Was The Recession Caused By Financial Crimes Or Bad Luck?

Financial crimes

Financial crimes are often referred to as white collar crimes. Money is often the motive behind them. It’s a hard subject to write about, as it’s a more complex subject than a hit-and-run. In addition, there are not nearly as many individuals sitting in jail or facing trial for the types of white collar crime I’ve written about here before.

That doesn’t mean it’s still not crime and that it doesn’t affect the lives of people around it. In fact, one issue in the news today has affected every American in some way or another: banking crime. Actually, there are a number of banking practices that weren’t crimes. However, very risky practices have been under heavy regulation since 2010.

When president Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 – usually called the Dodd-Frank Act – it was with an eye to protect the economy from another meltdown. Several aspects of the Dodd-Frank Act, and even the act itself, are coming into question by the new president. President Trump blames Dodd-Frank for making the recovery from the financial crisis slow.

What are the primary functions of the Dodd-Frank and how has it worked?

Dodd-Frank Act

One major area the Dodd-Frank Act was made to regulate was swaps trading – which is a kind of derivative trading. Derivatives, according to Forbes writer Steve Denning, are the kind of extremely risky financial instrument which caused the recession. He argues they will cause another, bigger recession sometime in the future.

Credit Default Swaps

If you could purchase your friend’s health insurance policy, presumably you would be raking in the monthly payments while he was healthy. You could be so confident in his health that you did not set aside any money in the event he got sick and needed you to pay for his hospital bill.

Your friend, still needing health care coverage, could sue you for the money, and if you didn’t have it you would be forced to declare bankruptcy. Imagine that your friend had purchased several other people’s health insurance policies, and those people also got into accidents forcing your friend to declare bankruptcy as well.

If those people also owned health insurance policies and declared bankruptcy, it would illustrate the chain reaction of credit default swaps and how it affected the global market in 2008.

Credit Default Swaps are essentially insurance policies issued by banks, taken out by investors, which protect against failure among their investments. They are called derivatives, which are any kind of financial instrument whose value is based on the value of another financial instrument. The value of a credit default swap is based on the stability of a company – whether your friend can pay his health insurance premium, in other words.

The main difference is: the health insurance industry is heavily regulated. This could never happen in health insurance because insurance providers have to prove they can cover every policy they sell. But the derivatives market? Completely unregulated.

You can read a great overview of credit default swaps at How Stuff Works.

Does the fault lie with financial crimes?

The question is where does the fault lie in a huge scandal like the financial meltdown of 2008? There had to have been unusual risks taken and unethical dealings. But, how does our government determine how to regulate going forward?

The Dodd-Frank Act was supposed to regulate the financial sector of our country. Now President Trump wants to dismantle parts of the Act to make way for financial growth.

Your Turn

What do you think? How should we regulate our financial markets to best protect both the taxpayers and value market freedom?

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