Impacts of the Recent Mortgage Crisis on the Money Supply in the United States - Research Paper Example

? Impacts of the recent mortgage crisis on the money supply in the United s and the actions of Federal Reserve take in response to the mortgage crisis Impacts of the recent mortgage crisis on the money supply in the United States and the actions of Federal Reserve take in response to the mortgage crisis One of the major reasons of the recent financial crisis in United Sates was the mortgage crisis. Mortgage crisis refers to a situation in which the money borrowers fail to repay the money they lent from financial institutions. American financial institutions miscalculated that American economy is strong enough to overcome any kind of crisis situation and it is not necessary to bother much about the repaying capacities of the people who approach them for loans and other financial aids. Greedy public exploited the opportunities very well and they approached American banks for financial aids to purchase lavish apartments, real estate properties, vehicles etc. American banks imposed no restrictions in mortgage sanctioning and dispersed huge amount of money for maximising their profits. In most of the other countries, mortgages are sanctioned only after the assessment of the financial abilities of the customer. But in America, banks have shown fewer interests in assessing the abilities of the customers. The unexpected mortgage crisis impacted heavily on the money supply in America and Federal Reserve forced to take strong measures to counter the mortgage crisis. Impacts of the recent mortgage crisis on the money supply in the United States The major impact of the recent mortgage crisis on money supply in America was the change in behaviours of the investors. The huge capital strength of American banks forced investors to invest heavily in American banks earlier, without a second thought. However when they came to know about the mortgage crisis and the foolish lending habits of American banks, they started to reduce their investments in American banks and as a result of that American banks started to experience shortage of money supply. As a result of that, Bank of America and Lehman Brothers like big financial institutions started to collapse immediately after the crisis started in 2007. “The critical situation of the financial system has driven some analysts to argue that should the monetary policy response fail to restore confidence among investors, the outcome would be the worst crisis seen since the Great Depression” (The United States Subprime Mortgage Crisis And Its Implications For The Caribbean, 2008, p.1). Real estate sector was the worst affected industry as a result of the recent mortgage crisis and subsequent money supply problems. Majority of the real estate business groups rely heavily on mortgages from financial institutions for the completion of their projects. As a result of the reluctance of the investors in investing in banks, Banks started to find money shortages to assist the real estate sector. Banks started to impose strict norms for sanctioning mortgages to real estate people. Moreover, people who approached banks for financial aids for purchasing properties were told that no more mortgages were possible without adequate proof about their financial abilities. Thus, both the real estate business groups and the people who liked to purchase some properties suffered heavily and as a result of that real estate business started collapse. The impacts of mortgage crisis have not been limited to the financial sector alone. In fact, it has spilled into the real economy also and as result of that American economic growth has been reduced considerably over the last four years period. Economic activities in America have been reduced considerably because of the shortage of money in the hands of the public. Moreover, Americans started realise the importance of saving money for future crisis situations as they learned a lesson from the recent crisis. Thus, Americans started to cut down their lavish spending habits because of the mortgage crisis and subsequent recession problems. According to renowned economic scientist and Nobel Prize winner Paul Krugman, spending should be increased at this recession times rather than saving (Newell, 2008). Increased spending will increases the economic activities and therefore the economic progress could be regained according to Krugman. However, American public could not digest this idea and they started to put breaks on their lavish spending habits. Actions of Federal Reserve in countering recent mortgage crisis Strengthening of the lending norms was the major activity performed by Federal Reserve to counter recent mortgage crisis. Now it is difficult for the Americans to get financial aids from banks without adequate evidences to prove their financial abilities. The norms in the mortgage backed security market were also been strengthened. In the last 14 months alone, the Federal Reserve, a non-government organization of private bankers, has interceded 34 times in the financial markets, primarily by providing fiat money backed by U.S. Treasury securities (government IOU's) to their friends in investment-banking firms in exchange for getting those companies' holdings of extremely poorly performing or non-performing mortgage-backed securities (Wallace, 2008) Securitization is a practice of combining different types of mortgages and selling them as bonds. There are two types of securitization are prevailing America at present; mortgage-backed securities (MBS) and asset-backed securities (ABS). Mortgage backed securities contributed heavily to the recent drastic financial situations in America. Selling of MBS was one of the major financial activities until recent times. Many people lost their money through the purchasing of poor performing or nonperforming companies. Now Federal Reserve has interfered in this matter and enforced more control in the transactions of MBS so that the loopholes in MBS transactions have been reduced considerably. Pumping of money in the form of huge bailout packages was another strategy taken to counter recent mortgage crisis. “By August, 2007, credit had become so tight that the Fed loaned banks $75 billion to restore liquidity long enough for the banks to write down their losses and get back to the business of loaning money”(Amadeo, 2011). However, the banks failed to utilize this money in an effective manner. Instead of using this money for sustaining their lending activities, banks started to stop their entire lending activities and as a result of that the crisis has worsened. Since Wall Street began to wobble in 2007, the Fed has been engaged in an enormous effort to stimulate growth. The central bank has held short-term interest rates near zero since December 2008. To further reduce long-term rates, it has amassed more than $2 trillion in government debt and mortgage-backed securities. On Aug. 9, 2011, the Fed's policy-making board said that it would hold short-term interest rates near zero through mid-2013 to support the faltering economy. On Sept. 21, 2011, the Fed announced plans to try to push long-term interest rates down by purchasing $400 billion in long-term Treasury securities with proceeds from the sale of short-term government debt, saying the economy clearly needed help (Federal Reserve (The Fed), 2011). Cutting down of the interest rates in order to increase the mortgage activities was another strategy taken by Federal Reserve to counter recent mortgage crisis. Many people stayed away from seeking loans from financial institutions because of higher interest rates and the uncertainty about the economy. By reducing interest rates, and increasing control over lending habits, Fed assumes that only genuine people will come forward for taking mortgages while others will stay away. Conclusions The recent mortgage crisis in America impacted money supply in many ways. Banks started to stop their lending habits even to the genuine customers. As a result of that, economic activities have been reduced considerably in America. Even though Fed reduced the interest rates considerably, neither banks nor the people were ready to take advantage of it. Fed flooded billions of money in the financial market in order to sustain the lending activities in the country. However, the efforts of Fed have not been fully successful because of the reluctance and concerns of the banks and the public in increasing their lending and borrowing habits. References Amadeo K (2011). Could the Mortgage Crisis and Bank Bailout Have Been Prevented? Retrieved from http://useconomy.about.com/od/criticalssues/a/prevent_crisis.htm Mortgage Crisis Bailout: Relief for Some, Risk for Others (2008). Retrieved from http://knowledge.wharton.upenn.edu/article.cfm?articleid=1912 Newell J (2008). Paul Krugman Wants To Spend So Much Money, For Fun. Retrieved from http://wonkette.com/404378/paul-krugman-wants-to-spend-so-much-money-for-fun The United States Subprime Mortgage Crisis And Its Implications For The Caribbean, (2008). Economic Commission for Latin America and the Caribbean (ECLAC). Retrieved from http://www.eclac.org/portofspain/noticias/noticias/8/32418/TheUnitedStatesSubprimeMortgageCrisisanditsImplicationsfortheCaribbean.pdf Federal Reserve (The Fed) (2011). The New York Times. Monday, October 17, 2011. Retrieved from http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_reserve_system/index.html Wallace J (2008). The Financial Crisis and the Federal Reserve. Retrieved from http://newsblaze.com/story/20080927140845tsop.nb/topstory.html Read More