paper about MBS

When the housing market crashed in the u.s this

Info iconThis preview shows pages 76–78. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: When the housing market crashed in the U.S., this credit risk materialized and generated the large losses that wiped out the inadequate capital that they had maintained. The force that led to the downfall of the GSEs is not uncommon to economic theory, which would call it a classic “race to the bottom” in bank risk-taking or underwriting standards. The important point is that the GSEs contributed to – and were influenced by – the risk-taking of private financial firms that were competing with them in the same mortgage markets. In effect, a set of privileged institutions – Fannie and Freddie, backed by government guarantees and enjoying a lower cost of funding – entered a financial market (less-than-prime mortgages) hitherto operated by less-privileged institutions (mortgage banks, commercial banks, and investment banks, among others); the less-privileged tried to guard against the entry by lending more aggressively, which prompted the more privileged to respond with aggression too. The sub-prime mortgage mess was in part due to government guarantees for Fannie and Freddie that distorted a level-playing field, resulting in the debacle of mortgage finance. 75 Chapter 6: In Bed with the Fed “ Policy, whether it be printing money, guarantees or deficit spending, can prop up asset values for a while. This may even be useful in a liquidity crisis. But a solvency crisis is another thing. The longer policy distorts markets by ignoring fundamentals, the longer those reliant on market signals will sit on their hands. The Fed’s recent decision to continue asset purchases shows there is no exit once this path is chosen. As we approach the second anniversary of the Fannie and Freddie bailouts, are we better off? ”- James Rickards (writer, economist, lawyer and investment adviser), Financial Times , August 12, 2010 The financial crisis that started in the second half of 2007 highlighted the extraordinary power of the Federal Reserve (Fed) to intervene in the economy in a crisis. The title of the book by David Wessel, In Fed We Trust: Ben Bernanke’s War on the Great Panic , sums it all up. Wherever there was a fire, the Fed used all its might to extinguish it. It also gave ammunition to those around the fire to defend themselves. In essence, the Fed played with flourish its role as the lender of last resort (LOLR) – lending to the financial sector (and even markets at large) when no one else would, so as to ensure the financial sector’s stability. The Fed pumped liquidity into the system with creativity and expedience seen never before from any other central bank. Macroeconomists who had long focused on the Fed’s role of determining interest rates to ensure price stability and full employment found the Fed’s methods “unconventional”. But to economic historians, what the Fed attempted to do in this crisis was not that unconventional....
View Full Document

{[ snackBarMessage ]}

Page76 / 151

When the housing market crashed in the U.S this credit risk...

This preview shows document pages 76 - 78. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online