In this Unit we’re covering the money supply and the tools of monetary policy. Regarding the latter, open market operations, the discount policy, reserve requirements and the interest paid on reserves, are the focus. An argument can also be made for the rate of interest, supply of money and the rate of exchange. Knowing this let’s go back to the 2008-2009 financial crises.
How did it get so bad? Greed is a good starting point. The American economy is built on credit. Credit is a great tool when used wisely. For instance, credit can be used to start or expand a business, which can create jobs. It can also be used to purchase large ticket items such as houses or cars. Again, more jobs are created and people’s needs are satisfied. But in the last decade, credit went unchecked in our country, and it got out of control.
Mortgage brokers, acting only as middle men, determined who got loans, then passed on the responsibility for those loans on to others in the form of mortgage backed assets (after taking a fee for themselves originating the loan). Exotic and risky mortgages became commonplace and the brokers who approved these loans absolved themselves of responsibility by packaging these bad mortgages with other mortgages and reselling them as “investments.”
Thousands of people took out loans larger than they could afford in the hopes that they could either flip the house for profit or refinance later at a lower rate and with more equity in their home – which they would then leverage to purchase another “investment” house.
A lot of people got rich quickly and people wanted more. Before long, all you needed to buy a house was a pulse and your word that you could afford the mortgage. Brokers had no reason not to sell you a home. They made a cut on the sale, then packaged the mortgage with a group of other mortgages and erased all personal responsibility of the loan. But many of these mortgage backed assets were ticking time bombs. And they just went off. The housing market declined, the credit well dried up, and we’re still trying to recover to a degree. (The 2008-2009 Financial Crisis – Causes and Effects by Ryan Guina: http://cashmoneylife.com/economic-financial-crisis-2008-causes/)
Now, our discussion; which tool, or tools, is most important and could have, should have, helped avert that crisis? What would YOU do if you were Federal Reserve Chairman for a day, to ensure we don’t experience this again, and why?