Question

1. a. Explain the reasons for the 2008 Financial Crisis and what extraordinary policies were put in place to fight the crisis.

b. Describe the monetary policy during the 2008 Financial Crisis.

Answer 1

(a): The primary reason for the 2008 financial crisis was the greed of lenders, individuals and financial institutions. Greed of these entities led to the increased use of exotic and risky mortgages. Brokers approved loans and packaged bad mortgages with other mortgages and resold them as good investments. People were lured to take loans larger in size than what they could afford. People were led by their greed to believe that in case of any problems the house could be flipped for profit or it can be refinanced later at lower rates. Thus deregulation in the financial industry led to the crisis. Deregulation enabled banks to indulge in trading of exotic and risky assets like derivatives, credit default swaps etc. and this gave rise to greed and unscrupulous financing and provision of credit. The extraordinary policies that were put in place to fight the crisis focused on financial institutions and markets and the flow of credit to households and businesses. Also institutions like the Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation (FDIC) have taken a host of measures to repair the financial institutions.

(b): The monetary policy during the 2008 financial crisis was an eased policy. The federal funds rate target was cut rapidly. Traditional interest rate instrument of monetary policy was eased during 2008 and credit to banks was provided at longer maturities. Provision of liquidity was restricted to U.S. banking institutions during the period of crisis but afterwards the Fed expanded its provision of liquidity to other financial institutions as well.