learn more about how to fix this type of problem,” he said. “Because clearly the incentives that they give to the market once you tell them ‘hey we’re going to bail out every single big bank,’ I don’t think are the right ones.”
Dodd-Frank
The impacts of the 2008 financial crisis were far-reaching and ultimately resulted in one of the largest pieces of banking legislation reform in U.S. history.
After President Barrack Obama took office in 2009, his administration introduced legislation that sought to address the causes of the crisis by reducing incentives for banks to engage in speculative activities and establishing new government agencies to oversee the financial system.
The Dodd-Frank Wall Street Reform and Consumer Protection Act — named after sponsors Sen. Christopher J. Dodd, D-Conn., and Rep. Barney Frank, D-Mass — was passed by Congress on July, 15, 2010, and signed by Obama a week later.
Dodd-Frank allowed federal regulators to seize and break up large financial services firms that pose a risk to the larger economy or are on the verge of collapse, strengthened oversight of executive compensation and included rules to prevent credit card and mortgage abuses.
It established the Financial Stability Oversight Council and Orderly Liquidation Authority, which monitors the financial stability of firms deemed “too big to fail” due to the impact their decline would have on the overall economy — as well as the Consumer Financial Protection Bureau, which works to prevent the kind of predatory mortgage lending that contributed so heavily to the crisis.
Another provision known as the Volcker Rule echoed the Glass-Steagall Act of 1933 by separating the investment and commercial functions of banks in order to restrict the ways they could invest.
Naranjo said the measure sent a powerful message to bankers that the government was willing to take a more active role monitoring and influencing the market as a result of the collapse. However, he said it failed to address the fact the government was likely to offer substantial bailouts to prevent major financial institutions from failing.
“The precedent of the government bailing out this kind of big institution was already there, so for me that’s kind of the negative side of everything,” Naranjo said. “I haven’t seen a clear message saying, ‘Look these are going to be the rules from now on, we’re not going to compensate risk takers by telling them hey if there’s any problem we can always help you.’”
The Trump Effect
A decade after the collapse, the Dow Jones has saw a new record single-day drop, as the index fell a total of 1,175 points in February, but Naranjo said that fall was “very far from what we observed in 2008.”
“I think right now what we’re going to have is normal market turmoil and uncertainty which is going to affect relations and protfolioships from people that might want to hold safer assets, but I would say it’s within what I would expect to be normal for markets,” Naranjo said.
While the record-breaking drop in the Dow didn’t seem to indicate the dawn of a new crisis, some have expressed concerns that President Donald Trump’s efforts to undo many of the regulations put in place by Dodd-Frank could lead to another such catastrophic occurrence.
In May, Congress passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which raised the threshold for banks that are subject to stricter federal oversight from $50 million in assets to $250 million and also exempted banks that originate fewer than 500 mortgages annually from certain racial and income data required by the Home Mortgage Disclosure Act.
Proponents of the measure praised it as a step toward stimulating the economy by removing regulatory burdens, while opponents warned rolling back the regulations could leave the financial system vulnerable to another crisis.
Naranjo noted that the regulations put in place by Dodd-Frank inspired change, but the switch from traditional trading into electronic trading also contributed to the way Wall Street looks today.
“It’s good that we think about regulation, sometimes letting the market go too loose is bad, but at the same time you see that when the market gets super, super hot is exactly when there’s going to be more pressure actually from industry to deregulate things. Even when there’s regulation in place, when the market gets too hot the regulation doesn’t seem too effective,” Naranjo said.
He added that the market has shifted and banks have moved away from activities that were very profitable, but are no longer as profitable today, due to the emergence of high-frequency and electronic trading firms.
“I don’t think these regulatory changes that are in place are going to have a big effect on the next crisis,” Naranjo said. “The players are going to be different from now on in the sense that banks used to be the big broker dealers that would sometimes send market makers to make the markets for stocks and today they’re recruiting from those markets and what you see is the emergence of all these little electronic trading firms that are taking their lead.”