Financial crisis of 2007-2009 was caused by bad financial policies by the government prior to the financial crisis.

Financial crisis of 2007-2009

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nFinancial crisis of 2007-2009 was caused by bad financial policies by the government prior to the financial crisis. This is because various forms of financial institutions were allowed to provide loans without adequate collateral. The government policies did not provide supervision and regulatory structures in financial market (YouTube, 2012). For instance, Freddie and Fannie were allowed to operate with insufficient capital to support their guarantees hence exposing them to more risk. Besides, there were policies that facilitated exotic mortgages such as ARMS prior to the crisis (Mishkin, 2013). Therefore, borrowers could not pay the ever-increasing payments on their exotic mortgages. The financial institutions were also permitted to package subprime and exotic mortgages into securities. Some of the securities were opaque and complex such as Collateralized debt obligations (CDOs). In addition, the rating agencies gave AAA rating to the majority of these securities. Majority of these securities were sold to the investors (YouTube, 2012). This intensified the risk of low quality lending because firms such as AIG sold insurance to safeguard the financial firms and investors that had these securities.

nThe financial crisis was inherent in market-based economy because both public and private sectors were affected by the crisis. Many private institutions were unable to adequately manage and monitor risks. In addition, they relied on short-term funding that increased their risks (Mishkin, 2013). Further, the government failed to provide sufficient attention on the stability of the financial system.

nThe government policies helped to get out of the financial crisis. This is because it took various actions to support the key financial institutions and market, and prevent financial panic. Additionally, the federal government limited the contraction in employment and output (YouTube, 2012). Further, the government took similar efforts to assist foreign government and central banks. For instance, the federal government mobilized G-7 countries to collaborate in stabilizing the global financial system.

nThe government policy responses did not cause problems of their own as it provided a temporary guarantee of the value of money market fund (MMF) shares. The government enabled Federal Reserve to provide liquidity to financial institutions (YouTube, 2012). Therefore, banks were able to provide cash to MMFs by purchasing some of their assets. These policy responses enabled to mitigate the effects of financial crisis (Mishkin, 2013).

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nReferences

nMishkin, F. (2013). The economics of money, banking, and financial markets (10th ed.). Boston: Pearson/Addison Wesley.

nYouTube,. (2012). THE FEDERAL RESERVE AND THE FINANCIAL CRISIS. Lecture #3 “The Federal Reserves Response to the Financial Crisis. Retrieved from https://www.youtube.com/watch?v=GLoqPm1nYRU&list=PL08C0992430469B34