Government Policies and finanical crisis

Government Policies and its Role in the Financial Crisis


Bear Sterns, Washington Mutual... Lehman Brothers. These are just a few companies that filed for bankruptcy within the past two years. All have reached out to the government for a bail out but only a few received it. The laws surrounding these events include failed policies by the government in regards to corporate responsibilities to their respective investors and consumers. The policies set by the government resulted to poor lending judgments that triggered a dramatic rise in mortgage delinquencies and foreclosures in the United States. Whether or not the programs or policies that artificially lower housing prices or monthly mortgage payments have been enough to offset other government policies that artificially raise housing prices, both local and national government policies are among the factors which have set the stage for the financial crisis we are facing today. This research paper will study the financial meltdown within our economy in the past years and the role of the government laws/policies surrounding the event. We will first define the causes of the meltdown and then examine policy alternatives and recommend specific courses of action as possible solutions to deal with the current crisis in the US economy.


Around 1997, the U.S. Congress did a few things that triggered the financial crisis we are facing today. One was the elimination of the capital gains tax on real estate held over two years and up to $250,000 for a single filer and $500,000 for a married couple. This is one of the biggest tax cut ever and it made the real estate market the most favored investment by all the financial gurus at the time. Real estate prices rose in an unprecedented manner for approximately ten years in a row. Around the same time, the Dot com bubble burst and with the events of 9/11, the Federal Reserve responded by cutting interest rate to 1%, the lowest level ever in their history.

Low Interest rates encouraged a lot of people to buy or invest on a house and the banks started to practice high-risk lending. In reality, government agencies not only approved this new standards for mortgage loan applicants, government officials were in fact the driving force behind the loosening of mortgage loan requirements. Members of Congress from both political parties have urged federal regulatory agencies to press banks and other lenders to lower mortgage loan requirements and have passed legislation to that end and to subsidize or guarantee loans made under lowered standards. Congress pressured the mortgage industry to provide loans to those people who were normally would be denied in the past. It was basically making the mortgage companies lower their standards and in return unlimited funds would be available from private institutions. In addition to easy credit conditions, there is evidence that both the government policies contributed to an increase in the amount of subprime lending during the years preceding the crisis. Major U.S. investment banks and government sponsored enterprises played an important role in the expansion of higher-risk lending. The term subprime refers to the credit quality of some borrowers, who have bad credit histories which means a greater risk of loan default than prime borrowers. At the center of it all were Freddie Mac and Fannie Mae, private companies but sponsored by the government and leadership was politically appointed. Basically, these two institutions were run by politicians from both parties, feeding the mortgage industry with billions of dollars earmarked for loans to those who previously didn't qualify for home ownership. Now you could buy a house for merely 10% down or maybe less in some cases even with a bad credit rating.Only $20,000 was needed to buy a house valued at $200,000 and the mortgage companies would even let applicants borrow that.Mortgage companies actively sold mortgages to people with bad credit and low incomes. The subprime market expanded very quickly. The value of the U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007.

Recognizing the demand for the housing market due to these new policies by the government, savvy investors jumped in the opportunity of buying homes with hopes of flipping it over for a profit. They started making fortunes overnight as they bought properties pre-construction and flipped them for a profit before they were even built. With the money they made, people started buying yet more properties, or larger ones. Home prices went higher and higher, banks and sellers reaped huge profits. With the consistent rise of the housing market, the government persuaded banks to relax its rules for loan approval. Mortgage applicants with bad credit rating or insufficient income were approved with banks simply charging them a higher interest rate after five years. The subprime market was seen as very profitable because of those higher interest rates. But insistent pressures on lenders from a variety of government officials and agencies to lend to those whom the government wanted them to lend to, rather than those that lenders would have chosen to lend to on the basis of the lenders own experience and expertise. When studies from the early 1990s showed different mortgage loan approval rates for minorities compared to whites, the media suddenly criticize the banks not thinking of the main reason why they were not approved in the first place. It was not because the banks were discriminating on them but simply the banks at that time analyzed that on an individual case basis some people are just not qualified for loans. Congress and the White House pressured agencies on regulating banks to impose new lending rules and to monitor statistics on the loan approval rates by race, community, and by income, with penalties on banks and other lenders for failing to meet government standards. One Attorney General even threatened legal action against lenders whose racial statistics raised suspicions. Lenders are in the business to make money and if they denied loans to people with good prospects of paying them back because they are discriminating on them is like cutting their own throats financially which is not likely to happen. But because of the intervention of the government and congress passing laws and new policies on lending, banks were forced to ignore their normal standards, took risks, and now we are all paying for it.


The US economy changed a lot in the past few years. Knowing that the intervention of the government played a big role in this crisis suggest a restructuring of the whole economic system or a change to some recent bad policies. We also need to ask ourselves if we really need to allow the government to have a bigger say in how businesses are run. Lenders did not begin to lend to people who would not have qualified for loans under the old criteria that had been used out of years of experience in the market. Such risky loans were made under the growing pressures from government agencies and politicians, and even threats of persecution from the Justice Department if the statistical profiles of borrowers whose loan applications were approved did not match the government's preconceptions. It is not likely that our government today will admit any responsibility for the financial disasters and widespread unemployment today. So it is up to us to pay attention and develop a sense of awareness and think what is really good for the economy as a whole. An economist at a leading financial firm put it plainly: “Lending money to American homebuyers had been one of the least risky and most profitable businesses a bank could engage in for nearly a century” (Sowell, 2009). It was the massive intervention of politicians in the housing market that changed that disastrously, not only for banks but for the entire economy.


Sowell, T. (2009). The Housing Boom and Bust. New York: Basic Books.

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