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2008 Global Crisis

Starting in 2005, the Federal Reserve perceived that its excessively broad financial strategy had made the potential for higher expansion. It properly started to fix arrangement through its standard technique of rising it’s focused on interest rate. A key initial phase in the money policy procedure includes the making of bank reserves; these are deposits that banks keep at the Fed. At whatever point anybody other than the Federal Reserve buys anything they have to have cash to pay for them. The Fed is diverse. It has the special capacity to pay for its purchases by informing banks that it has expanded their bank saves by whatever sum is important to pay for its purchases.
Making more bank reserves has a tendency to give banks more money that empowers them to make credits and ventures. This procedure has a tendency to add to the cash supply, which inevitably expands the rate of expenditure. After some time, an increment in spending well beyond the capacity of an economy to create products and administrations prompts inflation.
From 2001 to 2005, there was an increment of bank reserves in the Federal Reserve by about 20%. In the same period, other measures of money such as monetary base and currency increased rapidly. This increase in funds led to an increase in the rate of spending that consequently led to the increase in the dollar GDP. This made the Federal Reserve to ease its monetary policy by reducing the bank reserves; this caused the indicators or measures of money to slow dramatically. This caused the dollar GPD to slow. The slowdown in growth of money decreased the rate of spending in the United States. The Federal Reserve continued to drain or remove the bank reserves from the system, and this fuelled the financial crisis.

Keynes, the famous economist, introduced what is commonly known as “financial stimulus.” The basics of financial stimulus is the people who have more disposable income will lend the money to the government, and the government will give it to those who do not have to boost spending. Many have argued that this is true and have not questioned its validity, while others argue that the stimulus is not huge enough to cause an economic downturn. Before the 2008 financial crisis, the United States was practicing this theory widely as postulated by Keynes.
In reality, the financial stimulus policy is a drawback to the economy. For instance, in a year, the United States produces products worth $13 trillion, therefore they receive the same in income. The Population will save approximately 10% of this in order to purchase capital goods that will bolster future production. The government of the United States used to borrow this 10% meant for capital goods and pump it to the economy and most of it went to projects that were not resourceful to the economy. This meant that in the subsequent year, there were fewer funds for capital goods, and this weakened the economy.

The housing bubble pushed up the inflation rate that consequently led to US central bank raising the borrowing rates. This made borrowing quite costly, and the borrowers were not able to meet their mortgage payments, this led to foreclosures and lenders selling the houses (Krugman, 2009). Most of the Collateralized Debt obligations (CDO) were mortgage backed securities (MBS). The CDO’s rose exponentially in 2007 and the traders were ladling the consumers with securities that had no value. The subprime mortgages were riskier compared to the prime mortgages, and this is because the originators did not want to hold on to the mortgages. The mortgages were sold as a package known as Collateralized Mortgage Obligations (CMO); this was backed by subprime which was riskier and difficult to manage.

The U.S. housing bubble busted due to poor policies that encouraged homeownership. There financial crisis was triggered by interplay of several factors: subprime mortgages were overvalued on the assumption that their value will increase in the future. Banks and other financial institutions provided easy loans so that people will buy houses. The deals between the buyers and sellers were unscrupulous because they valued short term deal flow over long-term value creation. The banks and insurance companies that provided low interest loans did not have capital holdings to back the financial commitments they were engaging in (Krugman, 2009). Many Americans were unable to settle the mortgages, which led to plummeting of stock prices, especially in the real estate; this led to foreclosures and many people being evicted. The lending institutions had a liquidity crisis as they had lend much and the Americans were unable to pay. This crisis led to prolonged employment as many institutions had to cut back on expenses and costs by laying off the employees.

In response to the global recession, the United States and other countries had to come up with strategies, both short term and long term, to mitigate the crisis. The immediate response by the Federal Reserve and other central governments was to provide short term credits to restore confidence and address the liquidity crisis. The fed noted that it was important to keep credit flowing so that economic activities would not stall. In order to jumpstart the economies, different countries had to come up with a fiscal stimulus package (Savona, 2011). The United States had two stimulus packages that amounted to $1 trillion. The stimulus in early 2008 took the form of tax refunds/ tax rebates; most of the consumers chose to save the tax refunds instead of consuming, this plan had a small effect in improving the aggregated demand.
The first proposal was a $700 billion bailout plan that involved the purchase of impaired assets from the balance sheets of the financial institutions (Lefebvre, 2010). The bill was passed in October, 2008 where the treasury had planned to hold on to the purchased assets and resell them when the markets improved. Even though the Emergency Economic Stabilization Act of 2008 was approved, the financial market conditions were still on the decline. The treasury decided to invest directly in the financial institutions as it would be more efficient and faster. The United States government invested $125 billion in nine of the largest U.S financial institutions and a similar amount in the smaller firms. The buying of the troubled assets by the United States government was initiated by the Troubled Assets Relief Program (TARP) that was signed into law by the Bush Administration to address the subprime mortgage crises in 2008.

With an end goal to invigorate the business sector for transient loaning among enterprises, the treasury has additionally offered to specifically buy commercial paper from evaluated guarantors not able to raise cash in the private business sector. The administration likewise proposed a stimulus intended to improve economic activities. This eagerness to utilize deficit spending to help the economy amid a monetary downturn is a change over economist activities amid the 1930s, when it was by and large believed that financial plans ought to be balanced even in economic slowdowns.
The Fed brought down its key federal fund rate to give extra liquidity to the financial related framework, extended the scope of security it would willing to acknowledge consequently for loans, and gave direct lines of credit to a more extensive mixture of financial establishments. Before the financial crisis on the commercial banks would directly borrow from the Federal Reserve. According to Acharya (2011), the Fed nationalized two of the mortgage institutions (Freddie Mac and Fannie Mae) and promised to provide $100 billion in capital for each company; the government took 80% ownership in each. The government took a similar stake in AIG by promising that it will lend it more than $80 billion. The government agreed to shoulder the risk of losses for Bear Steams, a big investment bank, toxic mortgage assets; this was in a forced sale to JP Morgan.

Different countries responded differently to global crisis. For instance, Singapore implemented a financial policy known as Resilience package which was aimed at increasing job competitiveness and job retention. In Singapore there was Special Risk-Sharing Initiative (SRI) where the government took some default risk of loans up to S$5 million. The job credit scheme offered cash grant in order to encourage businesses to retain workers (Kawai, 2010).
In conclusion, during the crisis, the Federal Reserve injected liquidity in the system to hinder economic activities from stalling. The US government had to increase its expenditure that provides a financial stimulus to the economy. The government had to restore confidence in the financial system through insurance programs, direct investments, loans and guarantees. Some of the short term responses did not perform well. For instance, the Emergency Economic Stabilization Act of 2008 did not ease the financial crisis. In the long term, some policies worked and others did not. As at 2012, the housing market in the US had not stabilized as there were still troubled mortgages, the foreclosure rate remained high as homeowners could not modify their mortgages. On the other hand, the financial markets stabilized by the start of 2010, signifying some of the policies were working even though the economic growth was slow.