Central Banking and 2008/09 Financial Crisis

Posted: August 26th, 2021

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Central Banking and 2008/09 Financial Crisis

Question 1

The 2009/09 financial crisis is recorded as among the worst economic events ever been experienced in the U.S. and globally. The disaster resulted inan adverse plunge in housing prices despite committed efforts by the Federal Banks to alleviate the crisis. The investors and realtors were surprised with a turn in the economic events that went beyond their expectations. According to most of them, they had anticipated that the fall in prices as by 2006 would return to a reasonable and sustainable level afterward, which never happened, only to worsen onwards through 2008/09(Pereira et al. 109). The crisis emerged because several banks were trading for derivatives and the mortgage-backed securities which were being sold to investors for profit. The situation resulted in an increased demand for mortgage loans. Besides, hedge funds, among other financial institutions, began owning pension and mutual funds, corporate assets, and mortgage-backed securities. Such an ownership mix among these institutions complicated the nature of the financial crisis, further worsening it (Pereira et al. 109). Consequently, it was difficult to price derivatives on the financial markets,especially since they were already under the control of banks. Equally, the banks traded on the derivatives by reselling them in slices besides serving as concealment for bad loans and debts.

Question 2

The setting of the 2008/09 financial crisis generated a storm in the financial and security markets and needed direct involvement of the U.S Central Bank, that is, the “Fed” to help curb the crisis. The Fed was required to play its role in setting monetary policies and enforcing regulations of the banking systems to help avoid the collapse of the financial systems(Pereira et al. 109). The immediate action was to bail out financial institutions to ensure that they do not transfer their financial management failures to creditors. The move was also backed with the pumping of government money into the economy purposely to stimulate business activities at the level when private loans are limited(Pereira et al. 109). As a result, the government, through the Federal Bank, owned majority shares and the private sector after providing over $ 4 trillion to ensure that the financial industry is sustained. Subsequently, the bailed institutions managed to repay to the government early enough. Thus, this lowered the cost of the crisis to $ 1.2 trillion by the end of the crisis in 2009. Precisely, therefore, the Feds role included the following policies;

1. Cutting on the interest rates which was targeted at assisting the ailing institutions
2. It engaged in quantitative easing, that is, large scale purchase of assets to wipe out excessive liquidity and,
3. Lastly, the Fed provided forward guidance on interest rates.

However, despite these efforts, the unemployment level remained high for some time. As such, the U.S Central Bank was again required to engage in managing the crisis excessively.

Question 3

The market action and Feds’ actions are in a competing perspective. Whereas banks are determined to increase profitability by controlling the market demand and supply factors, it is evident that they cannot entirely be left on their own without control(Latest Memo from Howard Marks). As such, I agree with accounts from Mark’s memo that the crisis is bound to happen again if the Fed accedes to the current pressure from traders and financial markets to easing interest rates, especially in the current crisis(Latest Memo from Howard Marks). The same situation could plummet into a moral hazard in the future among financial institutions and creditors who may tend to engage in careless handling of financial resources while expecting solutions from the Central Bank and the government in a crisis.

Works Cited

Latest Memo from Howard Marks: Knowledge ofthe Future. Accessed on 4^th May 2020 from https://seekingalpha.com/article/4338495-latest-memo-from-howard-marks-knowledge-of-future

Pereira, Luiz C., Jan Kregel, and Leonardo Burlamaqui. Financial Stability and Growth: Perspectives on financial regulation and new developmentalism. Hoboken: Taylor and Francis, 2014. Print.