Financial Crisis
The financial crisis has been described as one that figuratively hit the American economy ‘below the waist’. Yet, to date, the reason behind the emergence of this crisis is yet to be known to the American public. There have been attempts by numerous economists to give a solid conclusion to this enigma. However most of these conclusions and reasoning have culminated in plenty of contradictions. Despite this, there are a number of recurrent conclusions that come out as being among the factors that contributed to the great financial crisis. These include over-dependence on investments using easy credit, accountability oversight, and an overlap of investment and commercial banking. John Cochrane of the University of Chicago offers insightful information regarding the financial crisis in the econ podcasts. . His main arguments explore the causes of the financial crisis, the role of the Troubled Assets Relief Program (TARP), and the reasons why economists should not blame the mark-to-market accounting for the crisis (Roberts, 2009). This paper explores Cochrane’s reasons for the financial crisis as well as his thoughts as far as Troubled Assets Relief Program (TARP) is concerned.
Cochrane on the origin of the financial crisis
Cochrane insists on the fact that reduced accountability over the years could not have been the reason behind the financial crisis. He believes risks are inevitable thus the fact that that poor investment decisions coupled with haphazardly made investments could not have led to failures in the American banking system. I am not of the same opinion. Indeed, risk is part and parcel of human life. However, risks taken blindly, more so where finance is concerned, can be detrimental to any individual. This is more so where there is a system in place that is greatly interlinked and where financial institutions inter-depend on each other. In such a case, if a single unit or a cluster of units in this system fail, this means that the whole system will fail due to this links (Gray et.al, 2010). The American economy is one that can be described as a system that is interlinked. Thus while Cochrane may argue that risks taken by individuals in the banks, is not responsible for the crisis, interdependence as well as interlinkages of the American economy seek to prove him right. Indeed, systemic risk usually occurs for example where a bank run takes place setting panic in the other banks which are owed money by the first bank. This leads to cascading failure by all the banks involved. The depositors of these banks, sensing the unrest will rush to liquidate their assets leading to a market full of sellers and no buyers (Haubrich & Lo, 2013). The American economy is one that thrives on the interlinkages that exist between the different stakeholders; more so in the banking sector. Therefore, risks that are taken without much consideration are very capable of leading the country into a financial crisis. All that needs to happen is that the banking system to experience a number of bank runs and this is enough to create a significant dent in the economy of that particular economy. This just goes to show how any amount of laxity in the banking sector could lead to a financial crisis of major proportions.
The Role of TARP
Cochran believes that the move of the congress to by Troubled Asset Relief Program (TARP), played little or no role in salvaging the already crumbled economy (Kindleberger & Aliber, 2011). At one point, I agree with Cochran, however, there are so many points that prove this point wrong. For one, it established an American economic antifreeze. This is because it created a relief for major financial institutes from frozen credit markets. The program created liquidity at a time where there was a lot of financial panic in the market. There was also the fact that the program ended up ultimately costing less than had been intended. The program had originally intended to purchase $700 billion worth of mortgage-backed securities. Recent numbers from treasury indicate that they have $475 billion in total commitments and it is estimated that TARP’s lifetime cost is at $49 billion. The program also managed to withdraw money from the American banks. The government invested in the banks and got returns that amounted to a profit of $7 billion. There is also evidence that companies that were bailed out by TARP are now showing signs of recovery. One example is General Motors who in 2010 were able to show their biggest profit yet since 1999. Finally, TARP’s major impact on the economy has been indicated in the job sector. The treasury department has indicated the fact that through recovery initiatives such as TARP, 8.5 million jobs have been saved. This is a greater evil than if the same or even larger number of people would have been left jobless (Ericson et al, 2014). Thus, while the impact according to Cochran was insignificant, it was better than no impact at all.
Conclusion
Cochran’s analysis was valid and even correct to a larger extend, however, the fact that he feels that risks in the banking systems cannot topple an economy and that The efforts made were in fact significant in saving that economy leaves a lot to be ‘desired’ as far as this economists reasoning is concerned.
References
Roberts, R. (2009). “Cochrane on the financial crisis.” Library of Economics and Liberty. http://www.econtalk.org/archives/2009/02/cochrane_on_the.html
Kindleberger, C. P., & Aliber, R. Z. (2011). Manias, Panics and Crashes: A History of Financial Crises. Basingstoke: Palgrave Macmillan.
Gray, D. F., Andreas A. J., and Samuel M. (2010), “Quantifying Systemic Risk and Reconceptualizing the Role of Finance for Economic Growth,” Journal of Investment Management, Vol. 8, No.2, pp. 90–110
Ericson, Matthew; He, Elaine; Schoenfeld, Amy. "Tracking the $700 Billion Bailout". The New York Times. Retrieved October 19, 2014. At http://projects.nytimes.com/creditcrisis/recipients/table
Haubrich, J. G., & Lo, A. W. (2013). Quantifying systemic risk. Chicago, Ill: National Bureau of Economic Research.
