This first ‘case study’ is a medium to present and address issues in the question of private sector versus government and governmental policy: who is to blame and what is working? Both sides have important points to consider; therefore, people should not be faulted based off seeing the world from one perspective or the other. However, the real problem lies in when either side believes its position has all of the answers or does not deserve the blame and begins attacking the others’ positions. When this conflict appears, no one is able to healthily establish an effective system as it requires both sides working well.
Forgive me as to my explanation of the crisis. I researched it quite a bit but only as of recently. As I am not an economist or a more experienced historian, please excuse me but also be sure to help set me straight. This topic doesn’t require an in-depth analysis of the issue, but I do not want to lead you astray. My primary resources for this post will be a textbook Economics Private and Public Choice 14e, a movie based off a popular book Too Big Too Fail, and a documentary Meltdown.
The economic crisis started before the 2000s with businesses trying to gain profit through selling more and more loans and then bundling those loans into CDOs (collateralized debt obligations) and sold them to reduce their debt to finance this continued pattern. In the early 2000s, the Federal government wished to combat social issues, namely encouraging home ownership. To achieve this end, they instituted policies that loan providers should give out more loans.
Now, eventually, the loan providers had to reduce some basic requirements for loans like ability to pay back the loan and credit scores to meet these standards. Businesses themselves saw an opportunity to make a profit through selling this loans to more people and then sell the loans to investment banks who were looking for future payments to those loans. No one was concerned as the loan providers were getting immediate payment while the large investment groups were taking in money from investments like the CDOs rather than the risky loans.
However, this whole process was possible as the Federal Reserve had forced an artificially low interest rate, one that would not be reasonably created by natural business transactions, to encourage increased investment and economic growth. The effect of which was increased lending of sub-prime mortgages (risky loans based on low credit scores and the like). Soon, housing prices lowered due to a surplus in homes created by an artificial demand, and the only way that the Fed could fix this issue was to raise interest rates to restore prices.
The rise in interest rates increased mortgage defaults, especially in those with adjustable rate mortgages and sub-prime loans. This high rate of defaults reduced the ability of investment groups to function without government or third-party support, which is typical. But the high numbers were unnatural, this phenomenon increased panic in consumers and other banks, creating an even less fluid market. After Lehman Brothers’s and Northern Rock’s collapses and concerns about American Investment Group, the housing bubble completely burst and that burst rushed into the rest of the economy, stifled only by some government policies instituted to reduce its effect.
After that summary of the event, neither side is without fault and neither side is the only solution.
Starting with the Federal government, regulation and policy are needed. In order to have a functioning economy and government, there needs to be a system to provide a structure for businesses and individuals and, if necessary, should be given authority to help prevent catastrophes and injustices. However, government involvement can be seen as becoming too great or implemented without recognition of future harm in its policies. Just as the government provides an economic backbone, the Federal policies instituted to increase home ownership enabled risky endeavors as well as profit-seeking.
The private sector may get the reputation of being greedy and profit-making, but, through an economic and political standpoint, they are functioning the most effective, profitable manner that the government enabled. There was nothing that said business could not act in that way, in fact, it was encouraged to a point to further the Federal policies. Business does provide an important economic role in a nation’s operation but is also an extension of liberty. Now, when business steps over its bounds it typically is in seeking profit over moral concerns or long-term sustainability. The risky business model brought in a lot of profit but was shown to be unstable in the long-run.
Where does this leave us? Should we see government as the economic guardian and regulator to prevent harmful failings of the system? Or should business be allowed to function freely as eventually the nature of capitalism will cycle the nation back, if not better?
Each person will view this question a little more from one side than the other; however, there can be a healthy system of both. Government can provide the structure as well as necessary monitoring to prevent long-term failure or concern but, otherwise, reduce its interactions that simply manipulate the system. While business can approach the need for profit for themselves as well as the provision of services and products to consumers. Yet, risky and harmfully greedy business practices should be able to be regulated to encourage a healthier economy. This cooperation encourages long-term prosperity while also supporting the rights and freedoms that flow from a free market and democratic republic.
This debate continues on as to how much of each entity should be present and to what extreme. Neither system is perfect and both systems have their faults, such as how each contributed to the 2008 Economic Crisis. However, there can be reasonable consideration of the matter to create a healthier system that enables a better nation. It is up to the merits of both positions as well as the arguments of each’s proponents to decide the nature of it. As for that debate,we should keep our views as rational and considerate as possible to others’ opinions while realizing our own personal views on the matter. I hope this analysis of real-life example helps provide a nice basis for you to consider each’s merits.
-Michael C. Tofte