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The Great Recession

The United States Federal Reserve is the Central bank that is mandated with the duty of

providing flexible, safe, and stable monetary system. In 2008, the United States was at its lowest

point economically since the 1930 Great Recession period. This crisis happened despite the

efforts put by the Treasury and Federal Reserve to prevent the collapse of the banking industry.

The study will analyze the role of the Federal Reserve in the economy of the United States

during the 2008/2009 crisis.

Background Information

The first sign of the economic downfall was experienced in 2007 when the prices of

houses reduced tremendously. This fall in prices affected the financial sectors in the United

States than other countries. The most affected areas in the United States included Insurance

Companies, the mortgage lenders, the most extensive commercial banks, and the two enterprises

that were chartered by the government to assist in mortgage lending process (Verick and Iyanatul

5). The problem also affected companies which relied on credit. The crisis was as a result of

mortgage dealers giving mortgages to borrowers who did not qualify for the loans. These people

did not understand the terms of taking the loans, and they later realized that interest rates doubled

as the years progressed; penalties for failing to pay for the loans were also substantial. However,

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they took the home loans since the mortgage dealers did not clearly explain to them the terms.

The issuer of the mortgage loans kept on taking more loans because of the investors, the Fannie

Mae and Freddie Mac, were buying the loans and replenishing the lenders. The two institutions

would sell the mortgages to banks that would then pay them more loans (Verick and Iyanatul 9).

Loans that were borrowed for mortgage were one cause of recession.

The recession also occurred because Fannie Mae and Freddie Mac fell into financial

crisis; investors withdrew their money from bond funds and stock market leading to the credit

market shut down. The shutdown led to instability in the economy because there was no credit

circulation. Unemployment increased, and the consumer was no longer confident in the economy

of the country. There was no flow of money in the country due to bankruptcy leading to

recession.

Role of the Federal Reserve in Recession

The Federal Reserve put in more credit in the United States economy as it saw that the

mortgage business was booming since many people were applying for the loans. The effect led to

a reduction in the interest rates in the country to its lowest point since 1970 (Hetzel 211). The

economy was booming correctly, and all that the investors were doing was celebrating. It is

noted that the Treasury Secretary Henry Paulson made a statement in March 2007 that, “the

global economy is more than sound: it’s as strong as I’ve seen it in my business career." (Alton

230). This statement was right, but it prevented the Fed from forecasting the future trend of the

economy. In such a way, Fed contributed to recession.

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The Federal Reserve played a role in the 2008/2009 economic crisis by giving more and

more loans to mortgage lenders without analyzing the terms that were used by the lenders to

enable them to acquire such a broad market (Alton 223). Instead, they gave more loans and hired

more people to work on their firms. In the long run, the mortgage borrowers could not pay their

loans leading to debt which caused recession.

Additionally, since many people applied for the mortgage loans, the prices of the housing

reduced because there was a surplus of mortgage in the market compared to the demand.

Investors in the industry pulled out their resources because they were making losses.

Consequently, the banks were left with massive debts, and the economy did not have enough

flow of credit (Alton 225). Had Fed regulated the extent to which the loans were being given,

this flood in the mortgage sector would not have happened. Fed, hence, directly contributed to

the problem of recession.

The Federal Reserve and the Treasury-backed up the investment in the mortgage industry

as the house prices increased. New financial players and financial recklessness, which could not

be controlled by market regulators, were witnessed. According to Verick and Iyanatul, the next

fall in the housing prices directly affected the commercial players in the sector and other

economic institutions in the economy (17). Fed and Congress are to blame for the reckless

financers whom they allowed and entertained the way they conducted their business. If Fed had

regulated the extent of investment they made in the industry, the crisis would not have happened

or its scope reduced.

There seemed to be competition between Federal Reserve and Treasury on who was the

most significant contributor to boosting the economy of the United States. Fed, as such, kept on

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giving more and more loans without paying attention to how they would be paid back. Fed

reduced its interest rates to help it attract more customers for investment. According to Hetzel,

by the end of the year its Funds rate had decreased to between 0-0.25 percent for about two years

(217). That meant that the bank was paying people to borrow mortgage money. Fed created

other means of giving more money, such as having loan guarantees and purchasing government

securities. Fed failed to notice its mistake and stop before the problem escalated. Instead, it was

driven by greed and competition.

United States’ Economic Goals

The United States national economic goals include providing full employment, stable

prices, and economic growth to its citizens. During the 2008/2009 financial crisis, America did

not honor its economic goals. Over-lending to many by banks and government-chartered

mortgage institutions made citizens take loans, including those who were not capable of paying

back. As a result, most people got mortgages, hence flooding in the market and flipping the

prices of the mortgages (Hetzel 210). Those who owned homes also reduced the value of their

homes to promote mortgages. In such a way, the United States did not honor its goal of

providing stable prices for its goods.

The disaster period was marked by loss of jobs among the citizens. About 2.6 million

People who worked in various sectors are said to have lost their jobs during the recession period.

The job losses were as a result of companies down-sizing their employee capacity to a number

that they could manage to pay (Alton 228). More people worked part-time and for shorter hours

because there were low wages and benefits offered. The United States failed to meet its goal of

providing full employment to its citizens.

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A growing economy is one which increases its asset value and chain. The year 2008 was,

however, marked by the economic crisis that did not lead to any growth in the economy (Verick,

and Iyanatul 4). Inflation and unemployment marked the recession. During the period, consumer

demand was low as a result of low purchasing power due to high increase and the uncertainty on

future economic situations. Consumers, as such, considered saving the little they had for the

future. The country did not experience any economic growth because investors from various

countries withdraw their investments. In addition, the state and mortgage lending institutions

were in debt, and borrowing rates between banks also increased. Banks did not lend money to

individuals for economic development purposes. The United States was at a standstill in its

economic growth. President, Barack Obama called for quick action to help salvage the situation.

Monetary and Fiscal Policy Efforts by U.S. Government and Federal Reserve

Following Fed’s policy, the government created a program in 2008 to offer short-term

loans to major dealers of government securities were given loans like banks. This helped

improve their situation in the year 2009. While Lehman Brothers were bankrupt, investors

refused to put their money in the short unsecured loans. They removed their money from the

market fund which offered the loans leading to an increase in the interest rates. Fed availed

sufficient funds to ensure banks and other financial institutions were able to offer secure loans.

This policy has helped reduce the interest rates.

Federal Reserve aided in the purchase of Bear Stearns by JPMorgan Chase bank through

the provision of loans (Hetzel 215). Months later, Lehman Brothers collapsed because no

investor was willing to bail it out financially. Lehman Brothers also did not qualify for a direct

loan from Federal Reserve since it did not have adequate collateral. Fed gave secure loans to

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American International Group (AIG), an insurance company that played a crucial role in

guaranteeing financial instruments in the nation. Fed made an effort to save the economic

situations of the institution.

The government has in place measures to defy impacts of the global recession on India’s

economy. RBI has pumped adequate into the banking industry to enable bank credit to meet the

economy’s expanding requirements. Through series of reduced CRR and flexibility in meeting

SLR requirements, banks have been given adequate liquidity. Interest rates have been reduced in

the repo and reverse repo rates. Additionally, accessing external commercial lending has been

made liberal to enable borrowers’ access funds from abroad too. Such measures help reduce risks

of recession.

The government has directly purchased commercial paper from insurers to raise money in

the private sector. In addition, it proposed a stimulating financial package to boost economic

activity. Additionally, the government has increased the FDIC bank insurance deposit from $

100,000 to $ 250,000 so that commercial organizations can give short-term bonds that would

help guarantee deposits in money market fund (Verick and Iyanatul 51).

Involvement of Federal Reserve and U.S Government in U.S. Unstable Economy

The government and Fed are both responsible for the unstable economic situation in the

United States. The financial instability is as a result of 2008 recession. Both played a role

because the Fed controls the tax and expenditure patterns while the government controls the

interest rates and supply of money in the nation. These areas are the players in the economy of

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any country. Wrong choices that were made by the government and Fed resulted in recession,

and the situation has remained unstable to date

Measures the Government and Federal Reserve Should Pursue

Fiscal policies refer to the use of taxes and government expenditure to drive economic

growth and to increase employment. According to Verick and Iyanatul, the government should

apply the expansionary monetary policy to bring economic growth in U.S by increasing

expenditure on new goods and services (48). This goal can be achieved by increasing

government purchase or decreasing taxes to encourage investment and consumptions. This

strategy will help reduce unemployment and promote economic growth if it creates investment.

The Federal Reserve has authority to increase or decrease money supply and lower or

raise short-term interest rates. Fed should increase the money supply and reduce interest rates in

the US to enable people to borrow money to conduct better business. This method will also

enhance production and expenditure among the customers. The United States will then be able to

deal with the recession.

United States Low Interest Rates

The United States has a low-interest rate for both short and long-term investments with an

estimate of 1.9 and 2.5 percent respectively. Interest rates paid by households and enterprises are

slightly higher because of risks on credit. However, these rates are meager when considering the

historical situation. Low-interest prices are a long-term (Verick and Iyanatul 8). For example, in

1981, the interest rate rose to 15 percent, when in 1960s, it was relatively low (Hetzel 207). The

interest rate has been reducing since then with a significant decline during 2008 recession when

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Fed was interested in giving loans at low interest. The interest rate of U.S. is presently at -0.1

percent. Low interest rates encourage investments in a country, hence, reducing chances of

recession.

Federal Reserve Balance Sheet and Debt Levels

The year 2009 was marked with large-scale asset purchase with the Fed purchasing $1.25

trillion mortgages, $ 200 billion debt given by Lehman Brothers to fund mortgage purchase and

$300 billion in long-term Treasury securities, which were to put check on interest rates (Alton

228). These investments enabled availability of credit in the private market. In 2010, fears of

inflation led to purchase of more mortgages. $600 billion was invested in Treasury securities for

seven months at a pace of $75 billion per month. Later, when the European Union was about to

be in a financial crisis, the U.S. decided to sell its short-term Treasury securities leading to low

long-term interest rates while securities on Fed balance sheet remained stable. Federal Open

Market Committee (FOMC) bought and saved $667 billion treasury securities (Alton 237). Since

there were no signs of financial securities, FOMC made more mortgages purchases in 2012.

Reserve balances at the Fed are as a result of LSAP programs through credits that were given to

financial institutions. Excess reserves held by Fed are isolated from real economy, hence

negligible effect on inflation pressure. Since the vast recession, personal consumption

expenditure inflation data has remained at 1.4 percent. The 2017 financial year gross federal debt

is at $20.24 trillion with a deficit of 3.5% GDP. The highest debt in the U.S. was in 1946 after

World War II at 119% GDP with a shortage of 20% GDP (Alton 236). United States has high

debt level.

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Fed has made the federal funds' rate consistent with economic indicators such as inflation

and unemployment. Taylor Rule can be used together with economic forecast to predict the right

bearing for monetary policy. Fed has in the past years increased its balance sheet. However, as

the country recovers economically, it may require Fed to decrease its balance sheet-size and to

raise its fund's rate. Such a move would help reduce chances of recession again.

United States Experiencing “New Normal”

Many economists say that the United States is experiencing the ‘New Normal” as a result

of the Great Recession, and it is true. The United States has not recovered from the financial

crisis. The recovery is taking a long and slow process. America’s growth rate has remained at 2%

instead of the previous 3% (Hetzel 216). Since 2009, various sectors of U.S. economy have

shown positive growth from recession period. However, the concern is about all industries

maintaining positive growth, and it is predicted that it would take a long time for such to be

achieved. It is, hence, right that the present situation is American’s new stable economy.

Summarizing, the United States economic recession period was because of faults made

by both government and the Federal Reserve. However, despite the wrong strategies applied

then, now, the two organizations have adopted measures to salvage the country from the mess,

and the process is ongoing. There is hope that however long it may take, the United States of

America will overcome the effects of the recession period.

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Works Cited

Alton, Gilbert, R., et al. “Federal Reserve Lending to Troubled Banks During the Financial

Crisis, 2007-2010.” Federal Reserve Bank of St. Louis Review, vol. 94, no. 3, 2012, pp.

221–242.

Hetzel, Robert L. “Monetary Policy in the 2008-2009 Recession.” Economic Quarterly, vol. 95,

no. 2, 2009, pp. 201–233, http://ideas.repec.org/a/fip/fedreq/y2009isprp201-

233nv.95no.2.html%5Cnhttp://richmondfed.org/publications/research/economic_quarterly/2

009/spring/pdf/hetzel2.pdf. Accessed 17 Nov. 2017.

Verick, Sher, and Iyanatul Islam. “The Great Recession of 2008-2009 : Causes, Consequences

and Policy Responses.” Institute for the Study of Labour, no. 4934, 2010, pp. 3–61.

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