Define Monetary Policy and its purpose. What factors led to the mortgage default

Question

Define Monetary Policy and its purpose. What factors led to the mortgage default crisis and ultimately the Housing Crisis? How did mortgage defaults affect banks involved in mortgage lending and mortgage investing? Evaluate TARP and illustrate the problem of moral hazard? What did the Federal Reserve do during the financial crisis of 2008 up until now -- 2016? How did the recent financial crisis affect the financial services industry? Explain how the policy attempted to "stabilize" the economy.

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Explanation / Answer

Monetary policy is the process through which monetary authority of a country, generally a central bank controls the supply of money in the economy by its control over interest rates in order to maintain price stability and achieve high economic growth.

The main cause was the rise in subprime lending. The percentage of lower-quality subprime mortgages during a given year rose from 8% or lower range to approximately 20% from 2004 to 2006, with much higher ratios in some parts of the U.S. A high percentage of these subprime mortgages, over 80% in 2006, were adjustable-rate mortgages. These two changes lowered lending standards and higher-risk mortgage products. Also, U.S. households had become increasingly indebted, with the ratio of debt to disposable personal income rising from 77% in 1990 to 127% at the end of 2007, much of this increase mortgage-related. When U.S. home prices declined after peaking in mid-2006, it became more difficult for borrowers to refinance their loans. As adjustable-rate mortgages began to reset at higher interest rates (causing higher monthly payments), mortgage delinquencies increased. Securities supported with mortgages, including subprime mortgages, widely held by financial firms globally, lost most of their value. Global investors also quickly reduced purchases of mortgage-backed debt and other securities as part of a decline in the capacity and willingness of the private financial system to support lending. Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the world and slowing economic growth in the U.S. and Europe.

When increasing numbers of U.S. consumers could not pay their mortgage loans, U.S. banks lost money on the loans, and also the banks in other countries. Banks stopped lending to each other, and it became difficult for consumers and businesses to get credit. In the long term, the financial crisis influenced banking by creating new regulatory actions internationally through Basel III and in the United States through the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost.The Troubled Asset Relief Program (TARP), passed by Congress in 2008, in USA, was an example of moral hazard because it bailed out companies that had made bad investments.

The Federal Bank has taken extraordinary action to boost economic growth. The Fed continues to do its level best to achieve its congressionally mandated goals of maximum employment and stable prices.  It introduced a number of emergency credit facilities to provide increased liquidity directly to financial firms and markets.These were designed to fill perceived gaps between open market operations and the discount window, and most of them were designed to provide short-term loans supported by collateral that exceeded the value of the loan which helped to curb the crisis.

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