Bureaucracies Throughout Congressional Hearings Various Essay

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However, during the real estate boom at the beginning of the 21st century, banks lent money to people later called 'NINJAs' (No income, no job, no assets) Some of these people were seduced into buying homes they could ill-afford by predatory lenders extending adjustable rate mortgages with low interest rates for a short period of time that quickly became prohibitively high. They ignored their own self-interest in not buying more homes they could afford out of ignorance, and the bank did nothing to deter them because the bank was cushioned from risk in the world of credit default swaps.

Credit default swaps transfer the risk of lending money to other economic entities. Credit default swaps are the main reason for the failure of the insurance behemoth AIG that was otherwise financially sound, except for its purchase of the risks of too many bad 'NINJA' loans. In these swaps, "the insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small," giving banks an incentive to extend bad loans and then sell the risk ("Credit default swaps," Times Topics, 2008). Then, when the "mortgage-backed securities that many swaps were supporting began to lose value in 2007, investors began to fear that the swaps, originally meant as a hedge against risk, could suddenly become huge liabilities" and tried to sell them on the open market, which of course no for-profit organization wanted ("Credit default swaps," Times Topics, 2008).

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Buying up bad loans, which may or may not be repaid at some point, was one of the cornerstones of the proposed economic bailout -- only the federal government will buy up the loans which are worth, most economists believe, next to nothing given the likelihood they cannot be repaid.

The new financial innovations like credit default swaps essentially neutered the moral hazard that is supposed to be a built-in check into the capitalist environment. For Greenspan, this conflicted with his most dearly-held ideology -- it made no sense. Yet it had happened. "In 2005, I raised concerns that the protracted period of underpricing of risk, if history was any guide, would have dire consequences," he said. "This crisis, however, has turned out to be much broader than anything I could have imagined" (Grynbaum 2008). New regulatory boards must ensure that banks that extend loans assume an appropriate degree of risk, which means limiting the credit default swap market. It is essential that we learn from Greenspan's mistakes, and do not merely bail out the failed banks and firms today. More regulation is necessary to deal with these new financial tools. Regulation of capitalism is not bad -- no matter how some people might preach against government regulation. Without regulation we now have more government interference in the economy, in this form of 'welfare corporate bailout' capitalism. The New Deal created new regulatory institutions, and that is what is essential for the American economy to become functional again.

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