Question

1. In your view, what was the cause of the Great Recession of 2008-2009? Did we follow the proper steps to mitigate its effects? Explain.

2. What impact would federal spending cuts have on the current equilibrium level of economic activity? Would you favor such cuts? Why or why not?

150 words per question, please (:

Answer 1

1)

The first signs of troubled economy were visible in 2006 when housing prices started to fail. It wouldn’t have caused a panic if the borrowers that took out loans didn’t have a questionable credit. (Subprime lending) Also, amounts of upto 100 per cent of the value of homes were provided as loans. When prices of housing started to fall, borrowers started to default on loans( Subprime lending crisis)

The Gramm-Rudman Act allowed banks to trade in derivatives that needed mortgage-backed securities as collateral. It pushed the demand for more and more mortgages. Hedge funds and other financial institutions around the globe had bought these mortgage-backed securities. These securities were bundled and were resold in tranches. These securities were also in pension funds, mutual funds, and backed other financial instruments such as derivatives, which made all these too risky.

When securities started to lose value, banks started to panic as there was a lot of confusion around and they realised they would have to absorb the loss. They stopped lending to each other, the mistrust between the banks was one of the primary causes of 2008 financial crisis.

The Fed had to bail out banks like Bear Sterns and insurance company AIG. Treasury Department had to bail out Fannie Mae and Freddie Mac.

The government passed the Dodd-Frank Wall Street Reform Act to prevent banks from taking too much risk; it allows gives Fed the power to reduce the size of banks that become too big too fail.

Were these steps enough? Financial institutions innovate ways to escape regulations. To prevent another event like 2008-09 the government must regulate the financial system and make sure that regulations are being followed.