Inside the Meltdown

In class this week we discussed the Federal Reserve and watched the Frontline production, Inside the Meltdown. The film uncovered how the economy crumbled so fast after the housing bubble burst in 2007 and why Fed chairman Ben Bernanke and Secretary of Treasury Henry Paulson were forced to take action.

The film posed a puzzling question: should the banks have been allowed to fail - causing another great depression - or did the Fed do the right thing by intervening?

I am a firm believer in people taking responsibility for their actions so part of me is in favor of a policy involving moral hazard. However, when the consequences of those actions are so large that they will be detrimental to millions of innocent people, intervention is necessary. Even though the Fed and government eventually got involved they did not approach the situation in the best possible way.

I think there should have been a complete audit of the banking system - investment and commercial - once the Fed realized how much trouble Bear Stearns was in. I realize it was a rather chaotic time and quick decisions were necessary, but if the Fed and the government had a better understanding of the crisis then they could have attacked it more effectively. 

The Fed believed that by bailing out Bear Stearns they would fix the entire toxic system. However, that was not the case and bailout after bailout pushed Henry Paulson to enact a policy of moral hazard with Lehman Brothers. Unfortunately for the market, Lehman Brothers was in worse shape than Bear Stearns and their failure caused the stock market to stall which stalled the entire economy. Banks lost confidence with the market and were refusing to lend any money. When people and businesses cannot get loans to buy houses, cars, start a business, etc. then they aren't spending money and in turn are not stimulating the economy. Also, when there is lack of confidence in the stock market then people want their money out quickly and stop investing which also hinders the economy. Maybe if Paulson had compared Bear Stearns' problems to Lehman Brothers at the beginning they would have let Bear Stern fail instead, or decided to bail out all of the banks with systemic risk, lessening the negative impact on the economy.

It seems throughout this financial crisis that a lack of knowledge is what continues to get the market into trouble. I can appreciate and understand why Wall Street does not want to be regulated, but if they aren't willing to share information then I don't believe they have earned that privilege. As we saw in the article "Swallowed by the London Whale", Ina Drew lost $6 billion dollars for JPMorgan and Chase because she was investing in these risky investments. Unfortunately, Drew and her team were unaware how toxic these investments were because they weren't given all of the details.

People like Alan Greenspan are huge advocates for an open, unregulated market. In theory this system makes sense, but unfortunately when you add in human emotion the system falls apart. Investors become easily blinded by greed and therefore overlook potential problems within the system. They also neglect to share information in order to get ahead. This is why it is necessary for the government to enact some form of regulation. I do not believe the system should be completely nationalized, but regulations with policies of full disclosure are necessary for the prevention of another market meltdown.