Can Financial Regulation Prevent A Financial Crisis?

Financial Regulations to Prevent Future Financial Crisis
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Financial Regulations to Prevent Future Financial Crisis
The financial crisis is the condition in which some commercial assets unexpectedly lose their nominal value. The serious economic crisis occurred in the 19th and 20th century which were related to banking panics and other declines associated with this bank panics. Different situations that resulted in financial crises are stock market crashes, severing defaults and also currency crisis. The financial crisis is a global disaster that directly leads to a loss of paper wealth and significant change in the economy. However, many economists have tried to offer theories regarding how to prevent the financial crisis, although this problem continues to occur. In the year 2007 and 2008, there was a monetary crisis referred to as global financial crisis and 2008 financial crisis that are considered to have been the most horrible economic crisis since the 1930 Great Depression. This problem started in the US from 2007 in the subprime mortgage market and later developed into a full-blown worldwide banking crisis. This issue resulted in 2008 collapse of investment bank Lehman Brothers. Accordingly, the understudy will, therefore, discuss causes of the financial crisis and whether financial regulation can prevent a financial crisis.[R. W. Kolb, Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future, Hoboken, N.J., Wiley, 2010, P. 56.] [Kolb, P. 74.] [Kolb, P 104.]
Causes of Financial Crisis
The financial crisis is primarily caused by deregulation in the commercial industry. Deregulation means eliminating constraints, particularly in economic regulations (Kolb et al., 2010). Earlier, some rules allowed banks to participate in hedge fund and trading with depositor's money through risky investments. However, there was a time when banks created a lot of money; therefore, they used to raise the house prices and also take risks on financial markets. Moreover, when a bank gives out a loan, new money is generated. Nevertheless, this money gets invested outside of the commercial sector which includes personal loans and credit cards. Lending large amount of money to property markets makes the housing price to go up. Therefore, interests to every loan that the bank gives out have to be paid. And with the debt rate rising rapidly than the incomes, some individuals become unable to pay their mortgages. Therefore, following the failure from repaying the debts, banks find themselves in a position of going bankrupt.[R. W. Kolb, Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future, Hoboken, N.J., Wiley, 2010, P. 56.]
In the year 2001, Fed funds were lowered to 1.5% by the Federal Reserve to battle the recession. During this period, investors used hedge funds to gain higher income. Therefore, low interest meant that bonds brought low results to allowance fund managers; as a result, a huge amount of money went to hedge funds. In 2004, fed funds rate was raised by the Federal Reserve as the interest rate to the loan reset. Therefore, housing prices began to lower as the supply outpaced the demand. This trapped the house owners who were not able to afford the expenses and also could not sell this houses. Therefore, the banks created more risky investments to earn an edge in the competitive market and raised their use of exotic derivatives. However, when the value of by-products crushed, the banks stopped loaning each other money which developed financial crisis resulting in Great Recession.[C. W. Murdock, “The Dodd-Frank Wall Street Reform and Consumer Protection Act: What Caused the Financial Crisis and Will Dodd-Frank Prevent Future Crises”, SMU Law Review, vol.64, no. 4/8, 2011, p. 1249.]
In 1999, the Glass-Steagall Act of 1993 that prohibited banks from using investor's money was repealed by the Gramm-Leach-Bliley Act. This repeal permitted banks to utilize deposits to invest in the derivatives. According to bank petitioners, banks needed reforms and start competing with the international firms. However, they guaranteed to only work with low risky securities to safeguard their clients. In 2000, the Commodity Futures Modernization Act released credit default trades laws that had earlier banned this by referring it to as gambling. Therefore, Texas Senator, Phil Gramm who was the chairman of Banking Committee, Housing, and Urban Affairs acknowledged to the bank petitioners. Moreover, Enron was a primary contributor to Gramm's campaign, and he wanted to engage in by-products trading through online exchanges. Therefore, analysts pointed Enron as exposing dangers of uniting investment and commercial banking. However, investment bank criticized that retail banking together with Section 20 members pressured clients to hire Section 20 Members to guarantee securities so that they can receive loans which dishonored the "anti-typing" provisions of Bank Holding Company Act.[Kolb, Lessons from the Financial Crisis, p. 154.] [D. Silvers and H. Slavkin, “The Legacy of Deregulation and the Financial Crisis-Linkages between Deregulation in Labor Markets, Housing Finance Markets, and the Broader Financial Markets”, Journal of Business & Technology Law, vol. 4, no. 2, 2009, pp. 314.] [D. Silvers and H. Slavkin, p. 320.] [D. Silvers and H. Slavkin, p. 328.]
The present financial crisis has made clear the downfall of the three pillars of Basil II structure. There has been an insufficient risk assessment, disclosure, and market discipline because of the 'too big to fail' policies. However, the financial crisis has also been caused by insufficient regulation. Financial regulatory has proved ineffective and systemic risk go unchecked. Due to regulatory change and excessive liquidity stress, banks encounter problems in fulfilling financial intermediation role. For instance, Dominique Strauss-Kahn, International Monetary Fund former managing director accused the 2008 financial crisis as a regulatory failure to safeguard against unnecessary risk-taking in the financial system. Moreover, credit default swaps deregulation resulted in the crisis. The Basel II Accord has been blamed for requiring the banks to raise their capital whenever risks increase which might result to the decrease of banks' lending when there is capital scarcity, therefore, theoretically exasperating a financial crisis. Worldwide financial regulatory has deduced regarding deepening market herding, regulatory herding as well as raising systemic risk. However, this has resulted in fraud which plays a role in financial institutions collapse. For instance, the early 20th century Charles Ponzi's fraud and also the 2008 Madoff Investment Securities collapse. Scam in mortgage financing is another factor that resulted in 2008 financial crisis.[D. Silvers and H. Slavkin, “The Legacy of Deregulation and the Financial Crisis-Linkages between Deregulation in Labor Markets, Housing Finance Markets, and the Broader Financial Markets”, Journal of Business & Technology Law, vol. 4, no. 2, 2009, pp. 330.] [D. Silvers and H. Slavkin, p. 340.]
How to Prevent Future Financial crisis