Money and Banking

There mortgage crisis clearly had an impact on the money supply in the U.S. Many borrowers stopped making schedule mortgage payment and led almost the entire mortgage system into default. The stimulation package designed to fuel the economy and to offset the sudden lose in the money supply. Lenders, commercial banks and insurance companies that had toxic items on their balance sheets were either saved by the government or were forced to merge with other firms to protect their client base and the entire economy from completely financial disaster.

In September 20th, 2007 Chairman Ben S. Bernanke gave a detailed speech in front the committee on Financial Services in the U.S House of Representatives. The chairman started his speech with a brief background on the subprime loans, according to Bernanke the subprime loans were introduced in the middle 80s but it was only till the middle 90s that the subprime market expend significantly.

The expansion was fueled by innovations--including the development of credit scoring--that made it easier for lenders to assess and price risks. In addition, regulatory changes and the ongoing growth of the secondary mortgage market increased the ability of lenders, who once typically held mortgages on their books until the loans were repaid, to sell many mortgages to various intermediaries, or "securitizers." The securitizers in turn pooled large numbers of mortgages and sold the rights to the resulting cash flows to investors, often as components of structured securities. This "originate-to-distribute" model gave lenders (and, thus, mortgage borrowers) greater access to capital markets, lowered transaction costs, and allowed risk to be shared more widely. (Testimony: Chairman Ben S. Bernanke, 2007)

Post-Crisis Period

The mortgage crisis began in the U.S and quickly became a global issue; there is an inevitable comparison between the current crisis and the Great Deprecation. Zhou Qiren suggests that during the Great Depression that swept the world from 1929 until the late 1930s, the US was hit by an unemployment rate of more than 25 percent. Many US banks went bankrupt; its stock market dropped by 90 percent. The Fed respond to the crisis indeed results in a shorter than expected recovery time, the mortgage crisis bailout were introduced as the individual problem turned into a national problem.

The Fed Response to the Crisis

According to Wharton the interest rate increase during 2007 boosted the monthly payment on most of the subprime loans, in the end of the third quarter that year seven of every hundred subprime borrowers were in foreclosure. The interest rates were already low in early 2008 and the fed couldn't use the interest rate as the changing factor, as a result the Fed became a direct lender. Mortgage companies, commercial banks and Insurance companies needed the Fed's help immediately.

Christopher Rude suggests that the U.S government and the Fed took an active management of the U.S' global credit and liquidity risk. The Federal Reserve used the ability to lend that it had developed in the interim to engineer the largest increases in bank reserves in US history, an increase in reserves more than necessary to push the federal funds rate to zero and which US banks absorbed as excess reserves. Rude continue and claim that in the end of 2008 the Fed flooded the U.S financial system with its own riskless liquidity zero-interest rate.

The Federal Reserve's initial response to the crisis was thus a radical one. Between December 2007 and March 2008, the Federal Reserve transformed itself from being a participant in the US Treasury market into a direct lender, replacing US Treasuries with less liquid and credit worthy loans on the asset side of its balance sheet. (Rude, 2009) The Fed increased the money supply