Federal Policy Responses to the 2007–2009 US Credit Crunch

Łukasz Goczek

doi:10.12775/equil2011.018

Abstract

This paper discusses the key characteristics of the U.S. financial crisis 2007-2009 and focuses on the Federal Policy Response to the lack of liquidity in the financial sector known as the “Credit Crunch”. The surprising depth of the crisis required unprecedented policy measures to be used in order to tackle the mounting liquidity problems in banks and prevent the subsequent credit crunch from taking its toll in the real economy. This required extension of monetary powers of the Federal Reserve and Treasury, which was unmatched in history. The policy response to credit crunch and house price bust was especially important given the fact that recessions following such events tend to be much deeper and longer than any other types of recessions. More importantly, however, the analyses of the current policy responses will determine which form financial markets will take in the next few decades, thus how vulnerable the world economy will be to next disruptions and liquidity problems.

Highlights

At the time of writing, the 2007–2009 global financial crisis seems to be over, the U.S economy shows signs of a still unsteady revival
The analyses of the current policy responses will determine which form the financial markets will take in the few decades, how vulnerable the world economy will be to the disruption
The analyses of the current policy responses will determine which form the financial markets will take in the few decades, how vulnerable the world economy will be to disruptions and liquidity problems

Summary

Introduction

At the time of writing, the 2007–2009 global financial crisis seems to be over, the U.S economy shows signs of a still unsteady revival. The surprising depth of the crisis required unprecedented policy measures to be used in order to tackle the mounting liquidity problems in banks and prevent the subsequent credit crunch from taking its toll in the real economy This required extension of monetary powers of the Federal Reserve and Treasury which was unmatched in history. The cheap funding and unknown nature of new financial assets, including securitization, the innovative originate and distribute banking model, credit default swaps and other OTC derivatives led to excessive optimism of the asset value and a subsequent pricing bubble in real estate and commodities This was, not enough for an asset bubble to be created, since the level of interest rates or financial innovations are just two of the many factors taken into account by individuals in financial decision-making.

Asymmetric information during financial crisis

Conclusions and policy implications

Literature