Response to the great recession of 2007-2008
Introduction
The 2007 financial crisis had various causes, with the primary ones being the failure of key corporations in the state, asset value depreciation, lack of adequate government intervention to control the financial market and finally reduced economic activities. However, to manage the situation, both regulatory and market strategies were sought by different stakeholders, with the aim to achieve economic recovery in the U.S. Global housing bubble reached its peak in 2006, leading to significant fall in the valuable asset price by a margin of 40%. The different securities attached to the housing market were exposed to more risks, a fact that led to the development of financial losses in the sector. One of the sectors that were significantly affected by the crisis includes the stock market, a feature that made the financial institutions lose liquidity. Furthermore, the impact led to the dawdling development of the global economy, as the international commerce was unfavorably influenced by the same. One significant effort appreciated throughout the paper is that different governments across the globe implemented diverse approaches, monetary and fiscal policies, and institutional bailouts to help revive the economy from collapsing. Scholars have, however, directed the blame to the financial institutions in the country for giving inaccurate ratings of the MBS and failing to enforce effective regulatory practices to help establish financial stability.
It is worth appreciating that the 2007-2008 recessions had adverse effects not only in the U.S but the global economy, the situation considered as the worst financial crisis experienced since the great depression. More importantly, the crisis started its encroachment in the U.S and later spread to other countries around the world, leading to significant economic losses and collapse of major banks in the country. However, to escape these adverse effects encountered as a result of the crisis, different governments settled on different strategies to bail their economies from collapsing. The purpose of the above study is to discuss at length the different response actions taken by the Federal Reserve towards solving the 2007-2008 recession.
Causes
Various causes are directed to the 2007-2008 crises, with the key reason being the housing bubble experienced in 2005-2006. The situation led to increased cases of defaults on the mortgage rates as banks offered more credit to the homeowners, an issue that resulted in increased housing prices. Moreover, the country suffered massive inflow of foreign currency into the U.S economy, contributing to the house construction boom. The bubble, therefore, was as a result of the over expenditure by the consumers, an aspect that led to a rapid increase in the real estate standard. The populace had easy access to various kinds of loans in the nation, an issue that contributed to increased liability load among the consumers. The financial challenges started with the drop in house prices as the investors who had borrowed huge loans to invest in the real estate industry reported huge losses.
The recession lasted for almost two and half years, and scholars consider it the largest since the great depression due to its adverse effects. Some of the factors that were affected by the recession include a significant drop in the gross domestic product (GDP) by a margin of 4.3%, a drop that had not yet been experienced for decades. Another negative externality that resulted from the recession includes the high unemployment rate that further rose by 4.5% to hit the 9.5% mark in 2009.
More importantly, we can appreciate that the recession had a significant impact on various sectors of the economy, therefore, impairing the economic growth of the state. Financially, the concept contributed to drop in house prices by almost thirty percent, which led to massive losses to the real estate investors, a feature that resulted in increased number of loan defaulters. Hence, the U.S economy lost a lot of revenue due to the fall in the home prices experienced in the country from the usual $69 trillion experienced in 2007 to $55 trillion realized in 2009.
Apparently, due to the numerous adverse effects realized from the recession, there was a need for the international community to take measures to revive the economic growth. Fed introduced different programs, enacting policy measures that utilized both the government spending and cut of tax to jump-start the economy. The Federal Reserve embraced various non-traditional approaches with a goal of solving the crisis. The first strategy that was employed by Fed included the reduction of interest rates so as to encourage consumption among the public. However, the decrease started with a negative impact on the economy as it resulted in the reduction of output experienced and reduced chances of inflation.
The government enacted policies that significantly reduced the Federal fund rate for a period, an aspect that planned to use the monetary stimulus to control the market interest rates and create the expectation of inflation while at the same increasing money supply into the market due to low real interest rates. It is, therefore, import to appreciate that the Federal Reserve utilized its policy approach to controlling the fund rate in the market, manage inflation and attain economic stability by increasing consumption rates. Besides, Fed sought two other non-traditional methods to the solving the financial crisis that followed the 2008 recession with one of the approaches focusing on the different ways through which it was able to ease credit programs. The move was intended to facilitate credit flow while at the same time reducing the cost of the credit as experienced in the market.
Lending to other banks is one of the roles performed by Federal Reserve with its discount window program being limited to the member banks only. Nevertheless, due to the economic predicament experienced as a result of the depression, the terms of lending were expanded to include more parties. In 2007, new programs were introduced by the Fed to target the market areas that experienced high-interest rates.
Another approach that was sought by the Fed was the large-scale asset purchase (LSAP) program that was intended to bring down the borrowing rates for significantly long periods. Some of the significant investments made in 2008 included agency mortgage-backed securities (MBS) and the various debts associated with government housing in the country. Moreover, the choice of assets to purchase was based on the fact that it would contribute towards reducing prices of the assets while at the same time increasing the availability of credit in the country. The move was to encourage and support the public in acquiring homes that contributed to the recession, an aspect that helped realize financial stability in most sectors of the economy. The program saw the Fed purchase about $500 billion MBS and a total of $100 billion in agency debt within one year although it spilled over to another year. Scholar appreciates that the Fed's effort to purchase $300 billion long-term Treasury securities in 2009 contributed to eliminating the recession, a response that resulted in financial stability in the country.
It is worth noting that by 2013, the U.S economy had started recovering from the financial crisis that was experienced with its GDP slowly growing while the unemployment is reducing slightly to 7.3%. Fed utilized the monetary policy in controlling the crisis at it managed the fund rate to zero to encourage more borrowing. The purchase of the long-term assets significantly reduced inflation as it contributed to a reduction in property price in the country. The Fed has thus sought to use different policy issues to help meet the financial stability goals and implementation of more LSAP programs to manage inflation.
Emergency and short-term responses
The U.S. Fed Reserve in conjunction with other central banks from the rest of the world was involved in efforts to manage the crisis by expanding the money supply in their respective countries, therefore evading inflation. Moreover, through the concept of expanding the money supply released into the economy, the states would experience an increase in consumption, hence attracting more employment opportunities for the people thus contributing to economic growth.
Apparently, one of the aspects that almost collapsed the world economy is the credit freeze experienced in the country. Therefore, the liquidation injection that was embraced by Fed and other central banks around the world through the purchase of the government debt and other private assets helped solve the situation significantly. Moreover, the Fed helped supply other key banks with funds to bail them out from the financial instability experienced. Therefore, it is important to assert that it is the U.S. government commitment to solving the financial crisis suffered due to the recession that helped explain the situation.
One significant observation made from the study is that Fed employed both monetary and fiscal PLANS in retort to solving the depression. This can justify the aggressive efforts implied by the government in the attempt to purchase mortgage securities from other banks with a goal to increase money supply into the economy with a rationale of stimulating it. It is worth to appreciate that different financial programs discussed in the paper were implied to support the financial institutions to operate generally and markets so that the household members can have easy access to credit for consumption. Moreover, the Fed took the different types of collateral under its jurisdiction and other credit protection measures against any form of losses whatsoever.
The provision of liquidity can be explained by the effort of the Fed to expand its collateral lending to other banks, a feature that ensured that institutions had access to funds as required for their daily operations. It is important to appreciate the further that commercial banks get their loans from the central banks through a process referred to as the discount window lending. Nonetheless, due to the financial crisis experienced during the recession, the Fed was forced to lend to other non-commercial banks through a program referred to as the short-term secured loans. This helped improve the financial condition of the market as it made credit available to different people in the market as evidenced by 2009 case.
The second response through which Fed addressed the crisis was by supporting the impaired financial markets. The first tool used is the money market is mutual funds, a feature that implied that Fed had to collect funds from the investors and using the money, invested in treasury bills and offered unsecured loans to a different corporation that required jumpstarting their business operation, a condition referred to as the commercial paper. However, the investment did not last for long despite the fact that it was a key source of funds for most businesses, and this is because some of the investment banks were declared bankrupt, making people pull out their money from such investments. However, to solve the situation, Fed had to chip in and secure the various loans given to corporations in the market, hence guaranteed investors of adequate money supply into the market.
Financial reform proposals
As evidenced by the above study, the recession had adverse effects not only on the U.S. economy, but the global economy, a feature that almost led to its collapse. However, it is worth noting that the Federal Reserve assumed its role in protecting the world economy from recession and therefore, implementing the above reform strategies would significantly protect the world financial sector.
The various financial firms around the world should consider strengthening their risk management approaches
Another important solution is re-evaluating the different compensation schemes set in place
Reinforce the capital principles
Consider enhancing the various regulations set in place to manage the institution and supervise the same among others
The suggested reform steps will not only improve efficiency at the institution, but will also restore growth, an aspect that will stimulate credit flows.
Conclusion
It is evident from the study that the Federal Reserve assertively responded to the 2007 recession by implementing various programs. The schemes intended to help financial organizations reach liquidity and enhance the souk condition of the down market established. Although some of the programs were brought to an end, the Fed is doing all it can within its jurisdiction to achieve its monetary objective of ensuring that there are maximum employment and stability in the market. One of the strategies still in use to date is the purchase of the long-term securities to ensure that the interest rates are still maintained low. The study revealed that Fed uses different instruments in the revival of the economy from recession. Apparently, Fed is renowned for its traditional responsibility that involves acting as the lender of the last resort, and this included t servicing of different banking institutions with short-term liquidity to allow them to operate with ease. However, the Fed also jumped into assisting the key investor in the market by offering them with the availability of a secured loan to borrow from so as to enhance the level f economic activities experienced.
In concluding of the above study, we can assert that the objective of the study is seeking to understand the different response actions taken by Fed are actually explained. The Federal Reserve did not only offer loans to other financial institutions to enhance liquidity, but also supported the various financial markets using different approaches. Moreover, it provided assistance to the already collapsing baking institutions to help jumpstart their normal operations, a move appreciated for reviving the global economy. The monetary policy enforced by the system helped enhance credit flow into the market while reduction of the interest rates ensured that everyone in need of credit had access to it at an affordable rate to stimulate economic growth of the country.
The 2007-2009 financial crisis experienced in the U.S was as a result of a reduction in liquidity experienced in various financial markets, a feature that contributed to increased cases of defaults. The Fed responded by injecting extra cash into the marketplace, a feature that enhanced the liquidity of the monetary organizations. Different liquidity regulations were thus put into place to control the process with some scholars citing market failure, and small lending by the central bank as the primary cause of liquidity challenges. Some of the key issues that influence the liquidity level of the financial market are the reduction in the credit flow while the second aspect is solvency, an aspect that leads to withdrawal of investors from doing business with troubled corporations. The study, therefore, justifies the fact that the response by central banks to incur in more lending was the best approach to resolve the situation. However, adhering to the different liquidity regulations set in place will help towards realizing financial stability, and offer the necessary authorities adequate time to evaluate the nature of risks involved and how they can be resolved in a more efficient way.
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