Introduction
The financial crisis of 2007-2009 is justly considered to be among the most traumatic and serious economic downturns with far-fetching consequences. Since the decline affected a series of national economies, it has been termed the Great Recession, which probably allowed drawing analogies between the recession and severe economic situations of the previous decades, such as the Great Depression. The crisis affected multiple economies to a different extent and at a varying speed and stemmed from the economic decline that started in the summer of 2006. As for the United States, with regards to causes and potential triggers, subject matter experts associate the events with the subprime mortgage crisis (Thakor 155).
The financial crisis being discussed was associated with a variety of issues and warning signs that required focused and effective policy responses. Among the critical signs were the announcements made by mortgage companies, such as Freddie Mac, that purchasing high-risk mortgages would no longer be possible and reasonable (Thakor 160). After that, a few mortgage companies specializing in the provision of loans to potentially unreliable borrowers, including the New Century Financial Corporation, announced their bankruptcy. The continuous tightening of credit markets and other signs of recession required the implementation of multiple policies to address the crisis. Measures in at least four areas were introduced by the Federal Reserve to reduce the burden on the economic system.
Financial Regulation and the Addressed Problems
The crisis could not be left unaddressed, which resulted in a range of measures to prevent further exacerbation of the recession and stabilize the economic system. One financial policy intervention implemented to deal with the crisis was the provision of liquidity to banks and other financial organizations. The measure was aimed at addressing liquidity issues and helped to address the decrease in the supply of liquidity. As for larger problems, the measure responded to them with mixed success. In 2008, the introduction of new lending facilities by the Federal Reserve could not effectively address the ongoing decline in asset prices and prevent economic “bleeding” (Thakor 161).
The second critical financial policy decision involved a set of measures and initiatives helping to facilitate the direct provision of liquidity to both investors and borrowers. The principle was implemented into practice using several projects, including the CPFF and the MMIFF, and the addressed problems varied depending on the initiative. The CPFF, for instance, addressed the lack of liquidity affecting the issuers of commercial paper in the U.S. (Thakor 190). Another intervention, the MMIFF, had two important impacts. Aside from helping to deal with the lack of liquidity, it also supported the provision of senior secured loans to special purpose entities. It allowed “insuring” money market investors against financial losses related to declines in their holdings’ values (Thakor 191).
To continue on financial policy decisions, the Federal Reserve also implemented a set of measures to effectively manipulate the supply of money by expanding open market operations. Within the frame of those initiatives, the Federal Reserve focused on purchasing long-term securities for its portfolio. The so-called Quantitative Easing programs also involved such measures. The problems that the initiatives were meant to address included strengthening credit markets by facilitating their functioning, lowering long-term interest rates, and increasing the supply of money. Other possible effects of the selected strategy include improving access to loans.
Counterparty risk refers to the risks of losses stemming from specific parties’ inability to fulfill their obligations in transactions, and the fourth category of policy interventions during the crisis aimed to address this issue. Examples of such decisions include the TARP program and transactions between the Federal Reserve and government-sponsored enterprises (GSEs). The policies were implemented to resolve two important issues, including the impact of “rising insolvency risk perceptions” on financial institutions’ access to funding (Thakor 193). As for GSEs, the key problem that it had to address was to facilitate the process of purchasing houses for common citizens.
Reference:
Thakor, Anjan V. “The Financial Crisis of 2007–2009: Why Did It Happen and What Did We Learn?” The Review of Corporate Finance Studies, vol. 4, no. 2, 2015, pp. 155–205.