Light Touch Regulation and its Role in Global Financial Crisis

Solution Preview

Light Touch Regulation and Global Recession

For many years before the subprime crisis started, real estate proved as a lucrative investment option to many. The rate of growth in the real estate was the fastest as compared to any other investment option. In fact, the real estate was growing at a rate from 7-8%. During late 1990s to mid 2000s, the real estate boom lead to a major increase in construction related jobs in the United States (Reavis, 2009).

The onset of global recession was in year 2005 when home buildings and their prices started appreciating unbounded. The real estate market slowed for some time after which it began to implode. At the same time oil prices shot up from an average of $41 per barrel in 2004 to a peak of $147 per barrel in July 2008. "The rise in oil prices meant a sharp decline in the U.S. in terms of trade, a heightened risk of broader inflation, and a shock to the expected cost structures of a wide swath of industries from trucking to petrochemicals" (Foster, 2009). This increase in oil prices immediately led to decline in sales of cars, trucks and SUVs which had lower mileage. However, despite these fallbacks the American economy remained strong until finally succumbing to recession in December 2007. The economy was initially able to weather the recession but in 2008 with epicenter in home financing, tremendous contradictory forces built up leading to collapse of economy. The home financing sector crumpled down as homes sales reduced and prices slashed.

The recession was a culmination boom in credit and debt. There were many factors which fueled the boom.
In the early 2000s many banks in advanced economies pursued exceptionally low interest rates in the context of low inflation and prolonged economic expansion. It increased the amount of debt and risks those borrowers, investors and intermediaries were willing to take on (Chwieroth, 2011). It resulted in asset price bubbles which could disturb the normal functioning of financial system and could pose macroeconomic risks. Though Central bank was aware that blind spots in macroeconomic models are being used to take leeway, there were few who took sufficient account of systemic risks resulting from increasing leverage and asset prices. The Chairman of U.S. Federal Reserve, Alan Greenspan referred to this as "benign neglect" as most of the central bankers were not willing to take lesson from the pressure that was getting built up in asset price bubbles. Instead of finding ways to deflate it before they burst, they were enjoying their ride high on these bubbles. ...