US_Financial_Crisis

RESEARCHPAPER09/3422APRIL2009ThefinancialcrisisintheUS:keyevents,causesandresponsesThecurrentfinancialcrisisstartedintheUShousingmarketin2007.Thecrisisspreadacrosstheworldandseverelydamagedtheeconomiesofmanycountries,includingtheUS,andreachedanewlevelinSeptember2008asanumberofprominentUS-basedfinancialinstitutions,includingAIGandLehmanBrothers,collapsed.ThisResearchPaperfirstexaminestheunderlyingcausesofthecrisisintheUS.Inparticular,itexaminestheemergenceandcollapseofthehousingbubbleandthesignificanceofthecomplexfinancialinstrumentsthattransformedanassetpricecorrectionintoasignificantdomesticandglobaleconomicdownturn.ThemainfocusistheresponseofgoverninginstitutionsintheUS.LookingatresponsesbeforeandafterSeptember2008–drawingcomparisonwiththeUKwhererelevant–thisPaperexaminestheactionsofawiderangeofinstitutionsincludingtheFederalReserve,USTreasury,Congress,SecuritiesandExchangeCommissionandFederalDepositInsuranceCorporation.JohnMarshallBUSINESSANDTRANSPORTSECTIONHOUSEOFCOMMONSLIBRARYRESEARCHPAPER09/342RecentLibraryResearchPapersinclude:09/19SmallBusinessRateRelief(AutomaticPayment)Bill[Bill13of03.03.092008-09]09/20EconomicIndicators,March200904.03.0909/21StatutoryRedundancyPay(Amendment)Bill[Bill12of2008-09]11.03.0909/22IndustryandExports(FinancialSupport)Bill[Bill70of2008-09]12.03.0909/23WelfareReformBill:CommitteeStageReport13.03.0909/24RoyalMarriagesandSuccessiontotheCrown(Preventionof17.03.09Discrimination)Bill[Bill29of2008-09]09/25FuelPovertyBill[Bill11of2008-09]17.03.0909/26UnemploymentbyConstituency,February200918.03.0909/27CoronersandJusticeBill:CommitteeStageReport19.03.0909/28GenevaConventionsandUnitedNationsPersonnel20.03.09(Protocols)Bill[HL][Bill69of2008-09]09/29Members’payandtheindependentreviewprocess31.03.0909/30EconomicIndicators,April200908.04.0909/31Memberssince197920.04.0909/32UnemploymentbyConstituency,March200922.04.0909/33Apprenticeships,Skills,ChildrenandLearningBill:Committee23.04.09StageReportResearchPapersareavailableasPDFfiles:•tomembersofthegeneralpublicontheParliamentarywebsite,URL:•withinParliamenttousersoftheParliamentaryIntranet,URL:@parliament.ukISSN1368-8456RESEARCHPAPER09/34SummaryofmainpointsInSeptemberandOctober2008,theUSsufferedaseverefinancialdislocationthatsawanumberoflargefinancialinstitutionscollapse.Althoughthisshockwasofparticularnote,itisbestunderstoodastheculminationofacreditcrunchthathadbeguninthesummerof2006andcontinuedinto2007.TheUShousingmarketisseenbymanyastherootcauseofthefinancialcrisis.Sincethelate1990s,housepricesgrewrapidlyinresponsetoanumberofcontributingfactorsincludingpersistentlylowinterestrates,over-generouslendingandspeculation.Theburstingofthehousingbubble,inadditiontosimultaneouscrashesinotherassetbubbles,triggeredthecreditcrisis.However,itwasthecomplexweboffinancialinnovationsthathadpurportedlybeenemployedtoreduceriskwhichensuredthatthecrisisspreadacrossthefinancialmarketsandintotherealeconomy.Inparticular,allmannerofprofit-seekingfinancialinstitutionsusedacomplexfinancialprocesscharacterisedbyhighlyleveragedborrowing,inadequateriskanalysisandlimitedregulationtobetononeoutcome–abetwhichprovedtobemisguidedwhenassetpricescollapsed.PriortoSeptember2008,theresponsefromgoverninginstitutionsintheUSprimarilysoughttoaddressliquidityconcerns,stimulatedemandandpreventmortgageforeclosures.Themainpolicyresponsesincluded:•theFederalReserve(Fed)loweringinterestratesaswellasaintroducingnumberofliquidity-enhancingschemestoabatetheemergingcreditcrisis;•theorderlytakeoveroffailedinvestmentbankBearStearns;and•legislationseekingtostimulatedemandandmitigatemortgageforeclosure.AftertheshocksofSeptemberandOctober2008,wherecreditandriskinterestratespreadsshotupandthesystemicnatureofthecrisisbecameapparent,anewapproachwasadopted.InadditiontotheFed,theUSTreasurybecameakeybodyinadministeringtheEmergencyEconomicStabilizationActpassedbyCongressinOctober2008.Thecentralfeaturesofthepost-Septemberresponseincluded:•theFedandUSTreasurydecisionnottobailoutinvestmentbankLehmanBrothers;•Treasury-administeredcapitalinjectionsintotroubledfinancialinstitutionsinexchangeforpreferredstockandcommonequitystakes;•asequenceofbailoutsbytheFedandTreasuryfortheinsurancegiantAIG;•continuingeffortsfromtheFedtolowerinterestratesandincreaseliquidity;•theunprecedentedpurchaseofmortgage-backedsecuritiesandTreasurybillsaspartoftheFed’spolicyof“crediteasing”;•thetemporarysuspensionoftheshort-sellingoffinancialinstitutionsbytheSecuritiesandExchangeCommission;•theHomeownerAffordabilityandStabilityPlan,whichpermittedstrugglinghomeownerstorefinancetheirmortgages;and•thepassageofthe$787bnAmericanRecoveryandReinvestment