Fed Reserve Response

Being runner up to the “great depression” as the largest financial crisis the United States had ever faced, the “great recession” of 2008 was a huge test to see what congress and the Federal Reserve had learned from past crisis. By providing liquidity, supporting impaired financial markets, and backing systematically important financial institutions, the Federal Reserve responded with great efforts to sustain the financial strength of America.[1]

A financial crisis is described as a lack of information in the financial system or markets. In 2008, with the internet booming there was no lack of information. However, the information that was available was not all accurate or reliable. The financial analysis of institutions was more complex than ever, but it did not measure risk properly. Fannie Mae and Freddie Mac are private corporations that were established by the Congress and are referred to as government sponsored enterprises (GSE). They were the largest "packagers" of individual mortgages into mortgage-backed securities (MBS), which they guarantee against loss. Many types of financial institutions "packaged" exotic and subprime mortgages into securities. Fannie and Freddie were permitted to operate with inadequate capital to back their guarantees; this was recognized by the Fed prior to the crisis.[2] Rating agencies gave AAA ratings to many of these securities, due to companies like AIG insuring these securities. These financial system practices amplified the risks of low-quality lending. When the housing market spiraled downward, almost all institutions took a hit depending on how many MBS’ they held. Companies like AIG were expected to pay for the losses they insured. This is where the Fed had to step in; otherwise the entire financial system could have caved in for a long period of time.

“Lender-of-last-resort” and “Monetary Policy” are the two main tools that the Fed utilizes to steer or aid the economy. The first problem the Fed faced was...