AN HISTORICAL PERSPECTIVE ON THE CRISIS OF 2007 – 2008

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AN HISTORICAL PERSPECTIVE ON THE CRISIS OF 2007 2008. BY: MICHAEL D. BORDO DEPARTMENT OF ECONOMICS RUTGERS UNIVERSITY. OUTLINE. Explain Financial Crisis of 2007 2008 Compare and Contrast Crisis with other past occurrences Combating Future Crises. - PowerPoint PPT Presentation

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AN HISTORICAL PERSPECTIVE ON THE CRISIS OF 2007 2008

BY: MICHAEL D. BORDODEPARTMENT OF ECONOMICS RUTGERS UNIVERSITYAN HISTORICAL PERSPECTIVE ON THE CRISIS OF 2007 2008OUTLINEExplain Financial Crisis of 2007 2008 Compare and Contrast Crisis with other past occurrences Combating Future Crises

There are 2 different types of credit activities: Depository Banking and Investment Banking. We established the Glass Segal Act after the Great Depression which separated the two. Although with the Financial Securities Moderation Act, we repealed this it and the wall separating the two was done away with. After tech bubble and Sept. 11th occurred, Alan Greenspan decreased the federal funds rate, in effect loosening monetary policy. Wall Street and foreign investors took grasp of this opportunity for cheap credit. They increased their leverage exponentially. Since, the wall was down between commercial and investment bankers. 3

Investment bankers fabricated Collateralized Debt Obligations, which enabled investors to invest with them. All prime mortgage qualifiers where already settled with a mortgage, but commercial lenders and investment bankers were banking off these CDOs, so they used subprime mortgages instead to back them. Prices were bid up so high that people could not afford their mortgage payments any longer and defaulted.

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Subprime Mortgage Picture ( Defaulted!)5

Now I-Banks held billions worth of these houses whose mortgages were not being paid. The bubble burst as I-Banks tried to rid their Balance Sheet of this plague of an asset. The worst part is they borrowed billions in order to buy these CDO and were now facing bankruptcy. The freezing of the financial system was apart as credit tightened, Private equity firms could no longer attain financing for their LBOs and interbank lending ceased because people believed that big banks were not reliable any longer. A recession hit. The Fed chose to let Lehman brothers fail in order to prevent moral hazard in the future. AIG was nationalized and Bear Sterns merged with J.P. Morgan and was bailed out. The fed in response to the recession provided liquidity injections including its $700 billion TARP bill (Troubled Asset Relief Plan).

6In the past we have seen: Tightening in PolicyBust & RecessionAsset prices IncreaseBubbles created because of: From loss of Fundamentals to value assets Financial Innovation Leverage Similarities with Past Economic Crises: What makes this Crisis Unique? Combating Future Issues: Fed developed series of new programs which would provide liquidity in times of need These would only benefit firms having severe solvency issues and that would have an extremely harmful tole on the economy if they were to fail This is contrasts the previous way of helping firms by Buying Treasury Securities

2. They also plan to act with greater speed in regards to monetary policy decisions.

Michael Bordo (author) suggested that they provided excess amounts of liquidity in the market in 2001 2004 and that this was also an issue. So do not utilize liquidity measures for to extensive a period

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