Question

During the financial and economic crisis of 2007 and 2008, the excess reserves to deposit ratio increased significantly. what do you think happened to the money supply?

Answer 1

>In the year 2000-2002 the stock price in america makes a downfall so no one is willing to buy any stock at that time, so in the year 2001 the interest rate in america redused down to 1%.

>At that time no one is willing to invest their money in stock market, and people do not want to put their money on bank due to low interest  rate.

>As the bank interest  rate is very low so people are taking lones to buy houses so for that the realestate market is growing up, as the demand of realestate increases at that time so the investors are noe investing their money in realestate.

>As the realestate demand is going up the investment bank at that time try to make profit, so for this the investment bank buys a lot of loans from the banks and make a collateralizaed debt obligation.

>These CDO at that time got AAA rateings so due to this more number of investers demand for CDOs, for this the investment bank demanded more loans in bank.

>So to full fill the demand of investment banks the bank provide more sub-prime(unsafe loan) to people.

>The bank then givethese sub-prime lone to investment bank and investment also make CDO of those loans and between 2000-2007 they provide a lot of CDOs to investors and made profit.

>Moody's one of the biggst credit ratting agency of US make alot of profit between 2000-2007.

>As CDO are AAA rated so AIG start providing insurance on CDOs, so all investors take the insurance of their CDOs so that their loss can be makeup.Name of that insurance is CDS.

>At first the interest  rate was low but latter the interest  increases and all the sub prime loans become bad loans for the bank.

>So at that time bank trys to sell the houses of the loan defaulters but no one is now willing to buy houses.

>No atthese time bank are facing more defaulters of loan so the CDO value became 0.

>As the CDO value was became 0 so AIG faces a bis loss at that time and there accure a crisis in the market.

>Now no one is buying CDO so the 5 big investment bank in US faces a big loss at that time.

>Lehman Brothers became bankrupt , in this crisis the bank and other finantial institutes faced a $450 billion loss.

>So due to this crisis credit crunch happens, a lot of business and companies did not got loan at that time so that they can not able to generate capital for their business.

>Us economy growth was stopped at that time and there happens a lot of unemployment.

>Global trade also face a problem due to this crisis,as the us is a big economy in the word and the the contry economy is inter related so a lots of country's bank became bankrupt.