Federal Reserve response to crisis

U.S. housing policies were the root cause of the financial crisis . Other players – “greedy” investment bankers, foolish investors, imprudent bankers, incompetent rating agencies, irresponsible housing speculators, short-sighted homeowners, and predatory mortgage brokers, lenders and borrowers- all played a part in crisis that stuck USA in 2007 . But as a matter of fact, they were just following the incentives laid out for them.

The global housing boom led to one of the biggest bubble in history with the total value of residential property being risen by dollar 30 trillion, an increase equivalent to 100% of those countries combined GDP . Residential investment being influenced by a number of factors: wealth of individuals, low mortgage rates, low short term interest rates, etc., peaked up the prices much faster than the household income, creating an adverse effect on the stock market and ultimately leading to a massive financial crisis .

While recession prevailed in the economy for reasons such as : Declined wealth, reduced demand, reduced supply and increased unemployment, the response of the federal reserve to the crisis in particular was that of an “interventionist”, aiming to rebound the recovery .

Moving with a plan of action, the U.S. monetary authority responded with a swift and large reductions in their official interest rates at just above 0.0% suitably called the ‘ Zero interest bound ‘ with riskless liquidity. Acting as a lender of last resort, it took a large part of the U.S. financial system under its supervision . After August 2007 , it began advancing its own credit against collateral. In December 2007 , it established two lending facilities: a term auction facility (TAF) and a system of foreign exchange swap lines . The fed also facilitated the purchase of Bear Stearns and AIG, by transferring their toxic waste off the hands of US capital, indeed giving primary dealers access to its Discount window .

Thus , although the Federal Reserve and the government took every possible stand to mitigate the effects, the crisis left an indispensable mark worldwide because “if US catches cold, each and every economy sneezes” .

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