Question

What are 5 financial innovations and deregulations that led to the financial crisis in 2008? What are 5 policy responses by the Federal Reserve and the U.S. Government and Treasury department that helped us to get out of the financial crisis? Who are the winners and losers?

Answer 1

Financial crisis implies a steep decline in the market price of assets such as real estate. Because of the fall in value, it is difficult for businesses and consumers to pay their debts and financial institutions report liquidity shortages. A financial crisis is often witnessed with a panic run to the bank where investors withdraw money from savings accounts because of fear of asset devaluation.

The five financial innovations and deregulations that led to the financial crisis in 2008. are :

1. Sub-prime Mortgage lending crisis: One of the main reasons for the financial crisis in the US in around 2008 was the mortgage policy. The mortgage loans are given to low or moderate-income Americans. The high default rate of these types of loans led to the crisis.

2. Trade Deficit: The US had invested a huge amount of money to import products from China. However, the rate of production in China was quite low leading to a loss in the money invested causing the trade deficit

3. Unchecked Mortgage Loans: No review on loan recoveries was another reason for the crisis as huge unregulated loans collected due to the heavy Collateralized Debt Obligations (CDO) gathered during this time.

4. Rating agencies: Failure on part of rating agencies to give the right advice to the investors.

5. Predatory Lenders: Predatory lending implies unscrupulous lenders and enticing borrowers entering into "unsafe" secured loans for all the wrong reasons.

Five policy responses by the Federal Reserve along with the United States Government and Treasury Department that helped us to get out of the financial crisis are:

1. Expansion in the money supply to avoid deflation.

2. Large fiscal stimulus packages enforced by the government through borrowing and spending to offset the reduction in private sector demand caused by the crisis.

3. Regulatory proposals introduced in US by President Barack Obama and key advisers in June 2009 helped.

4. Basel III regulations introduced in Europe for banks and helped increase capital ratios, limit leverage, limit counter-party risk and provided new liquidity requirements.

5. The government also bailed out a variety of firms.

The Banks and their shareholders along with the taxpayers and their governments are on the losing end in a financial crisis.