The recovery process – Evaluating the impact of fiscal and monetary tools used to reheat the markets
1. Government responses and interventions in the financial crisis
According to the causes and effects discussed in the above parts, the global financial crisis can be divided into two main phases. The first phase was from August 2007 to August 2008, stemmed from losses in a small segment in the financial system , i.
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e. the subprime mortgages market. The second phase was in the mid-September 2008, in which the disruption developed far more rigorously. Rapidly, the moderate financial recession had transformed into a significantly disruptive global crisis in a short period of time. In order to stabilize and boost the weaken economy, policymakers have acted aggressively to deal with the heterogeneous causes of the crisis ( A. Russo, J. Katze, 2010) since its emergence in 2007. Even though there are many opposers to government’s reaction (Moore, Baker, Taylor ), it is also approved by a significant number of economists and authorities ( IMF, McCain, Blinder, Zandi ) that the legislative and regulatory response prevented a far worst outcome , that is the second Great Depression. From August 2007, central banks began to lower interest rates ( Fed, timelines of policy responses ) to spur economies and make it more profitable for banks to loan. Interest rates then were discounted during diverse stages of the crisis. Following that cutting, incentives were created for US taxpayers, i.e tax rebates. Homeowners also received government’s assistance by refinancing their mortgages. Regarding individual institutions, governments did offer them bailouts ( Davidoff, Zaring, 2009). In September and October, 2008, central banks did implement a comprehensive, global action to recapitalize banks. For instance, on 30th September, French government and state-owned banks offered 3 billion euro to Dexia recapitalization; and on 13th October, Germany 70 billion euro recapitalization fund was pledged (the Fed, International timeline). Hence, central banks have imposed a great number of additional policy tools as the need arose. In general, these responses can be divided into three main sets as follows.
(1) Lending to financial institutions
During the crisis, the Federal Reserve has applied numerical actions to insure financial institutions have adequate liquidity for short-term credit activities. These actions include issuing new facilities for auctioning credit as well as banks and dealers to borrow at the Federal Reserve’s discount window. For instance, the Fed’s timelines of policy responses to the global financial crisis reports that since August 2007, the difference between federal fund target rates and the discount rates have been reduced from 100 basis points to 25 basis points. Similarly, many related terms were altered for the favor of financial institutions including Term Auction Facility ( TAF, Fed’s timeline, 12/12/2007), in which depository institutions can borrow funds at the rate below discount rates with term up to three months ; Term Securities Lending Facility ( TSLF, Fed’s timeline, 11/3/2008) together with Primary Dealer Credit Facility ( PDCF, Fed’s timeline, 16/3/2008) . Moreover, as the financial crisis affected severely to the global economy, the need of providing liquidity into other countries’ economies arose. The Fed had entered into swap agreements with 14 foreign central banks. In this kind of agreement, these international banks are allowed to borrow dollars from the Fed to lend others bank which under their administration.
(2) Providing liquidity directly to key credit markets
Credit risk is known as one of the significantly contributing factor to the global crisis. On condition that anxiety of asset quality and creditworthy, financial institutions still constrained their loan provision after an abundant liquidity was put into the market. So as to solve and improve these problems, the Fed intervened by providing liquidity directly to demanders in key credit markets. These tools conclude Commercial Paper Funding Facility (CPFF) , which offers the Fed the high quality commercial paper with an expiration period of 90 days ( Carlson, Wakerfiled, 2009).
(3) Purchasing long-term securities
The last policy toolkit of central bank involved buying long-term securities in private credit markets. In an article by Benanke (2008) , $100 billion in government sponsored enterprise (GSE) debt together with more than $500 billion GSE mortgaged-backed securities were bought by the Federal Reserve. These actions put an effect of reducing the mortgage rate substantially.
2. Impacts of government actions to the markets
Other than the fundamental cause, that is leverage, there are plenty of contributing factors led to the worst economic recession since the 1930s. Of which, complicit governments ( central banks, regulators and legislatures) also bear a share of the responsibility( A. Russo, J. Katze, 2010). For instance, in the case of Citigroup and AIG, the US policymakers did not alter the existing law so as to bail out rapidly, and also offered the discount window to Morgan Stanley and Goldman Sachs that allowed them to convert into bank holding companies. However, in an article of Blinder and Zandi ( 2010), it is indicated that the economic recovery has made certain progress. As show below in the figure 5, by September 2010,the Fed and government has brought back the mild stabilization to the financial market.
Source: Blinder, Alan S. and Zandi, Mark , How the Great Recession Was Brought to an End, July 27, 2010
Although the growth of economic recovery has still been in sluggish pace and uneven, authorities including IMF, former Federal Reserve Vice Chairman Alan Blinder, and current Moody’s Analytics Chief Economist Mark Zandi , have concluded that with the absence of the monetary and fiscal measures implemented by the Federal Reserve as well as the Bush and Obama Administrations, it would have been much more worse. As the IMF observed “… thanks to a powerful and effective policy response, the United State recovery from the Great Recession has become increasingly well established. Since mid-2009, massive macroeconomic stimulus and the turn in the inventory cycle have overcome prevailing balance sheet strains, and- aided by steadily improving financial conditions- autonomous private demand has also started to gain ground.” Likewise, the opinion of Blinder and Zandi is that the “…effects of the government’s total policy response…on real GDP, jobs, and inflation are huge, and probably averted what could have been called Great Depression 2.0.” On the basis of these analysis, Blinder and Zandi “…estimate that, without the government’s response, GDP in 2010 would be about 11.5% lower, payroll employment would be less by 81/2 million jobs, and the nation would now be experiencing deflation”.
Albeit the combination efforts taken by government and the Fed have positive effects to some extent to the economic recovery, recent analysis shows that the stimulus attempts are small and insufficient to reduce the unemployment rates and restore market confidence effectively. Hence, even though the housing market has recently attained some good news, there has been a rise in unemployment and “underemployment” rates of 9.6% and 16.7%, respectively ( A. Russo, J. Katze, 2010).
Recent economists indicated that, the government’s responses to the brutal financial disaster led to dramatic increases in public sector spending. Thus, the 2008 crisis was initially in the private sector has been increasing to sovereign debt. So, new challenges have been contributed to the existing burden of many policymakers.
1. New trends on Financial landscape and changes in institution’s behavior towards risk
The global financial recession has been triggered by complex causes. One of its fundamental contributing factor, i.e. leverage, initially existed in the private sector. However, recent observers has drawn attention to the fact that the 2008 crisis has potentially probabilities to transform into government sector (Harper, Chritine,2010) , i.e. sovereign debt. In reality, there have been several countries experiencing this trend including Greek, Portugal, Spain, Ireland, etc. It is the view of professors Reinhart and Rogoff ( A. Russo, J. Katzel, P46, 2010)that the evolution from banking crisis to sovereign debt is inevitable to some extent. The reason is because in order to save a destructive financial system, government must intervene first by supporting vulnerable financial institutions, and following that is (1) enhancing private consumption through tax rebates or reductions in discount rates ;or (2) government stimulus measures. All these policy toolkits can involve considerable increases in government spending, affecting the asset side of the government’s balance sheet. Thus, it leads to the sovereign debt.
The main point that triggered the credit crunch in 2008 is the low interest rate and loose supervision. To code with that, IMF has announced the new version of global banking capital requirement for BASEL III which is highly demanded of the capital rate for banks. However, this is not the solution to fix out the problem. Obviously, the problem turns to be lack of supervision of the operational of Hedge Funds, not the banking sector. The flood of newly invented financial derivative forms the killer of this crisis. In order to keep these out of balance sheet, Hedge fund tend to use SIVs as a usual tool. Therefore, a strong demanding regulate should be focused on the Derivatives Market. We might establish a committee to supervise the new investment vehicle published, and call for standard trade contract could be allowance. In the contrast, part of risky private tailored structure product should be abandon. At the same time, we shall contend that the financial reporting standard for the Hedge Funds field should be changed, information they provide must be more transparent. What`s more, the submitting of the credit analysis of CDOs contrast.
1. International Monetary Fund, “United States of America Concluding Statement of the 2010, Article IV Mission”, June 21th, 2010
2. Blinder, Alan S. and Zandi, Mark , “How the Great Recession Was Brought To An End”, July 27th, 2010
3. Thomas A. Russo, Aaron J. Katze, “The 2008 Financial Crisis and Its Aftermath: Addressing the Next Challenge”, 2010. ( P32-P52)
4. Federal Reserve Bank, Timelines of Policy Responses to the Global Financial Crisis, http://www.newyorkfed.org/research/global-economy/policyresponses.html
5. John B. Taylor, “The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong “, November 2008.
6. John Carlson, Sarah Wakefield, “ The Impact of Credit Easing So Far”, 2009.
7. Bernanke, Ben S. (2008). “Federal Reserve Policies in the Financial Crisis,” speech at the Greater Austin Chamber of Commerce, Austin, Texas, December 1.
8. Walter B Moore, Cherie A Baker, “The 2008 Financial crisis: FAS 157 and FAS 59- Did They Reflect Realty?”, Journal of Finance and Accountancy.
9, Harper, Christine, “Crash of 2015 Won’t Wait for Regulators to Rein In Wall Street”, Bloomberg.com, August 9, 2010.