Question

Our Chapter 8 discussions will focus on short term financing, tell us your reaction to the following:

How did the 2008-2009 failures in the mortgage industry affect the supply of credit in the economy? How would you characterize the Fed’s response to the crisis?

Answer 1

Great Recession of 2008

Great Recession of 2008 happened because of Subprime mortgages.

Subprime mortgages are home loans which are given to borrowers who have poor credit histories. These types of loan are considered high risk loan.

Failures in the mortgage industry affected the supply of credit in the economy in following ways:-

- It freezed the interbank lending

- Recession led to higher unemployment rate as company started removing people from their companies as businesses were not able to make any profit or get any loan for any project.

- Bank were not able to lend loan to customer because of bank failure as they lost their money as mortgage default

- Bank followed tight credit

- Due to money crunch in the market there was less investment in money generating capital which further fuelled recession.

- Credit rating agencies downgraded the ratings for many companies due to which investment was low and businesses were not able to generate profit

Characterization of Federal Reserve responses to the subprime crisis in following ways -

- It used interest rate cuts which is one of the tools of monetary policy which is used by many banks when they face recession type of situation.

- Idea behind cutting interest will lead to more money with people which they will spend on items and this will increase demand and profit economy.

- It also used unconvention measures too to tackle with the crisis alon with monetary policy.

- Through  quantitative easing it made the new money and used it to buy bonds, basically injecting money in the economy as more money will increase demand among public.

- Fed is criticised for that currency which was made by the bank was not backed by any precious metal like gold which inherently considered as bad idea, to make pure fiat currency.