Business Studies
Choose 1 of the following topics related to the Great Recession:
• The housing price bubble, collapse, foreclosures, bailout of underwater mortgages
• Subprime mortgages and derivatives, bailout of FNMA, Freddie Mac and AIG
• The banking industry crisis, bailout of commercial and investment banks
Write a 350- to 700-word analysis of 1 of the following corrective actions taken by the Federal Reserve as a result of the crisis:
• Quantitative easing
• Purchase of toxic assets from financial institutions
• Paying interest on reserve balances
Address the following in your analysis:
• Actions taken by the Federal Reserve to mitigate the crisis
• How the corrective action helped to restore stability to the financial system
• How the corrective action should prevent recurrence of a similar crisis
Note: Use of charts and graphs is encouraged with appropriate citations. Any charts or graphs retrieved from the Federal Reserve Bank of St. Louis FRED website may only be included when the data sources used by FRED are US government sources such as the Bureau of Economic Analysis or the Bureau of Labor Statistics.
Cite at least 2 academically credible sources.
Format your assignment according to APA guidelines.
Submit your assignment.
ANSWER
Before the year 2007, the United States has been experiencing a boom for many years but within a period of a few months, the all that effort was wiped out to what became the Great Recession. Many Americans lost their jobs and even more lost their homes while the housing market plummeted to what was referred to as the housing bubble. In the year 2000, the average price of a house was $207,000 but by the beginning of the year 2007, the average had risen to $314,000 and was still growing unabated until he subprime mortgages were economically unsustainable (Svilenova 2011). This paper examines the Housing Bubble as well as the corrective measures taken y the Federal Reserve as a result of the crisis:
To understand what the Federal Reserve had to do about the issue of housing in 2007, we must first understand the factors that fuelled it to that breaking point. Watcher (), blames the even primarily on “the rush to lend money to home buyers without regard for their ability to repay” (Svilenova 2011). Credit was increasing at an exponential rate and in all directions and when the debtors could not pay, many foreclosures and defaults were issued crashing the housing market and largely depreciating value of the securities associated with the subprime mortgages (). As a result, a ripple effect reverberated across the whole finance system causing banks to fail and eventually forcing the federal government to mitigate the damage.
To impart corrective measures and restore stability to the financial system, the federal reserve “provided liquidity and support through a range of programs motivated by a desire to improve the functioning of financial markets and institutions, and thereby limit the harm to the US economy” (Federal Reserve History). In response to the housing bubble, the Fed supported specific financial institutions through the process of quantitative easing where the money is injected into the economy with the idea to expand economic activity. The Fed achieved this by a reduction of the reserve holdings of treasury security to reduce reserves belonging to banks and by this driving the federal funds rate low.
By late 2008, the Fed had achieved a lot towards correcting the situation (Federal Reserve History). It had gained the authority to pay bank interests from reserves that were in excess. In response, banks had the incentive to hold on to their reserves rather than lend them out and therefore mitigating the purpose the Federal Reserve to offset the expanded lending capability by reducing other assets.
To avoid another similar crisis, there are only two factors to consider, one is “how likely Americans are to get overexcited about housing again and the other is whether legislatures have policies set to protect people from overinvestment (Svilenova 2011). Experts on the topic say that it is likely that again at some point in the future, people will get excited by the wild returns from residential real estate and it is vital that we are prepared for it (Svilenova 2011). Such policies could include an increase in interest rates by the federal government as soon as economists predict unsustainable growth in one particular investment, in this case, mortgages. Similarly, while the real estate business does look lucrative with the potential to reap incredible benefits, the federal government should reflect the dangerous side of it to investors and the enormous risk that more than often gets overlooked.
The fact is that somewhere along with the line public opinion will be driven towards a particular excitement towards a singular investment option. This is the basis of the existence of a Federal Reserve, to ensure a balanced market. However, legislation and policy will be paramount in preventing another bubble.
References
Federal Reserve History. The Great Recession and its Aftermath. Retrieved on 18th July 2020 from https://www.federalreservehistory.org/essays/great_recession_and_its_aftermath
Svilenova, J. (2011). Regulatory response to the financial crisis of 2007-2008: will Basel III help prevent future crises in the banking sector? (Master’s thesis).
