Posted: March 23rd, 2023

The US Economic and Financial Crisis of 2008-09

The economic and financial crisis of 2008/09 was among the most challenging situations that the world and the United States faced after the 1929 recession. The crisis originated from the US mortgage lending markets. The economic downturn easily spread to the UK and Europe regions before causing the effect to the entire world. Although the crisis was realized in 2008, the factors that caused the disaster would be traced before that year. In the early years of the 21st century, the housing industry was growing tremendously, and the sector was fetching great prices (Writer 1). As such, many people invested in the industry with the speculative hope that the prices would keep rising. However, despite the situation being attractive, it led to the formation of the “financial bubble.” Before the crisis, the investors realized high returns and continued to spend more, situation that attracted prospective investors into the industry. After the massive and arguably unregulated lending in the mortgage industry in the years before 2007, there was the economic bubble created in the housing sector, which burst in the same year thereby causing the destabilization of the housing prices. Therefore, as the prices of the houses fell drastically, the lenders announced bankruptcy and subsequently closed their businesses. In fact, the origin of the global financial crisis would be traced from the U.S. housing sector, which later spilled over to the other economies. The rationale of this paper is to provide a persuasive discussion that evaluates the role played by the Federal Reserve during the time of the crisis, outlines the primary economic goals of the United States, and the working of the Fed through the monetary and fiscal policies in the U.S. history.

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Federal Reserve Role during 2008-09 Financial Crisis

The Federal Reserve is the U.S. national bank whose primary mandate by law is to safeguard the country’s financial system (Marshall 26). During the crises in 2008-2009, the Fed took drastic measures to contain the financial panic that had engulfed the economy, which was slowly spilling over to other economies. It is worth noting that the Fed’s commitment to steering economic growth from the economic crisis would be visible during and after the crisis (Labonte 6). Primarily, the Fed would provide emergency loan facilities to the financial institutions affected by the crisis. In fact, for institutions to remain operational, they required such loans, which could only be borrowed from the government (Marshall 26). However, other programs would be run by the national bank to ensure that other vital financial markets in the country got support through the period.

The Federal Reserve initiated various policies to avert the effects of the crisis with the primary focus being on injecting liquidity as well as low-interest rates in the economy. First, the Fed governors unanimously voted the lowering of interest to as low as 2% in the month of August 2008 (Marshall 26). Besides, the Fed embraced a global campaign in lowering the interest rates in the financial sector to assist in averting the detrimental effects of the crisis, which was spreading all over the world (Marshall 26). There was also the intentional lowering of the gap that existed between the headline interest rates (the funds rate) and the discount rate (the primary credit rate). The intentions of the Fed to lower the credit costs for financial institutions was to have the banking system become more liquid. The discount rate was at 100bp above the expected Fed funds rate before the month of August 2007 (Marshall 26). However, through the application of the financial policies, the discount rate was recorded at 25bp in the month of March 2008 (Labonte 7). Although there was the massive injection of liquidity into the financial system of the economy, the effects of the response tools by Fed would not be noted immediately. The primary challenge that the Fed would face was in ensuring that the funds reached the institutions that most needed them.

Secondly, the Fed embraced the approach of introducing the TAF (Term Action Facility) aimed at offering short-term liquidity in the market (Marshall 26). The approach was taken in December of 2007, which enabled the depository institutions to receive funds through different kinds of collateral within a period of 28 to 35 days. Therefore, there were large auctions organized through the year 2008 under the watch of Fed, which resulted in rising of over $50bn by the month of May 2008 (Marshall 26). Although faced with the challenge of introducing long-term effect in the financial system, the TAF contributed enormously in introducing higher liquidity rates on the market.

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Thirdly, in efforts to lower spreads on the MBSs as had been adversely affected by the high-risk premiums, the TSLF (Term Securities Lending Facilities) were introduced by the Fed Through the program, billions of Treasury securities were auctioned with the focus on increasing the preceding bank liquidity levels (Marshall 26). As such, banking institutions would accept facilities, including the bonds and securities for collateral while advancing credit facilities. Although the program succeeded in initiating a short-term solution, it failed to produce long lasting remedies to the financial challenge

Other interventions of the Fed to the preceding financial crises were through facilitating strategic takeovers. For instance, during the takeover of Bear Stearns by JPMorgan Chase, the Fed insulated it against a possible loss of $1bn during the transaction, although at a fee (Marshall 27). Therefore, the institution played a critical role in advancing the credit as was required to finance the operations of the institution over the weekend before the institution would be purchased.

Primary Economic Objectives for the U.S.

As a result of the financial crisis experienced at the end of the 20th century, various aspects of the economy were affected, including the rates of unemployment, rates of inflation, as well as economic growth (U.S. Department of State 1). Therefore, these aspects became the primary economic objective of the federal government was to abate the effects of the crisis.

First, the economic growth objective was aimed at improving the standard of living in the country because the economy had been greatly destabilized. The government would take proactive measures aimed at restoring economic sanity in the country and, therefore, assist the populations to overcome the challenges of increased cost of living.

Secondly, the focus was on lowering the rates of unemployment, which had been exacerbated by the closure of many organizations during the crisis. In fact, the crisis increased the level of unemployment, where even the employed lost their job. Therefore, this contributed to the rise in the number of people looking for jobs. Finally, the government was focused on lowering the preceding inflation rates, which were adversely affecting the economy at the time (U.S. Department of State 1). The price levels of both commodities and services rose to unprecedented levels as seen through the preceding unstable price index. Therefore, although perceived as macroeconomic objectives, the federal government primarily focused on the three in the wake of the 2008-09 financial and economic crises.

The History of Monetary and Economic Policies

The U.S. government and the Federal Reserve (Fed) have worked together over the years in managing the overall performance of the country. As illustrated above, the economy had strategic objectives, including the stabilization of the process and ensuring higher levels of employment. As such, such roles have been fulfilled through fiscal policies aimed at ensuring the appropriate levels of spending and tax regimes are embraced (Fishback 386). Furthermore, the monetary policies were involved to ensure that the circulation of money was monitored. Therefore, since the great depression of 1930, the government and the Federal Reserve have embraced the most suitable policies in fiscal and monetary terms to ensure stable prices as well as realize the sustainable growth of the economy.

In the early years of the 20th century, the primary tool used by the government to stabilize the economy was through increased spending. Although with fluctuations in the scale, the government would induce higher spending through injecting varying levels of finances in the circulation (Williams 1). Income tax has equally been a primary tool used in stimulating the performance of the economy as well as easing the credit market in the country (Fishback 386). The rates of taxation would be decided through budgetary negotiations and under the guidance of the law. As such, through taxation, the government would raise the much-needed revenues to spend in the economy.

On the other hand, the fiscal policies were initially embraced after the great depression. Through the strategy, the government would promote the sustainable economic growth as well as support its operations (Fishback 387). The Keynesian thoughts inspired the government intervention through fiscal policies. The economist insisted that the government’s intervention would ensure the creation of the demand for the manufactured goods; hence, keeping as many production units as possible, which would also imply that higher employment opportunities are available (Fishback 387). Therefore, through the years, the government and the Fed would use the government spending as a critical fiscal tool for regulation of the economic growth and inflation levels. However, later years of the 20th century saw the government and Fed embrace discount rates and the rates of interest as the monetary tools for managing the performance of the economy as explained by the critical weaknesses associated with the previous policies.

Current Involvement of the U.S. Government in the Economy

The modern day involvement of the government in regulating the performance is by direct input of the Fed. The Fed uses various tools in determining whether the monetary policies adopted should be looser or tighter (U.S. Department of State 1). The comparison of the potential and the actual growth rates in the economy guides on the intervention measures advocated by the Fed and the government (U.S. Department of State 1). Besides, the analysis involves the review of the non-accelerating inflation-unemployment rate (NAIRU). Through the information, the government recommends the application of the most appropriate monetary and fiscal tools in the form of taxes, interest rates, and possible increase or reduction in the rates of government spending (U.S. Department of State 1). That would explain the sale of security bonds by the government in the open market during the 2008-09 financial and economic crises.

However, with the ever-growing federal debt as witnessed in the economy, the Fed and the US government should embrace effective tools in restoring the required economic status and reducing the federal debt (U.S. Department of State 1). Much of the debt may have resulted from the increased borrowing by the government to stimulate growth (U.S. Department of State 1). However, the Fed should guide the government in more stringent ways of raising revenues such as through taxation and periodic sale of government bonds to pay the debts instead of keeping it rising at least for the next 12-24 months.

The “New Normal”

As witnessed after the 2008-2009 financial crises, the intervention measures embraced would guide the economy to resume its normal operations. Besides, the recession that followed would also explain the expected performances in the economy (Xiang 1). Although a recession or financial crises would not be common or normal in performing economies, some economists perceive the financial crises or recession as normal for any healthy economy. Accordingly, this paper identifies with the position of the “new normal” where poor economic performances would be seen as abnormal. However, the rate of repetition of these cycles in the U.S. has almost made cycles appear normal.

As evident from the analysis, the US economy had to experience seasons of recession or boom as expected in any industrial economy. However, the involvement of the government and the Fed in the intervention mechanisms has been varying ever since the great depression. The government has been using monetary and fiscal policies to attend to the economic needs as influenced by the different performances. However, the 2008-09 economic and financial crisis has remained a historical feature in the performances of the economy, as its effects were not only localized but also global. The approaches of the U.S. government and the Fed have been quite successful in addressing the resultant challenges. In essence, they have ensured that there are reduced unemployment rates, lowered inflation rates, as well as general economic growth in the economy.

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