[group 1] credit crisis in usa ed4

8/12/2019 [Group 1] Credit Crisis in USA Ed4

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Credit crisis in America 2007-2008

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Preface

The financial and banking system of the United States is one of the most

longstanding and powerful system in the world. It has been through an innumerablenumber of major crises in history and since December 2007, the United States has

fallen into a credit crunch but perhaps this crisis has entered a new phase even

gloomier than ever before. This is probably the biggest crisis after the Great

Depression 1931.

The financial and banking system of the United States in late 2007 and 2008

suddenly fell into an unprecedented crisis. Hundreds of billions of dollars were

vanished. The spread is not over yet, and the consequences are unexpected. Thesewere the review of the economic experts about the U.S. credit crisis occurred during

2007 - 2008.

Some top U.S economic experts believed this chaos in Wall Street started from

the sub-prime mortgage crisis and would have significant impacts on the U.S economy

as well as the lives of American people.

Since December 2007, the U.S economy has suffered dramatic difficulties:

production and business activities declined, goods could not be sold and there was a

significant reduction in consumption power, the real estate market was at risk, stock

market was gloomy, while the price of gold, foreign currency and prices of some goods

were erratic.

This is an issue of great topicality and interest. Therefore, our group

respectively presents the essay of The U.S Credit crunch of 2007 2008. In the essay,

we will highlight the causes and events surrounding the 2007 2008 credit crunch,

followed by its impacts on the U.S economy and actions of the authorities.


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Contents

I. The root of credit crisis .................................................................................................................................... 4

1. Low interest rate .......................................................................................................................................... 4

2. Surplus in money supply .............................................................................................................................. 4

3. Continuously rising housing price ............................................................................................................... 5

4. Misunderstand the risks ............................................................................................................................... 6

5. Breach appear ............................................................................................................................................. 6

II. Causes of credit crisis ........................................................................................................................................... 7

1. Sub-prime mortgage .................................................................................................................................... 7

2. Mortgage bond market ............................................................................................................................... 8

The evolution of the crisis ...................................................................................... Error! Bookmark not defined.

1. In the stock market, the Dow Jones is constantly fluctuating.................... Error! Bookmark not defined.

2. The gold market reached the record levels continously. ................................ Error! Bookmark not defined.

Source: Bureau of Labor Statistics Data .......................................................Error! Bookmark not defined.

IV. Impact of the Credit Crunch ............................................................................. Error! Bookmark not defined.

1. GDP ........................................................................................................... Error! Bookmark not defined.

2. Financial market ........................................................................................ Error! Bookmark not defined.

3. Credit market ............................................................................................. Error! Bookmark not defined.

4. Household .................................................................................................. Error! Bookmark not defined.

5. Deflation .................................................................................................... Error! Bookmark not defined.

6. U.S dollar currency .................................................................................... Error! Bookmark not defined.

V. The solution of US to financial crisis ................................................................. Error! Bookmark not defined.

1. The Federal Reserve SystemFed ............................................................Error! Bookmark not defined.

1.1 The Monetary policy ......................................................................... Error! Bookmark not defined.

1.2 The open-market business ................................................................. Error! Bookmark not defined.

1.3 The Term Auction Facility Program (TARP) ................................... Error! Bookmark not defined.

2. The solutions of the US Government......................................................... Error! Bookmark not defined.

2.1 Bushs Government and the Economic Stimulus Act (ESA)............ Error! Bookmark not defined.

2.2 The Obama government and the American Recovery and Reinvestment Act (ARRA) ........... Error!

Bookmark not defined.

REFERENCE ......................................................................................................... Error! Bookmark not defined.


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I. The root of credit crisis1.Low in terest rate

In 2001, after the Dot-com bubble burst, US economy faced a depression.

The situation went even worse when the September 11 attack happened.

People were pessimistic and the economy started to go down. FED

chairman Alan Greenspan decided to lower the interest rate of T-bill to 1% with

the hope that low interest rate would boost the economy avoiding depression.

Lowering interest rate of T-bill made borrowing money easier than ever (not to

mention the surplus from China, Japan). This created a very friendly

environment for institutions borrowing money and they offered 30 Year Fixed

Mortgage Rates with 4-5% (the lowest in 40 years).1

2.Surplus in money supplyWith FEDs expanding monetary policy, money supply in America increased

dramatically.

1http://money.cnn.com/2001/12/11/economy/fed/

CNNfn's Louise Schiavone reports on the Fed's rate cut.
http://money.cnn.com/2001/12/11/economy/fed/http://money.cnn.com/2001/12/11/economy/fed/http://money.cnn.com/2001/12/11/economy/fed/http://money.cnn.com/2001/12/11/economy/fed/


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Along with capital inflow from foreign investment, this amount of money

encouraged business activities. Believing the economy was still recovering FED

did not take any necessary measure to neutralize. Personal incomes and firms

profit going up made FED keep money supply high and interest rate remain low

for the next 2 years.

3.Continuously r ising housing priceAt the end of 2002, profitable business, availability of low interest

mortgages, increasing in personal income promoted demands in housing market.

Because housing price keeps increasing while there were many interesting loans


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and mortgages. Investors bought houses and made fortune out of them using

leverage.2

4.Misunderstand the ri sksUnder activities of financials, the risks of housing bubble are less visible.

Homeowners who have sub-prime mortgage usually have low income, little

creditability, bad credit records and many of them are illegal settlers. Hence

nothing can guarantee their debt payment. But with Collateralized debt

obligation and the mortgage bond market, bank did not control their loans

closely, banks made profit by passing risks to other risk takers who were not

aware of the financial status of their real debtors. When issued, mortgage bond

only show interest rate.

Moreover these sub-prime mortgages are Adjustable-rate mortgage

which mean banks can increase the interest rate beyond affordable payment of

the household. If the housing price keep increasing, banks can easily default the

debt and have houses as their assets. However when the housing bubble burst

which means houses decrease in value, banks suffer losses.

5.Breach appearIn 2006 after 4 year of expansionary monetary policies, the inflation rate

started to worry FED. FED responded with a sudden increase in interest rate

which lead to increase in ARM. This shocked homeowners with sub-prime

mortgage. Their financial status can not afford payment. This is when

everything went wrong and the crisis started.

2By Ellen Florian Kratz, Fortune writer

March 1 2007


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So the mortgage brokers lower the qualification to get a mortgage like no proof

for income, no down payment. These kinds of irresponsible homeowner are often

illegal settlers. The investment banks are confident to did so because they believe if

homeowners are fail to pay and default the mortgage they would get the house as their

assets. Additionally housing price keep increasing so they can sell house to get new

mortgages.

Due to such characteristics of subprime risks are high but the return rate of

subprime loans also extremely attractive. As a result, the investors get profit much

higher than 1% FED offered.

2.Mortgage bond market 4Step 1:

At first the investment banks like Bear Sterns, Lehmam Brother offer financials

loans for sub-prime mortgages activities. By connecting to mortgage brokers

and lender, these financials buy the mortgage and then start to classified these

mortgages.

Step 2:5

After classified these mortgages financial will sell it back to the investment

bank with the exact amount of money they borrowed. Basically the investment

bank get back the money they lend.

Step 3:

Investment bank started to issue bond to sell the subprime mortgages for

investors. They establish a new company with the only asset is mortgage bond.

Investors would buy mortgage bonds form this company. Every activities such

as: govern debt payment, calculate interest etc would be control by otherfinancials.

4 http://legal-dictionary.thefreedictionary.com/Mortgage+bond

5 http://legal-dictionary.thefreedictionary.com/Mortgage+bond


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The bonds issued are called Mortgage backed obligation. Through the credit

rating agencies, the bond is divided into several packages with risk levels as

well as different interest stems (CDOs). The higher the risk the higher the

interest rate is. Packages with the highest coefficients were calculated using the

entire original payment first and the package with lower credit multiplier until

finally the package with the lowest coefficient of credit. If the credit portfolio

works well, the package has the lowest coefficient of credit will benefit most.

By classified CDOs in to several packages, with different interest rate, investors

can easily chose which packages to invest their money according to their taste

and interest.

By these activities risks are less visible in the eyes of investors which latter

created a crisis affect economy in the whole world.

III. The evolution of the crisisAmerica is the starting point and the center of the crisis. Before going into a

detailed analysis, this is a brief introduction of the evolution6of the crisis:

- 22/02/2007: HSBC dismissed the head of real estate mortgage loans of banks in the

United States, to accept losses of up to $10.8 billion.

- 16/3/2007: Accredited Home Lender Holding sold subprime portfolio which worth

$2.7 billion of its very high discounts to get cash for business.

- 2/4/2007: New Century Financial applied for protection under Chapter 11 in

Bankruptcy Law after being forced to buy back billions of dollars in bad debt.

- 9/2007, the FED cut interest rates also conducted for overnight interbank loans from

5.25% to 4.75%. In addition, the FED also has taken measures to increase the level of

liquidity in the credit markets.

6BBC News (7/08/ 2009); Timeline: Credit crunch to downturn http://news.bbc.co.uk/2/hi/7521250.stm#table
http://news.bbc.co.uk/2/hi/7521250.stm#tablehttp://news.bbc.co.uk/2/hi/7521250.stm#tablehttp://news.bbc.co.uk/2/hi/7521250.stm#table


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- 16/03/2008, JPMorgan agreed to buy Bear Stearns Bank - a deal marks the end of the

independent existence for a period of 85 years of Bear Stearns and turns the nightmare

of credit markets became the truth.

- 11/7/2008, oil prices hit historical level: $147.27/barrel.

- 7/9/2008, when two mortgages lending were mainstays in the market for U.S.

mortgages was Fannie Mac and Freddie Mac accounted for 40% market share, with

total assets of about $5000 billion was, declared the inability to pay, rocked global

financial markets and risk shatters all the FED's efforts during the past and forced the

FED to spend $200 billion to take over . Especially could push U.S. inflation higher.

That made inevitable concerns about other major financial institutions collapsed.

- 15/9/2008, 4th largest investment bank in the U.S., Lehman Brothers , after 158 years,

declaring bankruptcy .

- 16/09/2008, the FED said that the government has agreed to spend an amount worth

$85 billion emergency bailout for AIG, the top company provides financial services

and insurance.

- 01/03/2009, AIG continued to receive $30 billion. This could be the fourth time the

U.S. government had to pump money to rescue AIG insurance group . Thus, the U.S.

government has poured $150 billion into AIG and had become the largest shareholder

with 80% of AIG shares.

- 21/9/2009, Goldman Sachs and Morgan Stanley changed the operating model. The

FED has suddenly allowed two investment banks Goldman Sachs and Morgan Stanley

to convert into Bank holding companies.

With the bankruptcy of Lehman Brothers, Bear Stearns and Merrill Lynch

were acquired, the conversion model of Goldman Sachs and Morgan Stanleysynonymous with Wall Street had no more investment and independent banks.

- 26/9/2008Washington Mutual Bank with total assets of $327.9 billion applied for

bankruptcy protection.

- 28/9/2008mortgage bank Bradford & Bingley (UK) collapsed.


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- 29/9/2008, the U.S. Congress rejected $700-billion-plan, which made Dow Jones has

led the largest decline in history, nearly 778 points, and Wall Street lost $1,200 billion.

- 3/10/2008: U.S. House of Representatives passed the $700 billion package.

- 7/10/2008: UK spent $88 billion to save the banking system.

- 8/10/2008: The central banks cut interest rates in unison.

- 12/10/2008: Government of Iceland was at risk of collapse due to financial crisis.

- 27/10/2008: IMF pumped cash to support the economies.

- 05/11/2008: Barack Obama was elected The President of the U.S., with the economic

policy is expected to change the current state of the U.S. and global economy.

- 10/11/2008: China spent nearly $600 billion to stimulate the economy.

- 14/11/2008: 15 European countries admitted falling into recession.

- 17/11/2008: Japan announced recession.

- 25/11/2008: America spent $800 billion more to support the economy.

- 1/12/2008: U.S. admitted recession in late 2007.

- 11/12/2008: $50 billion fraud by Bernard Madoff broke, with thousands of victims:

industrial firms, corporations, charities, universities, and a number of reputable

investment funds.

Under the impact of the disruption of the housing bubble that led to the economic

crisis, FED pumps $1500 billions into the economy, that has led to the dolar become

devalued, together with series of bad bussiness reports of the business firms,

corporations, has led to the stock market plummeted miserably, metal market becomes

attractive, etc.


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1. In the stock market, the Dow Jones is constantly fluctuating.

Source: New York Times

For the first time, on 10/07/2007, the industrial Dow Jones peaked at 14.198

points. Then came the sequence of days and the peak is on 29/9/2008, the U.S.

Congress rejected $700-billion-plan, causing the Dow Jones underwent the biggest

decline in the history, nearly 778 points, and Wall Street lost $1.200 billion7.

On 6/3/2009, the Dow Jones had 6470 points, very close to its lowest level on

12/30/1996. Just over 1.5 years after a record, Dow Jones lost nearly 8000 points8,

which took it back to the point of 6500 10 years ago. The red color covers all the stock

market.

2. The gold market reached the record levels continously9.

- When Bear Stearns announced bankruptcy, gold has set a new record of 1.032.26

ounce.

- On a new record of 1126.37 on 3/12/2009, parallel with the deterioration of the U.S.

economy and speculation on markets.

7Cowell; Alan; Julia; Michael; Graham (24/10/2008), "U.S. Stocks Slide After Rout Overseas", The New York

Times: http://www.nytimes.com/2008/10/25/business/25markets.html

8 Jack (19/11/2008), Shares Near 6-Year Low, With More Losses Feared, The New York Times:http://www.nytimes.com/2008/11/20/business/economy/20markets.html9Tyler (02/16/2010); Gold Market Summary - Q4 2009, From The World Gold Council
http://www.nytimes.com/2008/10/25/business/25markets.htmlhttp://www.nytimes.com/2008/10/25/business/25markets.htmlhttp://www.nytimes.com/2008/11/20/business/economy/20markets.htmlhttp://www.nytimes.com/2008/11/20/business/economy/20markets.htmlhttp://www.nytimes.com/2008/11/20/business/economy/20markets.htmlhttp://www.nytimes.com/2008/10/25/business/25markets.html


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- The gold market at the end of the year promised to be more volatile as gold demand

increased. The central banks of the countries have been actively buying gold to

increase foreign exchange reserves that gold continues to rise rapidly.

- At the end of 10/2009, India bought 200 tonnes of gold in more than 400 tonnes of

IMF, after India, there were a lot of other Central Banks have placed many issues to

buy gold from IMF.

- Thanks to the large fluctuations of the gold market, the devaluation of the dollar,

stocks fell and led to the investment channel into this market attractive. In addition, the

developments in the gold market with the political instability of countries around the

world including the world's largest oil baskets Iran, Iraq, makes gold prices rise even

more.

3. Labor market, besides the fi nancial market and real estate, the U.S. labor market

is one of the heavily aff ected chain10.

The number of unemployed workers in 7/2009 in the U.S. is 14.5 million people,

while the unemployment rate declined from 9.5% in June to 9.4%.

Also in 7/2009, the number of workers fired was 247.000 people; on average, in

the second quarter of 2009, the number of workers losing their jobs fell to 331.000,

down more than half, compared with 645.000 in the earlier Quarter of 2009. Especially

after GM filed for bankruptcy, etc.

According to the data from the U.S. Labor Department, the unemployment rate

in the first 4 months of 2008 peaked at 8.9%, the highest level in the last 26 years.

Average there were about 600,000 workers cut down every month. Since the recession

occurred (Dec. 2007), 5.1 million jobs have been wiped out in the U.S. Until April,

2009, the official number of unemployed people in the United States reached 13.2million.

10Matthew (2009, p. 25-29), The Next Great Bull Market: How To Pick Winning Stocks and Sectors in the NewGlobal Economy


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Never before have so many Americans unemployed like this. Nearly 5.2 million

people were out of work for 6 months or more. Long-term unemployment accounted

for 41% of the total unemployed, while in other recessions the highest percentage was

only 22%11.

Source:Bureau of Labor Statistics Data

The longer one person was unemployed, the harder it was to find work again,

because skills declined and the opportunities to find new jobs were less. The increase

in unemployment rate affected negatively income as well as consumption of

households, which made it hard for businesses to sell goods.

In the current situation, one cannot deny the U.S. economy has entered a

recovery stage and had better improvement. However, what noteworthy is that

although the number of workers being laid-off every month in the U.S. has improved

considerably , but according to statistics showing the U.S. labor market is still in a state

of lay-offs employees rather than employers.

The U.S. government has made a positive move to save the U.S. economy, but

due to its global nature, there have been serious impacts on all aspects of the economy

of the superpower country and all other countries over the world.

Crisis widespreads quickly and more seriously increases.

11Labor Force Statistic 2007; Employment Situation
http://data.bls.gov/timeseries/LNS14000000http://data.bls.gov/timeseries/LNS14000000http://data.bls.gov/timeseries/LNS14000000


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IV. Impact of the Credit CrunchThis crisis is the main cause for the U.S. economy recession in December, 2007.

NBER (National Bureau of Economic Research-the U.S. Bureau of EconomicResearch) predicted that this would be the most severe recession in the U.S. since the

World War II. The crisis has produced unprecedented volatility in the financial markets

and large losses for many investors.

1. GDPGross domestic product (GDP) of the United States increased by only 6.8% in 3

years from 2009 to mid-2012 - the lowest level in any time of recovery from the war.

The GDP growth rate fell significantly in the fourth quarter of 2007, only 0.6%,compared with an increase of 4.9% in the third quarter. Real GDP decreased at an

annual rate of 6.1% in the first quarter of 2009, (that is, from the fourth quarter to the

first quarter), according to advance estimates released by the Bureau of Economic

Analysis. In the fourth quarter, real GDP decreased 6.3%.12

Source: US Bureau of Economic Analysis

The proportion of the U.S. economy to the world economy has been declining.

This proportion in 2008 was 23.79%, the lowest level in the last 20 years, decreased

12http://www.bea.gov/newsreleases/national/gdp/2007/gdp207a.htm


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8% compared to 2001. The average growth rate of the U.S. economy fell from

3.41%/year (1991 - 2000) to 1.61%/year (2001 - 2010), while the average growth of

the world economy increased from 3.07% /year (1991 - 2000) to 3.2%/year (2001-

2010).During the past 10 years, the U.S. economy continuously has a lower growth

rate than the worlds average growth rate.13

2. Financial marketThe U.S financial market wobbled when Dow Jones industrial average

continuously slumped since the third quarter of 2007.14

Stock lost points, bank stocks

fell to their lowest level in the last 14 years.

a. The Bond marketThe credit crisis primarily affected thebond market, when investors began to

avoid risky assets because of ultra-safe U.S. Treasury securities. The Optionadjusted

spread(OAS) showed the additional compensation that investors required for

purchasing corporate bonds contrary to ultra-safe Treasury securities. There was no

volatility between 2003 and mid-2007, and then the OAS increased to record highs at

the beginning of 2008, after that soared dramatically as the crisis intensified. This sharp

increase not only caused enormous losses for bankers and investors, but also reflected

much higher borrowing costs in order to raise capital.

Source: Merrill Lynch Corporate Bond Index

13http://data.worldbank.org/

14http://www.fedprimerate.com/dow-jones-industrial-average-history-djia.htm


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During the credit crunch, the yieldof the two-year Treasury bonds decreased

from above 5% to less than 1%.15

Yields on shorter term Treasuries declined

dramatically, and at some points the yield on several securities was actually negative.

Investors were not confident with the financial system so they chose to pay the

Treasury to hold their money rather than investing it somewhere else and trying to get a

reasonable rate of return.

b. The Stock marketWhile stock prices have been steadily decreasing since their peaks in November

2007, the selling has been intensifying after thebankruptcy of Lehman Brothers in

September 2008. When the U.S. House of Representatives failed to pass the Treasury's

bailoutplan on September 29th

200816

, the Standard & Poor's 500 Index (S&P 500) fell

8.8%, its largest one-day percentage decline since Black Mondayin 1987. On the same

day, the total U.S.stock market losses exceeded $1 trillion USD in a single day for the

first time.

Source: Bloomberg, U.S Global Investors

3.

Credit marketNumerous financial institutions including the giant financial institutions and

longstanding bankruptcy has pushed the U.S. economy into Credit-hunger17

: no money

15http://www.treasury.gov/

16http://2008financialcrisis.umwblogs.org/analysis/the-federal-bailout/

17In a credit-hungry economy, FICO, Feb.2008


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to lend, no money to borrow. Borrowing money has now become more difficult.

People are finding it harder to obtain low cost loans or credit cards, while expensive

payday loan services have been flourishing. Due to sub-prime mortgage crisis, the

credit market became frozen and there was no flow of money. The money was all on

the houses but unfortunately the house price kept declining. Credit-hungry situation

affected manufacturing sector. Because there was no cash inflow, the producers had to

narrow their production and cut down on their labors, which led to massive

unemployment.

4. HouseholdNever before have so many Americans unemployed like this. Nearly 5.2 million

people were out of work for 6 months or more. Long-term unemployment accounted

for 41% of the total unemployed, while in other recessions the highest percentage was

only 22%.18

Source: US Census Bureau

The longer one person was unemployed, the harder it was to find work again,

because skills declined over time and the opportunities to find new jobs decreased. The

increase in unemployment rate negatively affected income as well as consumption of

households, which made it hard for businesses to sell goods.

18Unemployment and the Credit Crunch, the local futures group, November 2008


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Source: Bureau of Labor Statistics

In addition, the devaluation of the real estate assets would push the debt ratio on

properties owned by American consumers to rise, forcing them to cut down on expense.

The tightening of consumer had a large impact on the economy which has depended on

domestic consumption for the capital, as well as the economy of the countries

exporting to the U.S.

5. DeflationThe credit crunch has made the leading industry collapsed, the automotive

industry with the bankruptcy of the 3 leading automakers which were General Motors

(GM), Ford Motor and Chrysler LLC.The CEOs of these three automakers have been

asking the Congress for help, however, they did not succeed. On December 12 th, 2008,

GM had announced the temporary closure of its 20 factories in North America.19

Reduction in consumption, redundant goods led to the steady decline in general

price level of the economy, pushing the U.S. economy to the risk of deflation. The

stock market volatility was too strong since 2000, especially since 2008, and the

American citizens have been saving more and more. They no longer believed that the

stock portfolio could support their savings all along.20

19G.M.s Bankruptcy Drawn into DefectInquiry, nytimes.com20

Trust, Confidence and Economic Crisis, Fran Tonkiss, July/August 2009


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6. U.S dollar currencyThe crisis also made the U.S. dollar depreciated. Since the early of 2007, the

currency of the world's largest economy fell 13% compared to other major currencies

(EUR, GBP), which fell 5% against the Chinese Yuan.21

Because the U.S. dollar is the most popular payment instrument in the world

today, so global investors bought dollars to improve its liquidity, the U.S. dollar price

was pushed up. This caused serious damage to U.S. exports.

Culmination is on 15/7/2009, EUR/USD exchange rate is 1.60373 from 0.8225

EUR/USD in 15/10/2000. The dollar has lost nearly half the value, compared to the

Euro. This means that the inflation rate in the U.S. raised high, dollar devaluated, the

consumption of goods decreased, prices increased ... When the dollar is cheap, it will

stimulate exports and restrict imports. And that led to the fact that a lot of goods

became more expensive and that also not good for the economies of those countries.

Currency% change compared with

Dec. 2005

% change compared with

Dec. 2000

USD -9.3 -17.8

EURO 11.4 32.7Yen 17.6 9.9

Renminbi 7.2 -0.5

Source: http://www.x-rates.com/

In 10/2009 there were reports that the countries Arab Gulf - the region has

strained relation with the U.S.- had secretly discussed with Russia, China, Japan and

France to replace the U.S. dollar by a different currency in oil trade and a new common

currency to be issued for the countries of the Gulf Cooperation Council.

Goods for import and export into Europe region will use the EUR; or in Japan,

the JPY, numerous operations to boycott the dollar took place.

21The Credit Crunch of 2007-2008: A Discussion of the Background, Market Reactions, and Policy Responses,

Paul Mizen, September/October 2008


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V. The solution of US to financial crisis

1. The Federal Reserve SystemFed1.1The Monetary policyAs soon as the credit crunch in secondary houses took place, Fed started to

intervene by reducing the interest rate and buy more MBS (Mortgage Backed

Securities). When the situation came to be a financial turmoil since August 2007, the

US Federal Reserve System (Fed) continued to carry out the currency loosening

measures in order to increase the liquidity for the financial organizations22. This can be

explained by the following details:

The interest rate for overnight interbank loans was reduced from 5.25% over 6phases to 2% in just less than 8 months (18/9/200730/4/2008). This interest rate then

continued to decrease until 16/12/2008 with the rate of 0.25%, an unusual near-zero

interest rate.

Take a look at the interest rate chart from June 2007 to December 2008 in US,

we can see that in only 18 months, Fed had 10 times of decreasing the basic interest

rate and the lowest rate is almost 0.

Source: U.S Federal Reserve

22Monetary Policy and the Financial Crisis of 2007-2008, Stephen G. Cecchetti, April 2008


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Along with the basic lower interest rates, Fed offered lower discount rate

applied directly to the loans from Fed to banks and securities firms from 1.25% to

0.5%. Level of required reserves of commercial banks reduced from 1% to 0.25%.23

1.2The open-market business

Fed also carried out the open-market operations (recollect the US government

bonds which US financial organizations possess) and reduced the rediscount rate24

.

Moreover, Fed issued the MBS purchase increase policy. Take a look at this following

chart, we can see the amount of Feds MBS purchase rocketed at the end of 2007.

Source: Reuters

From 2000 to 2006, the acquisition volume of MBS was just less than $10

billion USD. Up until 31/03/2010, Fed had bought $1.25 trillion USD of MBS agency

but continued to conduct the transactions in the following months. The MBS

acquisition program was monitored by Federal Reserve Bank of New York, controlled

by the Federal Open Market Committee (FOMC). This program was for assisting the

mortgage market and houses as well as to help recover the financial market.25

23Same reference24 DOMESTIC OPEN MARKET OPERATIONS DURING 2007, the Markets Group of the Federal ReserveBank of New York, February 200825The Federal Reserve's Response to the Financial Crisis, http://www.federalreserve.gov/


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1.3The Term Auction Facility Program (TARP)

17/12/1007, upon the impact of the under-standard credit crunch, the US

Government established and granted authority to Fed to host the Term Auction Facility

program to provide the short-term loans that had the maturities of between 28 and 84

days, with the highest interest rate that the financial organizations had offered during

the auction.26

The auction stared on 17/12/2007, with the starting interest rate of 4.17%

and ending of 4.65%. Up until November 2008, there was $300 trillion USD that was

loaned by Fed through TAF. Besides, Fed also loaned the mortgage loans to the

financial organizations with the sum of 1.6 billion USD.27

After Feds unsuccessful

effort to cope with the financial turmoil by reducing the discount interest rate, Fed

cooperated with other state banks like the Canadian State Bank, the UK State Bank,

ECB Bank, Switzerland National Bank to create the monetary policy tool to prevent

the situation from being worse.28

Source: Bloomberg

We can see from the diagram the total assets of the Federal Reserve Fed

investments from December 2007 to December 2008, which revealed Fed's efforts in

coping with crisis in 2007-2008.

2694thAnnual Report 2007, Board of Governors of the Federal Reserve System2795thAnnual Report 2008, Board of Governors of the Federal Reserve System28

How Do Supervisors Cooperate? Evidence from State Bank Examinations, Marcelo Rezende, March 2009


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Group 1 Page 25

the money would be gradually spent. This plan would expire on 31/12/2009, unless

the US Congress allowed 1 more year of extension.

b) This act would establish 2 monitoring services. The first service was the Financial

Stabilization Monitoring Service, which had Feds president, SEC president, and

some important individuals. The second one was a Congress service to monitor

the financial market, legislation system and the Finance Industrys activities in

using its authority in this plan.

c) The Finance Ministry would develop an insurance plan for the bad assets of the

firms with the fee paid by those firms, based on the risk level of the assets. The

insurance pay for the firms after tax would be deducted from the 700 billion USD

of the plan.

d) The US Government was asked to create a bearing on the loan organizations to

make them reduce the house claimations. However, one notable point on which the

US Government could not agree with the Congress was the very terms of capital

loans to help the house owners, who handed in requests to claim bankruptcy, to

keep their houses.

e) In this plan, the taxpayers would be regarded as the shareholders of the firms that

had their bad assets reclaimed. If the US Government had suffered losses from

overpaying for the bad debts, the act would have demanded that the President put

forward a plan for capital reclamation in case this plan suffered losses in 5 years

from the day of validity.

f) This act would apply some hindrances to the remuneration of the firms leaders

who were involved in the plan.


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2.2The Obama government and the American Recovery and Reinvestment Act

(ARRA)

1722009, Barack Obama signed the American Recovery and Reinvestment

Act. This article allowed the Government to deliver a second package since the crisis

took place. This package was worth 787 billion dollars.31

ARRA 2009 was promulgated in the time when the GDP of the US had

decreased at the rate of over 6% annually and the number of the employed fell by more

than 750.000 monthly. Together with the policies to stabilize the financial market,

increase liquidity and consolidate the belief, ARRA was part of the response policy to

the financial crisis.

ARRA has played a vital role in changing the economys orbit. It pulled the

GDP level up and provided about 2.5 to 3.6 million jobs in the second quarter in 2010.

At the end of June 2010, more than 60% of the 787-billion-USD relief package was

spent on helping the families and firms by tax reduction.

a/ The general impact

Source: www.whitehouse.gov

The table shows outlays, obligations, and tax reductions as of the end of each

quarter since the Acts passage (March 2009, June 2009, September 2009, December

2009, and March 2010). As of the end of the first quarter of 2010, the sum of outlays

and tax cuts was $373 billion, with an additional $151 billion obligated but not yet

31American Recovery and Reinvestment Act of 2009, http://www.ntia.doc.gov/


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Group 1 Page 27

outlayed. Additionally, the sum of spending, obligations in excess of spending, and tax

cuts is $525 billion.32

b/ Trends and developments

The usage of economic stimulus packages was categorized by 6 main points:

VAT reduction and the similar expenses, reduction of tax involved adjustments. Tax or

Alternative Minimum Tax, business tax promotions, the financial save of the state,

subsidies for the areas that were directly affected by the financial turmoil; and expenses

for state investment.33

The table shows important changes over time in the magnitude and composition

of the fiscal stimulus. After being stable at roughly $80 to $85 billion per quarter over

the last three quarters of 2009, total outlays plus tax cuts rose to $112 billion in the first

quarter of 2010. This surge stems from increases in individual tax credits and AMT

relief. This was expected: families are making smaller payments or receiving larger

refunds on their 2009 tax returns due to the tax provisions of the Recovery

Act. Section IV discusses in detail the tax credits available in the ARRA, how families

are benefiting, and the impact these credits are having on the overall economic

recovery.34

Source: www.whitehouse.gov

32Recovery Act Third Quarterly Report, http://www.whitehouse.gov/

33About the Recovery Act, http://www.whitehouse.gov

34Recovery Act Third Quarterly Report, http://www.whitehouse.gov/


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Group 1 Page 28

The components of the package were also expanded. As forecast when it was

passed, the VAT reduction and state bailouts were prioritized. Thus, these ones took a

great percentage in the overall expenditure in the second quarter of 2009. The aid for

the direct sufferers from economic recession raised remarkably in quarter III an IV in

2009. This indicates that some programs helped the fired people in times of recession.

Investment expenditure for areas like infrastructure and green energy was being

a bigger and bigger part of the stimulus package. These expenses increased from 7

billion USD at the end of quarter II/2009 to 86 billion USD in a year. When the

economy continued to recover and ARRA moved to re-investment, more than half of

the expenditure credits and tax were going to be under the form of state investment.

c/ Changing the economys orbit

Source:U.S. Bureau of Economic Analysis (BEA)The chart indicated the development ratio of the actual GDP. The line between

quarter I and quarter II year 2009 represented the before and after the appliance of

ARRA. GDP reduced rapidly in the period of from quarter III/2008 to quarter I/2009,

but started to rise after ARRA being officially valid. After the fall of 6,4% in the first

quarter of 2009, quarter II, after ARRA was valid, GDP only fell by 0,7% and after that

rose by 2,2% in quarter III and 5,6% in quarter IV. From quarter I go quarter IV in

2009, GDP growth rate rose 12% (from -6,4% to 5,6%). This was the biggest rise in 3
http://www.bea.gov/http://www.bea.gov/http://www.bea.gov/


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Group 1 Page 29

successive quarters since 1981 and was the second biggest since 1958. These numbers

proved the efficiency of ARRA.35

After having the high growth rate at the end of 2009 (5.6%), the growth rate was

adjusted to be 2.7% in quarter I/2010. The chart showed that the Blue Chip index on 10

7 expected the actual GDP to be 3.2%, this shows that the forecasters believed that

the stable growth rate in quarter I would continue in the next quarter. The important

thing is GDP growth rare was thought to be continued to stabilize in the second half of

year 2010 and 2011 as well.

Source: Bureau of Labor Statistics

The employment rate indicates that the big reduction trend of employment

demand reversed as soon as ARRA was valid. In quarter I/1009, on the average, the

economy lost about 756.000 jobs a month. This decreased to 476.000 each month in

quarter II, 261.000 in quarter III and 92.000 in quarter IV. The economy started to have

35 THE ECONOMIC IMPACT OF THE AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009,JANUARY 13, 2010, http://www.whitehouse.gov/


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Group 1 Page 30

more jobs in 2010, 63.000 each month in quarter I and 123.000 in the next, on

average.36

However the economy was still not fully recovered. The actual GDP rate was

still below average and the unemployment rate was still at 9.5%37. Whereas the rate of

increasing of employment was 123.000 monthly in the last 3 quarters but it was still

waiting for a big growth to reduce the unemployment rate. Of course the change of the

economy in the last 18 months was miraculous. Compared to the economic recession in

quarter I/2009, the changes in the economys orbit were so remarkable.

The duration of the changes in the economys orbit showed the important role of

ARRA. At the point the act was passed, the economy was a serious turmoil. The actual

yield was rapidly stabilized as soon as the ARRA was valid and started to grow in the

following quarters. Similarly, the sack rate started to be adjusted at the same time.

Source: http://innocentbystanders.net

36THE ECONOMIC IMPACT OF THE AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009,

JANUARY 13, 2010, http://www.whitehouse.gov/37

The 4thQuarterly Report, CEA, July 14, 2010


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Group 1 Page 31

REFERENCE

In a credit-hungry economy, FICO, February 2008

Unemployment and the Credit Crunch, the local futures group, November 2008

G.M.s Bankruptcy Drawn into Defect Inquiry, nytimes.com, March 21, 2009

Trust, Confidence and Economic Crisis, Fran Tonkiss,July/August 2009

The Credit Crunch of 2007-2008: A Discussion of the Background, Market

Reactions, and Policy Responses, Paul Mizen, September/October 2008

Monetary Policy and the Financial Crisis of 2007-2008, Stephen G. Cecchetti,

April 2008

DOMESTIC OPEN MARKET OPERATIONS DURING 2007, the Markets

Group of the Federal Reserve Bank of New York, February 2008

The Federal Reserve's Response to the Financial Crisis, Ben Bernanke, August

2, 2013

94th Annual Report 2007, Board of Governors of the Federal Reserve System

How Do Supervisors Cooperate? Evidence from State Bank Examinations,

Marcelo Rezende, March 2009

THE $700 BILLION BAILOUT RESCUE PLAN, Devvy, October 2, 2008,

NewsWithViews.com

The economic impact of the American recovery and reinvestment act of 2009,

Third quarterly report, Executive office of the president council of economic

advisers, April 14th, 2010

The 4th Quarterly Report, CEA, July 14, 2010

Economic Stimulus Act of 2008, www.govtrack.us

American Recovery and Reinvestment Act of 2009, http://www.ntia.doc.gov/

Bureau of Labor Statistics, http://www.bls.gov/

U.S. Census Bureau, http://www.census.gov/


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Group 1 Page 32

US Global Investors Inc, http://www.bloomberg.com/

Bureau of Economic Analysis, http://www.bea.gov/

Board of Governors of the Federal Reserve System,

http://www.federalreserve.gov/

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http://www.treasury.gov/

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http://www.x-rates.com/

http://www.reuters.com/

The Crisis of Credit Visualized,https://www.youtube.com/

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[group 1] credit crisis in usa ed4

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