Federal Reserve Policy Essay Example | Topics and Well Written Essays - 2000 words

Federal Reserve Policy - Essay Example The weakness in the real estate markets has spread to become a system wide problem as sub-prime loans turn into toxic assets leaving financial institutions under-collateralized. The US Federal Reserve Board has been criticized for enacting policies that exacerbated the problem, or at least for failing to curtail the spread of the problem by its lack of action. The purpose of this paper is to examine the policies of the Federal Reserve Board during the period of 2006-2009 in light of the current financial crisis. The paper will find that the Federal Reserve Board policies during this period were prudent and appropriate, but failed to exert the political will necessary to address the problems that have arisen in the financial system that were due to factors that are beyond the Board's authority. By many accounts, the current financial crisis began in the housing industry and was fuelled by the twin problems on over-evaluation and high-risk mortgage loans. As the problem grew, financial institutions continued to make high interest, high-risk loans on property that had reached values that were unrealistically high. When the real estate bubble burst, many of these institutions and borrowers were left with assets worth far less than the amount due on the loan. According Bernanke (2008), "housing and housing finance played a central role in precipitating the current crisis. As the crisis has persisted, however, the relationships between housing and other parts of the economy have become more complex.Declining house prices, delinquencies and foreclosures, and strains in mortgage markets are now symptoms as well as causes of our general financial and economic difficulties". Yet, could the Federal Reserve Board (FRB) have taken steps beginning several years ago to address theses ca uses of system wide failure Bernanke (2008) is very clear that the problem was "declining house prices, delinquencies and foreclosures, and strains in mortgage markets". In fact, the FRB was aware of these problems, but failed to enact policies to address these complex issues. Bernanke lists the first cause of the current crisis as the falling prices of housing as the real estate bubble burst. In a free market, asset prices will work to reach equilibrium. A bubble in any industry will eventually deflate in an effort to reach its true valuation. This was seen in the collapse of technology stocks in 1999-2000, and now has hit the real estate market. However, the FRB may have not been able to deal with this problem effectively. In retrospect, Stern (2008) states, "it is challenging at best to identify when asset prices have reached excessive levels, to build support for action once identification has occurred and to implement corrective policy successfully". There is a general philosophy in the FRB that the best strategy for asset inflation is a policy of containment and clean-up, rather than prevention (Stern 2008). In fact, the FRB's policy was "monetary policy easing and last-resort lending", which only deepened and prolonged the crisis (Blanchard 2009, p. 2). Asset revaluation is a political challenge, but is within the FRB's capacity. None of these actions took place, and the FRB continued dropping interest rates. While the falling interest rates were enacted to stimulate a lagging economy, other factors continued to prop up housing prices at unrealistic levels. When mortgage money is cheap, it creates more customers interested in borrowing and the demand for housing remains high. During the