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Angeles University Foundation

Angeles City

COLLEGE OF BUSINESS AND ACCOUNTANCY

Accountancy and Finance Department

PANIC OF 2008

A Macroeconomic Paper

(Case Study Analysis in Macroeconomics)

Dela Cruz, Krinkle Marie

Gopez, Matthew

Reyes, Kaila Camille

BSA/MA- 2A

Mr, Jean Paolo G. Lacap, MBA

ECON 1 Faculty

September 30, 2011

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Panic of 2008

Just when things go right in the American market of having the luxury of home ownership

and virtually low standards of living in their scheme, the world suddenly turns upside down for

citizens hardly making it through their daily living. After realizing that with the interval payments

that they make for their home loans getting bigger than what they should deserve to pay in the first

place, citizens started becoming anxious of their resources and started defaulting on their

mortgagesby literally running away from their indebted abodes and the like. Such irrational action

was driven by the fear of paying more than what they own; ignited by the revaluation of once called

Triple-A subprime loans to flunk their values and create paper losseslosses just defined in the

financial statements of enterprises. In the end, citizens, banking institutions, and insurance

companies have lost confidence dealing with each other and the funeral for the investment bankinghas commenced.

Yes. This is the Panic of 2008fueled by the meltdown of the Stocks Exchange, and

running through the course of economic mistrust and irrational decisions created by the people and

the industry themselves. Resulting from the crisis of credit payments and devaluing no-market

subprime mortgages, the people must find a way to fight the atmosphere of fear rather than

flying from the responsibility to stimulate the economy again to its prime. In this paper, we are yet

to discover the true course of the panic that professes the downfall of investment banking in the

USA due to its volatile nature in the downward cycle of the economy. As measures were done in the

economy by the government, like the Federal Reserve and other organs of the US Government

responding by flooding the markets with money and other liquidity, reducing interest rates,

providing extraordinary assistance to major financial institutions, increasing Government spending,

and taking other steps to provide financial assistance to the markets, the effect seemed to create the

perfect storm in the financial regulation of the economy; thus, making everything uncertain with

the hopes of a brighter future for the financial setting of the country. The stand of this paper is

driven by the Keynesian principle to encourage spending in order to stimulate the economy and tonot do anything at the moment until the real market values of assets formerly stamped with next to

zero values come out with pretty reliable values. That, in its way, may lessen the fear induced by the

whole cycle of the panic, and end the irrationality of the impulsive decisions made by both parties.

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Identification of the Economic Problem

The main economic problem arising from this situation is the downfall of investment

banking in the USA. This is an output of different situations marked by the irrational movement of

the market, bringing down the confidence of the people in investing their personal assets for future

growth and benefits. This becomes a problem in the sense that investment plays a key role in the

economy by ensuring a greater return on the people investing their money or properties on it, at the

same time not making the given resources stagnant in the bank vaults. The problem arises initially

from the quick judgment that investment, during the time that the federal push caused lending

institutions to mistreat such as investment per se by offering loans even to borrowers with the

lowest qualifications. Thus, creating the term subprime loans or mortgages.

Frailey (2008) defined Subprime Loan as a loan that is often offered to who is not a"prime" lending candidate, such as someone with a bad credit record. The interest rate on a

subprime loan is likely to be a lot higher than an interest rate you would expect on a standard loan

from a bank. Banks and mortgage companies fed speculation in home prices by offering cheap

credit to all comers, including those who would not normally qualify.

With this in mind, the expansion of investments was clearly supported dubiously by rating

agencies in which the Americans clearly relied upon way back in time memorial. Rating agencies

assess the financial strength of companies and governmental entities, both domestic and foreign,

particularly their ability to meet the interest and principal payments on their bonds and other debt.

Rating agencies also carefully study the terms and conditions of each specific debt issue. The rating

for a given debt issue reflects the agency's degree of confidence that the borrower will be able to

meet its promised payments of interest and principal as scheduled (Kolakowski, 2011.). Credit rating

agencies played a very important role at various stages in the subprime crisis. They have been highly

criticized for understating the risk involved with new, complex securities that fueled the United

States housing bubble.

Housing bubble, on the same notion is an economic bubble wherein housing pricespeaked in early 2006, started to decline in 2006 and 2007, and may not yet have hit bottom as of

2011. Increased foreclosure rates in 20062007 among U.S. homeowners led to a crisis in August

2008 for the subprime markets and the like (Bill Moyers Journal, 2007.)

Upon the massive recession in early 2001-2002, following the meltdown of the stock

markets with such loans in hand, default/delinquent payers started to arise, while analyzing that this

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may be likely due to the fact that lending institutions have dropped the standards with regards to the

mortgages that they gave out. With the default mortgages on hand, institutions are faced with

another crisis, the Credit Chaos. This is a crisis that began in the subprime lending marketplace

escalated into a full-blown credit freeze. Governments across the globe were forced to inject massive

amounts of liquidity and capital into the banking system to prevent a complete collapse (Hornell,

2009.).

Apart from that, the accounting technique of the financial reporting in the country may have

bruised the already impending problem with a heavy laceration ahead. Mark-to-market accounting

brings down the value of the assets that institution has with their current fair market value in order

to represent the faithful value of such instrument for clear representation. According to Susanti

(2008), Mark to Market accounting (MTM) or fair value accounting means that companies must

value their assets on their balance sheets based on the latest market price. MTM is great for financialinstitutions when markets are booming, but when the economy is in the midst of a severe downturn,

the use of MTM will reinforce the downward cycle. It adds momentum to a destructive downside.

Banks and other financial institutions argued that MTM rules have contributed to current financial

problems because they are required to value distressed assets at fire-sale prices. Current credit crisis

left Banks and other financial institution loaded up with bad debt and mortgage related security that

was valued to next to nothing in the market. As the assets value plummeted, trouble and bankruptcy

arises. The cycle created by the turn-out of events led to the economic problem, in which other

problems due to such rose, which will be discussed in the next part of the paper.

Statement of Key Problems

Key problems noted in the main economic problem include 1) the credit chaos. Due to the

seemingly unreliable ratings given to debt instruments with packaged subprime loans, such default

mortgaging rose from the very mistake of credit rating agencies to mark such debts as liquid, where

in fact, the absence of market for such investments classify them as highly illiquid. This in turnrelates to the second problem in the economy, which is 2) the public mistrust.

The public mistrust is caused by the series of unprecedented market value depressions and

unreliability by the lending institutions and the industry itself. People, in the fear of losing all of their

properties, just want out of the current crisis; thus, bringing in a condition of Panic. The last

problem encountered in the period is the 3) bankruptcy of investment banks and recession caused

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by paper losses.Such losses are created by the programmers in the Wall Street, in an attempt to

appraise the values of no-market subprime loans during the meltdown of stocks, of which fair-

value accounting becomes destructive. This in turn created the massive paper losses, generating

over-all low domestic products and risk for some institutions, and end for most of lending

institutions.

Evaluation

The problems presented were given solutions by the federal government in an attempt to

solve it the nearest time possible. The first and third problem, however, still remains as a problem

for the current market of these loans remain in the bottom-low, and until the market value of such

arise in order for people to feel obliged to pay for what they deserve, we cannot do anything thatwould hurt the economy further. The third problem compensates as well the adaptation of much

more reliable computer programs to identify the true market value of such dubious instruments so

as not to aggravate the situation caused by paper losses. The second problem however can be

alleviated by insuring people of the return on investment that they have once the economy picks its

momentum again. The federal government has launched expansionary fiscal policies by increasing

government spending so as to stimulate the economy and to gain the public trust in investing and

consuming products and instruments as well. This movement is the stand of this paper as well for it

is founded in the Keynesian principle to maximize spending in order to stimulate the economy to its

peak again, in that way, it can alleviate the effects of recession in the declining market value, and to

remove the fear in the industry so as to push the citizens of the nation not to default on their

obligations and such.

Recommendation

Nothing is certain yet in the progression of the panic, and it has not been determined stillwith the gravity of the decisions made together with its impact in the economic society of the

country, but one thing that is sure is that we can never entertain impulsive reactions at the moment

where everything picks up a pace that is accelerating and decelerating at the same time. Starting in

2008, there has been a resurgence of interest in Keynesian economics among policy makers in the

world's industrialized economies. This has included discussions and implementation of economic

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policies in accordance with the recommendations made by John Maynard Keynes in response to the

Great Depressionsuch as fiscal stimulus (Giles et al, 2009.). One of the great recommendations of

this paper include the maximizing of the government funds to generate employment for people to

have themselves available to recover from delinquency, and to subsidize lending institutions still to

sustain their liquidity with debts and other credit termsto equalize income by increasing

government spending.

Implementation

Subsidies implemented may be equivalent to the total losses garnered from mark-to-market

basis of institutions. These subsidies may be sustained until the delinquent mortgages pick their

momentum again to pay for their obligations. This may end the panic and start to get the trust of thepeople, credit rating agencies, and of themselves as a whole by serving as the keystone in igniting the

purchasing and liquidity of the people currently damped in the whole scenario. Still, other things that

are best to do yet are to not do anything impulsive until we see the progress of the panic into a crisis,

or to see its death as a panic alone, which is better.

References

Frailey, F. W. (2008). 15 Things You Need to Know About the Panic of 2008. Retrieved

Wednesday, September 24, 2008 http://finance.yahoo.com/banking-

budgeting/article/105826/15-Things-You-Need-to-Know-About-the-Panic-of-2008

Kolakowski, Mark. Rating Agencies. Retrieved September 18, 2011,

http://financecareers.about.com/od/ratingagencies/a/ratingagencies.htm

"In Washington, big business and big money are writing the rules on trade...". Bill Moyers Journal.

PBS. 2007-06-29. Transcript.

Hornell, Bill. "Credit Chaos | What a Year 2008 Turned out to Be | Jan 2009." Paper, Film & Foil

Converter Magazine . 1 Jan. 2009. Web. 19 Sept. 2011. http://pffc-

online.com/management/credit_chaos_0109/.

Susanti,Nanindvas. (2008, December 28). Mark to Market Accounting. Retrieved September 18,

2011, http://ezinearticles.com/?Mark-to-Market-Accounting&id=1836665

Chris Giles, Ralph Atkins and Krishna Guha. "The undeniable shift to Keynes". The Financial

Times. Retrieved 2009-01-23.

http://finance.yahoo.com/banking-budgeting/article/105826/15-Things-You-Need-to-Know-About-the-Panic-of-2008http://finance.yahoo.com/banking-budgeting/article/105826/15-Things-You-Need-to-Know-About-the-Panic-of-2008http://financecareers.about.com/od/ratingagencies/a/ratingagencies.htmhttp://pffc-online.com/management/credit_chaos_0109/http://pffc-online.com/management/credit_chaos_0109/http://ezinearticles.com/?Mark-to-Market-Accounting&id=1836665http://ezinearticles.com/?Mark-to-Market-Accounting&id=1836665http://pffc-online.com/management/credit_chaos_0109/http://pffc-online.com/management/credit_chaos_0109/http://financecareers.about.com/od/ratingagencies/a/ratingagencies.htmhttp://finance.yahoo.com/banking-budgeting/article/105826/15-Things-You-Need-to-Know-About-the-Panic-of-2008http://finance.yahoo.com/banking-budgeting/article/105826/15-Things-You-Need-to-Know-About-the-Panic-of-2008