In this Unit we’re covering the money supply and the tools of monetary policy. R
ID: 1121747 • Letter: I
Question
In this Unit we’re covering the money supply and the tools of monetary policy. Regarding the latter, open market operations, the discount policy, reserve requirements and the interest paid on reserves, are the focus. An argument can also be made for the rate of interest, supply of money and the rate of exchange. Knowing this let’s go back to the 2008-2009 financial crises. How did it get so bad? Greed is a good starting point. The American economy is built on credit. Credit is a great tool when used wisely. For instance, credit can be used to start or expand a business, which can create jobs. It can also be used to purchase large ticket items such as houses or cars. Again, more jobs are created and people’s needs are satisfied. But in the last decade, credit went unchecked in our country, and it got out of control. Mortgage brokers, acting only as middle men, determined who got loans, then passed on the responsibility for those loans on to others in the form of mortgage backed assets (after taking a fee for themselves originating the loan). Exotic and risky mortgages became commonplace and the brokers who approved these loans absolved themselves of responsibility by packaging these bad mortgages with other mortgages and reselling them as “investments.” Thousands of people took out loans larger than they could afford in the hopes that they could either flip the house for profit or refinance later at a lower rate and with more equity in their home – which they would then leverage to purchase another “investment” house. A lot of people got rich quickly and people wanted more. Before long, all you needed to buy a house was a pulse and your word that you could afford the mortgage. Brokers had no reason not to sell you a home. They made a cut on the sale, then packaged the mortgage with a group of other mortgages and erased all personal responsibility of the loan. But many of these mortgage backed assets were ticking time bombs. And they just went off. The housing market declined, the credit well dried up, and we’re still trying to recover to a degree. (The 2008-2009 Financial Crisis – Causes and Effects by Ryan Guina: http://cashmoneylife.com/economic-financial-crisis-2008-causes/) Now, our discussion; which tool, or tools, is most important and could have, should have, helped avert that crisis? What would YOU do if you were Federal Reserve Chairman for a day, to ensure we don’t experience this again, and why?
Explanation / Answer
ANSWER:
The financial crisis-2008 arose because of the following main reasons.
1) Monetary tightening improves both the reliance on and the concentration of wholesale funding within the banking sector, thus an indicator that monetary tightening could increase systemic risk
2) Central banks neglected financial stability and became too focused on their primary objective of price stability
3) Crisis spreads through securitization because banks bundled the mortgage loans on their books and sold them in secondary markets as securities
4) Prior to the crisis, financial institutions became highly leverage
5) Contractionary fiscal policy drives up prices in investments. That's called an asset bubble
The government regulations could have prevented or mitigated the credit crisis of 2008. If the government regulations were in place to the accumulation of subprime mortgages would have been less. The credit score setting, down payment and proof of income requirements that lenders need to adhere to could have prevented the credit crisis of 2008. Regulations would have mitigated or prevented the credit crisis because it would have prevented or limited leveraged financial institutions from taking on high risks
If I were a Federal Reserve Chairman for a day, to ensure that we don't experience this again, I would have opted a systematic combination of tighter monetary and fiscal policies through an approach of mixed economic policy, tighter financial regulation, and robust controls over the credit rating institutions and the shadow banking system. Bank rules and regulations is a form of government regulation which subjects banks to certain restrictions, requirements, and guidelines that are designed to create market transparency between banking institutions and the corporations and individuals with whom they conduct business, among other things. This is also vital for customers in order to in still confidence in the system of banking and preventing any such activities that can be to threaten the supply of money. Also, the Fed's quantitative easing program and low fed funds rate would not cause hyperinflation in the near future