Mariela Tinajero
MBA 6410
Professor Doris Geide-Stevenson
Project 1 – The Recent U.S. Business Cycle
Part I
This section of the paper will entail the major causes that led to the economic crisis of
2008 in the United States. Along with that initiative, the causes will be ranked in the order of
their importance as major causes that led to the economic crisis. Some of these causes are as
follows this includes their ranking: economic policy, deregulation, oversight, bank strategy,
derivatives, accounting, and cash flow. The ranking will be detailed in due time as these causes
are examined in more detail. However, before any more detail is surmised the following table is
a good example as to how such conclusions were garnered (Table 1). The table details 8 articles,
these articles were examined and regulated to find what subjects the articles stated as causing the
economic crisis of 2008.
Table 1
Articles
2008 Market
Crisis: Black
Swan,
Perfect
Storm or
Tipping
Point?
Economic
policy
(Interest
Rates,
Mortgage)
Bank strategy
(Loans/Secur
itization)
Derivatives
(Insurance/D
efault Credit
Swaps,
Hedge funds)
Deregulation
Causes of
the Current
Financial
Crisis
Fiscal Crises
of the
States:
Causes and
Consequenc
es
Lost Trust
The Real
Cause of the
Financial
Meltdown
Reflections
on the
Collapse of
'07 and
Related
Matters
The roots of
a crisis--and
how to
prevent the
next one
What
Caused the
Great
Recession?
Economic
policy
Economic
policy
Economic
policy
Economic
policy
Debt
Economic
policy
Bank strategy
Macroecono
mic shock
Bank strategy
Bank strategy
Bank strategy
Derivatives
Derivatives
Derivatives
Derivatives
Deregulation
Deregulation
Deregulation
Oversight
(Forecasting)
Oversight
Oversight
Oversight
Accounting
(Correct
Reporting)
Deregulation
– into
regulation
again
Oversight
(Too big to
fail)
Accounting
Inflow of
Money
Outflow of
Money (
Inflow/Outfl
ow of Money
Bank strategy
(house prices
always rise)
Deregulation
Deregulation
Oversight
Oversight
(Macroecono
mists)
Accounting (
Macroecono
mists)
Accounting
Outflow of
Money
What went
wrong with
economics
(Emerging
economies
save –
believe their
at risk)
Investors
invest in bad
securities)
(Catanach Jr. & Ragatz, 2010) (Fox, 2009) (Gerst & Wilson, 2010) (Suetin, 2009) (Weidenbaum) (Weisberg, 2010)
(What went wrong with economics, 2009) (Yandle, 2010)
Economic policy is a great determinate of the economic crisis of 2008; in fact it may be
the most important cause for the collapse. According to Catanach Jr. & Ragatz, and Fox this was
influenced by the Federal Reserve whom lowered interest rates in 2000, a response to the
collapse in the technology industry, and after 9/11 (Catanach Jr. & Ragatz, 2010) (Suetin, 2009).
The administrations of Bill Clinton and George Bush also influenced the economic crisis of
2008. These administrations made it easier for individuals to purchase homes. Fueled by low
interest rates, the rising price in homes, and easier credentials to purchasing a home; many
individuals took to the endeavor (Catanach Jr. & Ragatz, 2010) (Suetin, 2009) (Gerst & Wilson,
2010). Economic Policy also holds an important factor because the government holds the rule on
how much the government can leverage in certain situations (Gerst & Wilson, 2010)
(Weidenbaum) (Weisberg, 2010).
Deregulation is an important factor in the economic crisis of 2008. The two major acts
that helped cause the economic crisis of 2008 are the Financial Services Modernization Act of
2009, and the Commodity Futures Modernization Act of 2000, as Catanach Jr. & Ragatz state.
The Financial Services Modernization Act basically allowed such entities as insurance,
investment banking and commercial banking to merge. While the Commodity Futures
Modernization Act exempted certain derivatives like credit default swaps from being regulated
by the Commodity Futures Trading Commission. Catanach Jr. & Ragatz also state the fault lies
with government bank regulators that in 2001 lowered the amount of money necessary to buy
mortgage backed securities, this in turn stimulated banks into buying notably rated mortgagebacked securities. (Catanach Jr. & Ragatz, 2010). An increase in homeowners seemed to be a
result of deregulation, in part because it was easier for individuals to receive loans (Suetin,
2009). However, this was just an outer appearance. Without regulation there is no guarantee that
institutions would live up to certain contracts (Yandle, 2010) (Weisberg, 2010). In fact, later on
some pleaded for regulation from the government, when such institutions started failing rapidly
(Weidenbaum) (Fox, 2009).
It’s hard to foretell the future but a major flaw leading to the economic crisis was
oversight. According to Catanach Jr. & Ragatz oversight applied to regulators in banking and
securities because these sources failed to adequately regulate the deregulation of markets
proceeded by governments (Weisberg, 2010). The new regulators in banking and securities could
not foretell with precision such markets in part from pressure from politics, and lack or resources
including the lack of knowledge in new financial creations. Others sources of mislead oversight
include credit rating agencies whom inevitably helped in collapse because they handed high
credit ratings to certain pooled debt made of subprime mortgages (Catanach Jr. & Ragatz, 2010).
Many could not foresee the consequences of using borrowed money in order to receive more
investment (Suetin, 2009). Another major blow to the economic crises deals with the too big to
fail policy. Many spectators believed that the government would rescue big corporations, like
Lehman Brothers. When the government did not rescue these institutions, this led to shattering
confidence in investor markets (Catanach Jr. & Ragatz, 2010) (Fox, 2009). Some individuals
have pinpointed economists for not doing enough or not doing their job correctly in forecasting
such crisis (What went wrong with economics, 2009).
Oversight is not only to blame. Bank strategy was another cause of the economic crisis of
2008. Catanach Jr. & Ragatz stated that banks were part at fault for acquiring many subprime
loans which coupled itself with credit or most likely securitization of the loans (Catanach Jr. &
Ragatz, 2010) (Yandle, 2010). Such securitization allowed banks not to show these loans on their
balance sheets (Suetin, 2009) (Weisberg, 2010). In other words banks became in a since greedy.
Banks issued loans but once their ability to purchase more loans ran out they looked at other
ways to raise money to purchase more of these loans. The answer securitization, the banks would
pool the loans and sell interests to investors (Yandle, 2010). It should be noted that most
investors were forced to rely on agency ratings because securities were so fragmented and hard
to rate, in which case neither were the agencies good at rating such securities (Weidenbaum).
Most importantly institutions relied on the fact that the housing market would always go up
(What went wrong with economics, 2009).
Another important factor to the economic crisis of 2008 was derivatives. These
derivatives mostly fall on credit swaps and hedge funds according to Catanach Jr. & Ragatz
(Catanach Jr. & Ragatz, 2010). Derivatives are essentially financial contracts which gardener
value based on underlying’s or other things. The derivatives that most led to the economic crisis
were credit default swaps and hedge funds (Suetin, 2009). Credit default swaps and hedge funds
can best be described by an example. For instance, say company 1 loans money to company 2,
company 2 then proceeds to purchase a credit default swap from an insurance company like a
hedge fund. In affect the company keeps paying the hedge fund a premium consistently so that in
case they default on the loan in other words isn’t able to pay it the hedge fund will pay it. Like
most insurance, premiums go up for risker clients in this case risker loans. Soon bank regulators
obligated financial firms to purchase credit default swaps (Yandle, 2010). These derivatives in
turn put all financial firms at risk (Weisberg, 2010).
Accounting is a factor to consider in the economic crisis. Fair value reporting, initiated in
2007 by the government, led many banks to write down mortgage loans and securities. Fair value
reporting was essentially an estimation of the value of a good but many banks constantly under
estimated that value in relation to mortgage loans and securities (Catanach Jr. & Ragatz, 2010)
(Yandle, 2010). Many banks were in fact using off balance sheets to hide their actions.
Institutions like Moody’s and S&P miscalculated the safety of mortgage backed securities may
have to lead to further problems as well (Weisberg, 2010). Again others blamed economists for
not accounting for such problems that may have arisen (What went wrong with economics,
2009).
The last main cause to state is cash flows. Some countries will indivertibly save money,
this depends largely on foreign investments. Countries that depend highly on foreign investments
tend to save for such cases in which they don’t receive foreign investment. This is notable China
which is highly influenced by foreign investments, which the U.S. helped grow but that has
resulted in large part to a deficit in its own coffers (Suetin, 2009) (Fox, 2009). This plays a big
part because in essence the U.S. had to run its stimulus package even when it was in debt.
Another important aspect of cash flows is that they not only influenced the U.S. but other
countries. Foreign investors were investing in bad securities based in the U.S. (Yandle, 2010)
(Weidenbaum).
Given all the information so far it is presumable to give a ranking of the causes of the
economic crisis of 2008. Below is the ranking of such causes for the economic crisis and the
main reasons such causes were ranked in that matter are also given below.
1.
2.
3.
4.
5.
6.
7.
Economic policy
Deregulation
Oversight
Bank strategy
Derivatives
Accounting
Cash flows
Economic policy seemed to be the major policy that led every other cause to follow in its
footsteps. The main influence government had was their proposal to lower interest rates, and the
ease with which they allowed individuals to purchase homes, which in fact was made easier by
low interest rates.
Deregulation is ranked at the second spot because it was in part created by the governments’
economic policy. The government gave way to markets into regulating themselves. They also
allowed large companies to unite creating big enterprises which would become a tragedy if they
ever failed.
Oversight holds third place. Although, it may be the most difficult foretell. Oversight is fairly
high on the ranking because had the government realized that the markets could not regulate
themselves maybe the economic crisis would not has been as bad as it was. Given that many
markets had been regulated for so long by the government, now markets were expected to
regulate themselves. It’s no doubt that such bank and securities regulators could not find the
adequate resources to monitor the deregulated market, coupled with new financial creations to
deal with.
Bank strategy easily follows oversight. In part bank strategy follows oversight because banks
began to look for new ways to increase their volume in mortgage loans and reverted to
securitization to meet their needs. They wanted money and money they believed would come by
securitizing mortgage loans.
Derivatives could have been in the same ranking as bank strategy. However, derivatives were
in part mostly affected by loans and bank strategy. As banks lent money, banks or customers
could purchase credit default swaps which in case they ever defaulted would be paid by the
insurance.
Accounting will be stated had a lower impact although did influence the economic crisis. As
economy got worse institutions started to lie about the market. Such lies could therefore, impede
an accurate picture of what was actually going on earlier in the process.
Lastly, cash flow was ranked at the last position. There is no doubt that the economy is
intertwined with each other. However, most of the downfall was not produced by the world or
foreign market but by the U.S. market itself. This in turn created a blow for the rest of the world.
It is true that some nations dependent on foreign transactions save. The most notable market for
this action is China. In regards some people believe that may have led to the economic crisis and
it may have, however, it seems to only be a factor more so after the fact. In other words debt did
not create the problems in the housing market which were in large part the cause of the recession.
Yes, the recession became harder hit by debt especially in the financing of a stimulus, and debt
did further dent the recession but debt was not the cause alone. China perhaps may have made it
a little worse by not investing in the U.S. but the all the combined problems facing the U.S.
economy had to come forward. Furthermore the blow the U.S exported on the world was threw
foreign investors in U.S. goods and services.
Part II
It’s much simpler now to identify how such causes as economic policy, deregulation,
oversight, bank strategy, derivatives, accounting, and cash flow caused the recession. Each one
of the causes creates a domino effect which eventually led to the recession.
Economic policy was the first culprit of the recession obviously such policies allowed for
more individuals with low credit to purchase homes. This policy coupled with deregulation,
allowed many banks to become big entities as well as allowing them to regulate themselves. No
one oversaw how such actions would affect the future. Governments had no idea that most banks
weren’t well equipped for such quick transition. Moreover, they didn’t have the adequate
resources to predict the market which more than likely the government had been keeping track
of. Banks began to securitize loans believing they could gardener more returns in that manner.
In that same instance they were forced into purchasing credit default swaps obligated by their
new bank regulators. This credit default swaps obviously held subprime mortgages in which case
if a bank was not able to pay such accounts the insurance would pay as a result. Their reached a
point in which there was no way in which individuals with subprime mortgages could afford
their homes. These individuals did not have the creditworthiness required of them in the first
place. As the effects of such actions began to be noticed many institutions began to hide their
actions.
The result of individuals not being able to pay their loans kicked in in a massive way. The
following graph is a good rate at which residential, and commercial loans became delinquent
(Graph 1). The data to process the graph came from the Federal Reserve (Board of Governors of
the Federal Reserve System, 2010).
Graph 1
Real Estate Loans
14
12
10
8
Delinquency Rate
Residential
6
Commercial
4
All
2
1991:2
1992:2
1993:2
1994:2
1995:2
1996:2
1997:2
1998:2
1999:2
2000:2
2001:2
2002:2
2003:2
2004:2
2005:2
2006:2
2007:2
2008:2
2009:2
2010:2
0
Year : Quarter
The graph is a good predictor for recessions. The most recent recessions came in 2001 and 2008.
The graph seems to show that delinquency rates in real estate increased in 2000 before going
down again in 2001 which led to some consequences. A year before the recession was declared
in 2008, 2007 delinquent loans went up. One interesting factor lies in the recession of 1990/1991.
Although, not enough data exists on real estate loans before 1991 which coincides with recession
it seems that before 1991 delinquent loans had increased the year before. These are very
interesting findings. An important thing to notice is that as of the second quarter of 2010 the
delinquency rate seems to have reached the about the maximum of the parabola or the slope of
the curve in delinquency has seemed to slow down. In other words delinquency on loans has
slowly been diminishing. This seems to imply that the subprime mortgage crisis is starting to fall
out.
What the above graph exemplifies is important. What happens when people can’t pay
back their loans? The answer to question is very bad things for the economy. The problem with
people not paying for their loans is that these loans are tied with the bank. Banks in relation had
been allowed to merge with such entities as insurance which was allowed in part by government
deregulation. These same banks had been obtaining a lot of these subprime loans and securitizing
these loans, banking on the fact that house prices would continue to go up. Banks would then sell
interest on these loans to buy more loans. Furthermore, banks were obligated to purchase default
credit swaps. Whereby, in the case the bank would default unwillingly the insurance would pay
the dividends.
What comes thereafter isn’t hard to imagine. Individuals started to default on their loans.
Banks in regards weren’t able to pay interest to investors which dented the stock market. Banks
are therefore forced to default, so insurance companies are forced to pay. However, there’s a
problem. There are an unprecedented amounts of defaults and many banks just can’t pay up not
to mention some have merged with insurance companies or have just become grandiose
companies. They start failing, and insurance companies start failing as well. Insurance
companies must pay for credit default swaps. Again insurance companies have no way of paying
up many the unprecedented amount of failing banks. These huge companies provide loans and
insurance to other sectors of the economy but they are not able to loan because they no longer
have the funds. The problem is coupled emincely because a lot of the companies are huge and in
some cases merged. In the end these mammoth firms fail. With this catastrophe so does the stock
market.
What follows is immense unemployment from these failing firms which would therefore
increase delinquency on loans again. There’s another problem companies that do need loans can
no longer get loans because most banks have failed and those that are still alive are being more
careful and not loaning. So more companies start to fail and more employees lose jobs.
Construction jobs were seriously hit, as more houses were on the market, construction was less
in demand and there was a short supply of individuals looking to buy homes. These employees
can no longer spend in the economy which serious lowers real GDP. In that same instance
companies that observe this start to constrain their pockets because they know what is to follow.
The recession was in essence like a set of dominos. The first domino was economy policy
which set the next cause of recession to be propped up, and each subsequent cause for the
recession was another domino being propped up. Any player knows that eventually the dominos
fall and they did. The individuals that sent the domino effect into action were the individuals
with subprime mortgages. Furthermore, the economy is so tied with the world a blow in the U.S.
is felt in the entire world. Many foreign investors are invested in U.S. goods and services and
when those stock prices fall it hurt them. When individuals don’t have the means to participate in
the economy it hurts the world economy because they intentionally or unintentionally participate
buying or selling in foreign goods or services.
The consequences of the fiasco were a massive amount of people losing their jobs. This
in turn lowers real GDP because an economy can no longer produce the output it used to. It also
lowers real GDP because many individuals can no longer spend the way the used to in the
economy for the lack of jobs. Most importantly job loss is a consequence of recession what
caused the recession was the failure of many firms. This was coupled with stock downturns
further incremented by loss in consumer confidence in these firms or fear these firms would fail.
The failure of these firms led to job loss. These firms in their failings could no longer afford to
hire more workers or keep their workers.
Part III
I will be working for a company called Redgear. Redgear is a company that was bought
by H&R Block. Redgear specializes in providing tax software to companies or regular customers
while also providing technical support for their products. They have 3 main packages each one is
divided by which process it does. A regular customer could choose the cheapest package which
does the basics. The second package does little more things and can be used by more
experienced users or small businesses that do taxes while the third is for cooperation’s or big
businesses. H&R Block uses some of Redgear’s tax products.
Redgear is a software company which would be part of a cyclical industry because
demand software which is related to technology goes down during hard times. However, this
isn’t just any type of software it’s tax software, which helps people complete their taxes. Taxes
are a noncyclical industry. No matter whom you are and where you are, you must do your taxes.
So Redgear falls into both the cyclical industry and the noncyclical industry. I think it’s more in
the noncyclical industry because although, individuals can depart from using tax software most
will inevitably have to do their taxes whether they choose to do it using their computer or not or
going to small businesses or companies like H&R Block which might have the software. Most
companies usually use software because it’s easier to use, more organized, and can easily handle
many customers. Therefore, I think Redgear is in more of noncyclical industry because many
people must complete their taxes and it does that for them in an easy organized manner with the
software it provides.
From reading the article by Pearce II and Michael, I fathom that Redgear could benefit
from “positioning the company in multiple markets and geographies, plan to confront declining
sales, promote the firm’s products and services, and prepare for economic recovery” (Pearce II &
Michael, 2006). While they can benefit from all four strategies the most ineffective strategy they
could use would be “positioning the company in multiple markets and geographies”.
Redgear could benefit positioning the company in many places, markets, and country’s
which might protect it from slowing sells in software during a recession. However, it’s important
to understand that they do U.S. taxes. Therefore, they are constrained to the U.S. economy since
foreign nations could not use their product unless they made a product for worldwide taxes. It
would not make since to move their product to other countries because it would be a product that
specializes in foreign taxes. They could, however, move their product to various locations in the
U.S. alone in fact they recently wanted to expand in the Latin community and have expanded
into Puerto Rico.
They would mostly benefit by planning declining sales especially after tax season. They
may need to let go of certain employees or may hire only seasonal employees for tax season.
While holding on to workers that provide valuable skills and that cannot be easily replaced. They
may also benefit by promoting their products during the recession. Other software exists out
there to do taxes, but promoting before tax season in a recession, increases your probability of
gaining valued customers when other companies aren’t advertising. They may also choose to
stock more of their cheapest software or bundle their cheapest software and sell it to individuals
who may then distribute it to their families. The must spend enough money to make known or
spread their product. Most importantly they must conserve enough capital to make it easier for
them to expand again when there is no recession and demand goes up especially during tax
season.
Overall a company can either survive or fall based on the actions it takes. If it is able to
forecast a recession it must practice restraint. It will then be put in a good position when the
recession hits to play its cards. A company must always expand its product to vast and different
regions. It must do what a lot of companies are afraid to do in hard times. The firm must
advertise and work with prices. The most important thing is spend enough to position yourself
ahead of the pack but not so much that you hinder your possibility of a quick recovery from the
recession.
Works Cited
What went wrong with economics. (2009, July 18). Economist, 392(8640), 11-12.
Board of Governors of the Federal Reserve System. (2010, August 18). FRB: Delinquency Rates; All
Banks, SA. Retrieved September 5, 2010, from Board of Governors of the Federal Reserve
System: http://www.federalreserve.gov/releases/chargeoff/delallsa.htm#fn1
Catanach Jr., A. H., & Ragatz, J. A. (2010). 2008 Market Crisis: Black Swan, Perfect Storm or Tipping
Point? Bank Accounting & Finance (08943958), 23(3), 20-26.
Fox, J. (2009). The roots of a crisis--and how to prevent the next one. Time International(South Pacific
Edition, 174(12), 22-23.
Gerst, J., & Wilson, D. (2010, June 28). Fiscal Crises of the States: Causes and Consequences. FRBSF
Economic Letter, 2010(20), 1-4.
Pearce II, J. A., & Michael, S. C. (2006, May/June). Strategies to prevent economic recessions from
causing business failures. Business Horizons, 49(3), 201-209.
Suetin, A. (2009, July). Causes of the Current Financial Crisis. Problems of Economic Transition, 52(3),
44-58.
Weidenbaum, M. (n.d.). Reflections on the Collapse of '07 and Related Matters. Vital Speeches of the
Day, 75(5), 198-201.
Weisberg, J. (2010, January 18). What Caused the Great Recession? Newsweek, 155(3), 19-19.
Yandle, B. (2010). Lost Trust The Real Cause of the Financial Meltdown. Independent Review, 14(3),
341-361.