Government Policies to Manage financial Crises

With the credit crunch affecting many financial institutions and shaking the previously christened “too big to fail” institutions; the premier action of the US government similar to other developed countries was to bailout these corporate through a fiscal stimulus package (Kenc & Dibooglu 2010). Such actions were advised on the reasoning that failure to bail out these financial institutions would result into the public’s loss of confidence in the financial system; a phenomenon argued to be worse than the experiences any financial crises (House of Commons 2008). As such the US government instituted a $700 billion bailout plan which was subsequently increased but bore limited success at reviving the sector due to the widespread corporate failures that had been predicted in some of the early submissions (Weiss & Larson 2008; Goodhart 2008; Kenc & Dibooglu 2010). The bailout plan included nationalization of some of the failed institutions (e.g. Fannie Mae and Freddie Mac), guarantees for market mutual funds, and a program that would provide capital funding for doubtful assets. Bailout plans have however been criticized on their potential of propagating moral hazards within the bailed out institutions or the entire industry (Weiss & Larson 2008; Rötheli 2010).

A second strategy employed through the Federal Reserve was to increase the deposit insurance for financial institutions. Such a move is argued to better the decision to close a financial institution “with less social hardship and less consequential political fuss” (Goodhart 2008, p. 352). Further this would lead to early detection of institutions that are at the risk of failure thus informing early action to prevent the effect from spreading to the entire sector and the economy (Weiss & Larson 2008). This however could also be subject to moral hazard challenges and agency related issues where the deposit insurance provides regulators (agents of the taxpayer) with an incentive to ignore problems of insured entities that are at a risk of insolvency (Hanc n.d). This means that the financial institutions also do have a role to play in ensuring the stability of the financial system to withstand economic downfalls.

Status and Role of Financial Intermediaries in Recovery

The events of the recent financial crisis unearthed the inefficiencies of the financial intermediaries to self-regulate and create a functional financial system. Among the causes of the financial crisis imprudent practices such as lack of risk insights and limited rationality in the banking institutions dominated (Rötheli 2010). Whereas the market environment prior to crises allowed for risk appetite; prudence practice demanded the existence of stable risk management systems to safeguard against pitfalls (Kirkpatrick 2009). Lack of such risk averseness in the corporate institutions’ framework; led to failures in many intermediaries some of which were held in high repute in the society (Weiss & Larson 2008). Secondly; a promoter of imprudence in financial institutions has been remuneration trends that are not pegged on the entity’s performance thus deterring managerial attention to potential risks (Kirkpatrick 2009).

With such indications of inability to institute effective internal controls with regard to risks; external control of financial institutions is necessary. Such control could for instance be offered through the stock exchange and strengthening of regulatory institutions (Rötheli 2010). Further strengthening of accounting procedures to deter classification of significant liabilities under the off-balance sheet events that conceal the real state of affairs at the company would better the process of detecting failures early (Rötheli 2010). Finally the monetary policy and other government strategies need to be continually reviewed to reflect changes in the market thus avoid promoting imprudence among the financial intermediaries (Rötheli 2010).

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