Federal Government Has Played Vigorous Role in Tackling Foreclosures

May 5th, 2009 | Tags: Foreclosures

This has prevented another crisis. The success has been however only short-term. In the beginning the Federal Reserve took on expansive measures like lowering interest rates of short term loans and granting of loans to commercial banks. It was hoped that this would stimulate the banks to increase lending to business and homeowners. But this conservative policy did not work and banks continued to remain shy of lending. They were afraid of the credit worthiness of borrowers. Also they had to reduce their lending to maintain the ratio of loan to capital. The banks had already lost huge capital.

With the failure of conservative policies the Feds now adopted new policies that had not been adopted before. It widened the eligible collaterals for its loans. Till lately only treasury bonds qualified for loans but now various types of risky securities became acceptable – including the dubious mortgage-based-securities.

Secondly the Federal Reserve reached out its lending to investment banks for the first time. When Bear Stearns, an investment bank, was on the brink of bankruptcy in March 2008, the Federal Reserve decided to lend a leaning shoulder to it and to JPMorgan Chase that had taken over Bear Stearns. The latter was up to its neck in debt to various financial institutions. Its going into bankruptcy would have resulted in the total collapse of the financial system of the country. Nobody would be lending money to anybody. It would have been disastrous for the general economy. It was a nightmare for the Federal chief – Ben Bernanke. This was why the Federal Reserve intervened swiftly and decisively. Justifying this unprecedented move it was stated – “the financial system of the U.S. was at risk.” This one sentence highlights the fragility of the entire financial system of USA.

Last September Lehman Brothers – the fourth largest investment bank at that time, gave out red signals. The Federal Reserve took another unconventional step – bailed out AIG – the largest insurance company in the world. The name of AIG had become associated with credit-default-swaps. The latter is an insurance tool protecting defaulting bonds including the infamous mortgage-based-securities as well as few other exotic loans. The Federal Reserve began to fear that it would not be able to honour all the insurance policies that it had sold. This failure would translate into bank losses for it had bought insurances. So once again the Federal Reserve came forth to save AIG to “save the financial system.”