Professional Documents
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financial misconduct is equally shared with the US Fed. Analysts accused the Fed of three
main errors:
1. To loosen the monetary reins too much for too long in the aftermath of the 2001
recession. Fearing Japan-style deflation in 2002 and 2003, the Fed cut the federal
funds rate to 1 per cent and left it there for a year
2. To tighten too timidly between 2004 and 2006
3. To lower the funds rate back to 2 per cent earlier 2008 in an effort to use
monetary policy to alleviate financial panic. The first two failures fuelled the
housing bubble. The third aggravated the commodity price surge.
In the end it was the securitization of the subprime loans, not the subprime loans
themselves that actually resulted in the financial crisis
During the Crisis The Fed and the Treasury were determined to prevent the kind of
banking catastrophe that precipitated the Great Depression. Americas government made
some of the most dramatic interventions in financial markets since the 1930s:
The Federal Reserve and the Treasury between them nationalized the countrys
two mortgage giants, Fannie Mae and Freddie Mac (early September 2008)
Ad-hoc Rescue of Bear Sterns (March 2008)
Took over AIG the worlds largest insurance company and in effect extended
government deposit insurance to $3.4 trillion in money-market funds (midSeptember 2008)
Temporarily banned short-selling in over 900 mostly financial stocks
Pledged to take up to $700 billion of toxic mortgage-related assets on to its
books.
.
The US was particularly linear and expedite in its approach in handling the crisis
following the above measures:
Immediate Measures:
In spring 2008, JP Morgan Chase acquired Bear Stearns with the assistance from
Federal Reserve.
Fed started supporting specific financial institution by introducing a number of
new lending programs that provided liquidity to support a range of financial
institutions and markets:
1. Credit facility for Primary dealers, the broker-dealers that serve as
counterparties for the Feds open market operations, as well as lending
programs designed to provide liquidity to money market mutual funds
and the commercial paper market.
2. In cooperation with the US Department of the Treasury introduced the
Term Asset-Backed Securities Loan Facility (TALF), which was designed to
ease credit conditions for households and businesses by extending credit
to US holders of high-quality asset-backed securities.
In response to weakening economic conditions, the FOMC lowered its target for
the federal funds rate from 4.5 % at the end of 2007 to 2 % at the beginning of
September 2008.
As the financial crisis and the economic contraction intensified, the FOMC
accelerated its interest rate cuts, taking the rate to its effective floor a target
range of 0 to 25 basis points by the end of the year.
In November 2008, the Federal Reserve also initiated the first in a series of largescale asset purchase (LSAP) programs, buying mortgage-backed securities and
longer-term Treasury securities. These purchases were intended to put
downward pressure on long-term interest rates and improve financial conditions
more broadly, thereby supporting economic activity.
US introduced the Troubled Asset Relief Program (TARP) an instrument of the
executive branchs crisis management strategy through the Emergency Economic
Stabilization Act (enacted on October 3, 2008).
After the November 2008 elections, the phase of crisis management and
resolution was essentially completed with the publication of the results of the
Supervisory Capital Assessment Program (commonly referred to as 'Stress
Tests') which imposed significant capital-raising requirements on ten out of
nineteen participating banks.
For the traditional Banks, Significant increases in the amount of capital required
overall, with large increases for the Systemically important institutions
Liquidity standards were introduced that would for the first time formally limit the
amount of banks maturity transformations (Bank for International Settlements
2013)
Regular stress testing that will help both banks and regulators understand risks and
will force banks to use earnings to build capital instead of paying dividends as
conditions deteriorate (Board of Governors 2011)
Dodd-Frank Act 2010
Dodd-Frank Act 2010
Created new Provisions for the treatment of large financial institutions
e.g. Financial Stability Oversight Council has the authority to designate
non-traditional credit intermediaries Systemically Important Financial
Institutions (SIFIs), which subjects them to the oversight of the Federal
Reserve
The act created the Orderly Liquidation Authority, which allows the
Federal Deposit Insurance Corporation to wind down certain institutions
when the firms failure is expected to pose a great risk to the financial
system
The act also requires large financial institutions to create living wills,
which are detailed plans laying out how the institution could be resolved
under US bankruptcy code without jeopardizing the rest of the financial
system or requiring government support
The act mandated that the federal regulatory authorities develop rules
that require all financial institutions to report compensation
arrangements and to prohibit all incentive rewards that encourage
inappropriate risks that could lead to a material financial loss".
Transformation of the Financial Stability forum into the Financial Stability Board
The emergence of the G-20
o The premier forum for international cooperation which happened with in the
first few weeks following the collapse of the Lehman Brothers and the
ensuing wholesale market panic
o Increase in the representation of the large emerging countries into the
'premier forum' of political leaders triggering parallel expansion or
rebalancing of most of the global financial authorities that play a role in
financial regulation
o The G-20 set deadlines that the authority of the heads of state and
governments effectively made binding regulations in the form of BASEL III.
Basel III
o BASEL III is the international banking standards regulation accord on
Bank Capital
Leverage
Liquidity Management
Risk Management
o The implementation of Basel III accord by the various endorsing nations will:
Tighten the definition of Capital along with raising the Capital
Requirements (a phased implementation to be completed in 2019)
Introduce a maximum Leverage Ratio (mandatory from 2018)
Ushers in Liquidity requirements for banks to withstand liquidity
stress over periods of one month (Liquidity Coverage Ratio, to be
introduced in 2015)
One Year Net Stable Funding Ratio (to be introduced in 2018).
Capital Requirements
Requires banks to hold 4.5% of Common Equity and 6% of Tier 1 Capital of 'Risk
Weighted Assets'
Additional Capital Buffers such as:
Mandatory Capital Conservation Buffer of 2.5%
Discretionary Couter-Cyclical Buffer another 2.5%
Leverage Ratio
Introduced a minimum leverage ratio
Calculated as a ratio of Tire 1 Capital to bank's average total consolidated assets
Mandated to maintain the Leverage ratio in excess of 3%
For the Systematically Important Financial Institutions mandated at 6%
For the Insured bank holding companies at 5%
Liquidity Requirements
Liquidity Coverage Ratio requiring banks to hold sufficiently quality Liuid assets
to cover its total net cash outflows over 30 days
Net Stable Funding Ratio the available amount of stable funding to exceed the
required amount of stable funding over a one-year period of extended stress
Acquired Company
Acquirer
Type of acquired
company
Investment Bank
Subprime Mortgage
Lender
Subprime Mortgage
lender
Investment Bank
Insurance Company
$ 2 billion
$ 4 billion
Investment Bank
Retail and
Investment Bank
Diversified Financial
Services
$2
$15 billion
Apr 1, 2008
Jul 1, 2008
Bear Stearns
Country Wide Financial
JPMorgan Chase
Bank of America
Sep 7, 2008
Federal Housing
Finance Agency
Bank of America
US Federal Govt.
MF Global
USEC
Nomura Holding
Well Fargo
Value
$ 44 billion
$ 182 billion
$43 billion
References:
1. Article by Jonas Prager, THE FINANCIAL CRISIS OF 2007/8: MISALIGNED INCENTIVES,
BANK MISMANAGEMENT, AND TROUBLING POLICY IMPLICATIONS, New York University
2. Article by John Weinberg, The Great Recession and its Aftermath, Federal Reserve
bank of Richmond
3. Article by Nicolas Veron, Financial Reform after the Crisis: An Early Assessment,
Bruegel Working paper, Peter G. Peterson Institute for International Economics
4. Article by Dr Shrawan Kumar Singh, U.S. SUB-PRIME CRISIS & ITS GLOBAL
CONSEQUENCES, Professor of Economics, IGNOU
5. http://en.wikipedia.org/
6. http://www.federalreservehistory.org/Events/DetailView/66