Mike Morgan
PSC 403: Public Policy
Final Exam
April 13, 2011

Causes of the Great Recession

The Great Recession was something terrible and ugly in the making. This creature had been brewing since the late 70’s and was as fierce as ever by 2007. The Great Recession of 2008-09 has not one cause but several that were clearly underestimated by those in charge as well as average citizens of this country. The left will argue that there was a complete lack of regulation put in place to observe what was happening with mortgage lending. Robert J. Samuelson believes that “there was enough oversight that alert regulators should have spotted problems and intervened to stop dubious lending” (Samuelson, 19). They also say that there were numerous incentives for regulators and investors to ignore the risks that were being taking, which entails a tremendous amount of greed on their part of the matter. The left also states that there was a ‘mindless devotion to free markets’. Now their opponents on the right side of the fence will argue that interest rates had been too low for too long, and that the housing bubble had to pop eventually. They also insisted that the government’s housing policy was to get as many citizens to purchase a house as possible. They used tax incentives, rebates, and low interest rates to get homebuyers to act. I felt it was important to mention what the left and the right believed caused the Great Recession of 2008-09. Once we look at this disaster from afar and under a microscope, we tend to notice the real causes of the Great Recession. First off, things had been way too good for way too long, and the old saying goes “A good thing never lasts”. It was bound to happen at any given time, whether we were ready for it or not. We, the consumers, were over borrowing more and more. With the low interest rates, buyers were able to purchase more home than they originally anticipated on. We had thought that we had figured out how to solve the reasons for the downturn in our economic system, we thought that we’d figured out how to beat this beast of a monster, but we didn’t. We were in no better position than we were during the Great Depression of 1929. We had a 30 year period of financial deregulation, a system where failure could threaten the entire financial operation, or “too big to fail” motto where the government sees fit to save a financial institution from drowning along with all of the other institutions that it has connected with it. In March of 2008, Bear Sterns fails and the sale of that company was arranged for the sale to JP Chase Morgan. It was a spiral down from there on. It’s safe to assume that the deregulation of the financial institution as well as the advance in technology made the economy unsafe. Another aspect of excessive risk was involved with derivates. These were called credit default swaps or betting against CDO’s, a process where mortgage securities were sold and then bet against them. These mortgage securities were sold as a ‘safe’ investment. Subprime loans also contributed to much of the damage within the housing bubble that collapsed. It’s still too soon to get a better picture of how and why the market crashed, and more light will be shed on this in upcoming decades.

Dodd-Frank Provisions There were five major provisions of the Dodd-Frank law. The first was for consumer protection which is monitored by the Bureau of Consumer Financial Protection. Second there is a systemic risk oversight which does two things; first it is a financial stability oversight council, and second it can liquidate large financial firms that are failing. Third on the list regards capital requirements; it seeks to make the FDIC to impose higher requirements. The fourth key provision has to do with proprietary trading. This is the modified Volker Rule that limits banks investment of no more than 3% of a fund’s capital. And finally, the last provision of the Dodd-Frank Reform deals with derivative trading. The Commodity Futures Trading Commission was to create and regulate a more transparent market.

Likely Success of Dodd-Frank As much as we would like the Dodd-Frank Reform Act to be successful at preventing a future financial system from collapsing, ultimately things will happen as they should. There is a natural business cycle to how things work. We are still in the early stages of repairing our system now, so we are strict on whom we lend money out to. In a matter of months or years, the banks will be lending money out as frivolous as they were before the Recession took place. As times continues to take move forward, people will begin to take more and more risks within the financial sector and the cycle will therefore repeat itself. Therefore I must conclude that I do not believe that the Dodd-Frank reform or any other act will prevent another financial crisis from happening, simply because that is the nature of the beast.

Forces Leading to Income Inequality and Great Recession There are striking similarities between the forces that led to the greatly increased income inequality over the past 30 years and the conditions that favored for the Great Recession of 2008-09. We can presume that drift, which according to the author’s Hacker and Pierson is “the failure of government to respond to new economic realities” (83). In both instances, the government actions by not stepping in hurt the financial system deeply. In the instance of income inequality, with the government not becoming involved, they continue to advance the top one tenth of a percent further from everyone else. Another direct impact that has impacted both income inequality and the Great Recession is American exceptionalism. The wealthy continue to receive higher advanced degrees which continue to push them further and further away from the middle and low income families. Also involved in American exceptionalism is the advancement of technology and ‘extreme human ingenuity’ in our society. Another reason for both the greater income inequality and for the Great Recession of 2008-09 would be the extreme risk taking by those in the top income bracket, who feel that taking these huge risks will bring in massive rewards. These people are known as extreme risk takers. In the movie The Inside Job these people were said to have “Private gains at the public’s loss”. Therefore it’s simple for these individuals to take enormous risks since it’s others people’s money that’s being risked in the process. Another factor that needs to be inserted here in this section dealing with both income inequality and the Recession is the way that CEO’s and business executives are paid. Not only do they receive a handsome salary, but they also and more importantly receive the majority of their income in the form of stock options within that company that they are a part of. The executives of Bear Stearns, Countrywide, Meryll Lynch, Citi Group and Lehman Bros all made five hundred million dollars a year while their companies were being run into the ground. The people who fall into this category are without a doubt wealthy, a hyperconcentration of income that very few will ever be able to identify with. This is the large income discrepancy that only the top one percent of the population deal with every day, because they have the benefits and the advantages to take extreme risks, while everyone else struggles in sustained hyperconcentration.

Role of Economic Irrationality It’s no mystery that our citizens here in the United States of America are completely irrational when it comes to economics and also the way that our government operates. There is one group of individuals who knew this and took full advantage. Politicians use voter irrationality to their own personal agenda, and it works most of the time. There are many reasons why it’s better to keep citizens uninformed and in the dark; its complex and they would need to learn a substantial amount just to be able to get by as a rational person. Irrationality is worse than ignorance because it leads to bad decisions and it affects everyone. Just as with voting, uneducated voters hurt the entire community that they represent. When it comes to irrationality, the individual cost is usually low but the social cost tends to be extremely high since it affects everyone. The media’s involvement in this tends to lead us to the issue of using policies as an electoral spectacle, while the unsuspecting public remains oblivious to motivations that pushed the vote for social issues, while ignoring economic agendas. It’s obvious that people tend to do what in their best interest, and they usually do this simply because they have the money to do so. What all of this boils down to is that a democracy will not work cooperatively if it doesn’t listen to its people, and therefore if you have an irrational voter then you will most certainly have irrational policies. It is very important to have informed citizens within our society that have at least a basic understanding of the economics that our country faces on a daily basis, so that we are more informed of what’s transpiring.

Health Care Before the ACA Everyone has an opinion when it comes to the Affordable Care Act of 2010 that sparked major debate within members of Congress and Americans everywhere. Our current system of Health Care is an insurance based system, the largest is the employer insurance program where the employers provide employees insurance through their place of employment. The insurance system is based upon a fee for services conducted. The government plays a major role in the current system providing Medicare to forty five million Americans and Medicaid to fifty eight billion. The one thing on everyone’s mind from year to year is the rising costs that Health Care charges us. Health Care rates are growing at an ‘unsustainable rate’, and according to Michael E. Chernew, professor of health policy at Harvard Medical School, “those in power can only do what is politically possible in a system where health-care providers and insurers hold enormous influence” (508). The big problems that are associated with the current system is that there are forty six million people, that’s fifteen percent of the population that doesn’t have insurance. Since most insurance is employment based insurance, those who are part time employees, work for temporary agencies, those unemployed, or between jobs aren’t able to acquire insurance for themselves or their families. The rising costs of malpractice and defensive medicine that doctors are required to pay keep increasing each year. Another problem is that when moral hazard goes up, the quality of care that you receive will go down based on what the doctor is allowed to do. Finally, the last problem associated with the current health care system is that doctors are paid a fee for service incentives. Chernew adds further by saying that “the law also will launch numerous demonstration projects aimed at developing ways to pay doctors, hospitals and other providers for delivering good health outcomes efficiently rather than continuing the current system, which mostly pays for services whether they are successful and necessary or not” (507).

Main Provisions of the ACA The major provisions of the Affordable Care Act are just as heated as topics such as the Iraq war, the Stimulus Act that President Obama passed in 2009, and Gay marriage. These provisions include: tighter insurer regulations against insurance companies, health care insurance exchanges, and mandatory insurance for all Americans by 2014. This last provision is especially a touchy subject because many Americans claim that it is unconstitutional for the government to make them purchase insurance. The ACA will also cover thirty two million more people, including sixteen million from Medicaid. The cost for this Act will encompass almost two trillion over the next ten years, any which way you look at it it is going to cost quite a large amount of money to sustain itself.

Extent to Which the ACA Addresses Fundamental Health Care Problems These problems and issue are not going to be resolved with simple strategies and carefree attitudes. Too start with, the government is involved far too greatly into the medical field, providing regulations and too much oversight for this Reform to work properly. Doctors are going to order numerous and unnecessary tests to increase their wages in the case that Medicaid cuts many programs for doctors expenses. Let’s assume that moral hazard will go down, that is the best case scenario, that’s not a determined fact. I believe that this is going to cost quite a bit more than what was predicted originally. And lastly, does the government have the right to demand that if we don’t purchase insurance then we will be forced to pay a penalty each year? Is that constitutionally acceptable from the home of the free? Only time will tell.

Total words: 2,163