Choose 1 of the following topics related to the Great Recession:

  • The housing price bubble, collapse, foreclosures, bailout of underwater mortgages
  • Subprime mortgages and derivatives, bailout of FNMA, Freddie Mac and AIG
  • The banking industry crisis, bailout of commercial and investment banks

Write a 350- to 700-word analysis of 1 of the following corrective actions taken by the Federal Reserve as a result of the crisis:

  • Quantitative easing
  • Purchase of toxic assets from financial institutions
  • Paying interest on reserve balances

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Address the following in your analysis:

  • Actions taken by the Federal Reserve to mitigate the crisis
  • How the corrective action helped to restore stability to the financial system
  • How the corrective action should prevent recurrence of a similar crisis

Note: Use of charts and graphs is encouraged with appropriate citations. Any charts or graphs retrieved from the Federal Reserve Bank of St. Louis FRED website may only be included when the data sources used by FRED are US government sources such as the Bureau of Economic Analysis or the Bureau of Labor Statistics. 

Cite at least 2 academically credible sources.  

Format your assignment according to APA guidelines.

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The Banking Industry Crisis, Bailout of Commercial and Investment Banks

The Banking Industry Crisis, Bailout of Commercial and Investment Banks

            The 2008 financial crisis of 2008 saw banks losing money owned inform of mortgages because the public was stirred to purchase properties. High investment in credit default swaps and mortgage backed securities (CMOS) caused financial institutions problems. Increased lending to consumers resulted in businesses collapsing. Since trading of mortgage-backed securities was not practiced, the credit market was failing due to the utilization of toxic assets (worth less than their value). Cash was lying idle in financial institutions instead of lending it out (Garcia, 2016). Subsequently, the United States government thought of liberating the credit market. On 29th September 2008, the U.S House of Representatives rejected former president bush plan to bail out financial institutions during the financial crisis. After public lobbying and amended bush bill, the Senate settled on a 700 billion dollars Troubled Assets Relief Program (TARP). 

            At first, the TARP plan was meant to utilize the funds to buy mortgage backed securities from commercial banks. The effort would spur bank lending. “Shadow banks” or business lenders that were about to become commercial banks were also entitled to a share of the Troubled Assets Relief Program funds (Garcia, 2016). The mortgages backed securities were to be purchased at discounts to the right price of lending. As a result, banks would be moved to offer loans again. Creditors would reckon their financial standing while borrowers would be rescued from toxic assets. Even though the treasury price was less than the mortgages backed securities’ worth, it was more valuable than the low market value. The treasury supposed that the troubled, risky, and non-performing assets would be bought. Besides mortgages, the assets included college loans, auto loans, amongst others.

           Fast forward, the 700 billion TARP funds were cut to $475 billion, whereby 250 billion dollars was designated for banking firms, 82 billion dollars for the auto industry, and 27 billion dollars to revive the collapsed credit market. With the utilization of TARP funds, money would be infused in the banking systems after the purchase of troubled assets. Liquidity in the financial scope would increase from the purchase of bad debt accrued by mortgage debtors (Berger, Roman, & Sedunov, 2016). Banks would borrow and lend amongst themselves. As a result, normalcy in lending to businesses and households was evidenced after the purchase of toxic assets .banks could even out their balance sheets. Susceptibility to further losses was prevented. Investors’ confidence in banking institutions was reinstated due to easy credit (Garcia, 2016). As a result, the credit market started to stabilize. The auto industry was revived since unemployment and retrogression of the economy were looming.

            In summation, the Troubled Assets Relief Program prompted lending and access to credit. A functional or a growing economy depended on lends to service wages. Such funds are used in marketing, recruitment, investment, research, and development, amongst others. When these factors are addressed, rates of employment increase, investments blossoms, and the economy grow. With enough liquidity, banks can have their reserves. Increased economic activities translate into more savings. When banks and commercials have enough reserves, it is unlikely that they will go bankrupt.

References

Berger, A. N., Roman, R., & Sedunov, J. (2016). Do Bank Bailouts Reduce Or Increase Systemic Risk?: The Effects of TARP on Financial System Stability. Federal Research Bank of Kansas City.

Garcia, G. G. (2016). The US Financial Crisis and the Great Recession: Counting the Costs. In The First Great Financial Crisis of the 21st Century: A Retrospective (pp. 47-73).