Law can reform society. Because of law, black students are allowed to attend the same schools as white students. However, the current recession demonstrated a recent regressive trend in American law. Law has become less concerned with achieving justice than maintaining the power of the current economic and political elite, often at the expense of the working class.

I. The Recession

a. The Housing Bubble

The recent recession occurred primarily due to the 2008 Financial Crisis, which was triggered by the collapse of a bubble in the housing industry. After 1995, housing prices began rising dramatically. Consumers became “irrationally exuberant” regarding the profitability of housing investment, leading to further demand for houses. Consumers financed their home purchases through mortgages, which creditors issued irresponsibly. When housing prices declined, consumers began defaulting on their mortgages, leading to widespread foreclosures.

b. Securitization and Credit Default Swaps

Housing lenders resold mortgages in secondary markets in order to raise capital for future lending. These lenders had little incentive to ensure that the loans were safe because another party would face the problems associated with the original borrower’s default. The amount of subprime mortgages, or risky mortgages issued to homebuyers with poor credit and little ability to repay, skyrocketed. Firms that purchased the mortgages in the secondary markets packaged these individual mortgages into mortgage-backed securities, which were then resold to investment banks. Although ratings agencies, such as Moody’s, existed to provide information on the safety of the mortgage-backed securities, ratings agencies gave falsely high safety ratings to risky mortgage-backed securities for business reasons. Lack of government regulation prevented accountability in this process. These mortgage-backed securities were re-packaged several times, further increasing risk, and eventually sold as derivatives, such as collateralized debt obligations (CDOs), which were securities backed by mortgages and other assets. As a precaution against the risks of the securities, investment banks bought Credit Default Swaps (CDSs) against their securities from companies such as AIG. These CDSs served as a form of insurance—if there were defaults on the securities, then AIG would cover the losses of the investment banks.

c. The Collapse

The risky lending practices contributed to a rise in speculative activity, which quickly grew unsustainable. The federal government chose not to regulate this, arguing that the banks should be free to make these investments at their own risk. Securities investment grew, encouraged by the Federal Reserve’s low interest rates, enabling investment banks to operate with unprecedentedly high levels of leverage. Housing sales began to weaken in 2006, triggering a $20 trillion decline in mortgage-backed securities values, bursting the financial bubble. Major investment banks Bear Stearns, Lehmann Brothers, and Merrill Lynch, as well as government-sponsored enterprises Fannie Mae and Freddie Mac, soon failed. Insurance giant AIG, unable to compensate the investment banks for their losses, also collapsed. Because these institutions were “too big to fail,” the US federal government authorized a $700 billion bailout through the Troubled Asset Relief Program. Despite the bailout, a massive contraction of the credit supply began, as banks became reluctant to make loans after their losses. New businesses became unable to find funds to form and existing businesses were no longer able to take loans needed to expand and maintain operations. Businesses then began to cut production costs, laying off employees. Losses in the financial sector continued to drive down housing prices because banks were anxious to sell the properties that they foreclosed. Because it became increasingly difficult for consumers to take out mortgages, the number of potential homebuyers decreased. This further accentuated the problem of defaults, further contracting the credit supply, eventually leading to the recession.

II. The Regression

While the blame for a robbery lies solely with the robber, the failure of the police to protect the victim is equally problematic. In this case, the frauds in the financial sector robbed the American people, while the government, instead of protecting the people, idly stood by, even aiding the robbers. Since the collapse, the Obama administration has prosecuted zero mortgage frauds. The ratings agencies faced no consequences for their outright lies and the investment banks are still free to make gambles. Furthermore, President Obama’s economic team continues to be essentially owned by the banks. Larry Summers received millions in speaking fees from banks receiving bailout money. Peter Orszag even left the administration to become Vice Chairman of Investment Banking at Citigroup. The Obama administration thus refused to allow for any true financial reform. Of the $700 billion authorized by the Troubled Asset Relief Program, $0 has been used to actually purchase troubled assets. AIG even used over $200 million to pay executive bonuses. When Congress refused to authorize further payments to banks, the Obama administration instructed the Federal Reserve to lend money to the banks at 0% interest and borrow that same money back at 5% interest, circumventing the will of Congress. Banks still refused to lend again. Why should they, when they could still make record profits from government money? Furthermore, the banks that were “too big to fail,” became even bigger, as the Bush and Obama administrations negotiated mergers of failed institutions. More than five years later, the United States has still not recovered from the Financial Crisis. Several economists even fear a double-dip recession. Politicians are distracting the American public from the lack of recovery by focusing on non-issues such as inflation and budget deficits. Corruption and the inactivity of the law had clearly failed millions of Americans, causing widespread suffering.

III. Going Forward

The legal solutions for the economic crisis are clear. We need to prosecute the frauds and hold the banks accountable for their actions. We need to enact true legal reforms to ensure that another Financial Crisis can never happen again. However, the bankers that own our government will refuse to give up their power easily. America needs strong, skilled attorneys at our regulatory agencies to take on the banks, as well as improved anti-corruption efforts to prevent stalling of reform. I hope our generation will confront these challenges.

-- LilyVo - 08 Apr 2013