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The World Economic Crisis and the Federal Reserve's Response to It: August 2007-December 2008
Abstract
The world economy is clearly in the midst of a crisis as deep and profoundas the Great Depression of the 1930s. The crisis began in 2006 in the UShousing and related mortgage markets, but it soon spread to the rest of theUS economy and then to the rest of the world. In August 2007, the turmoilmoved from the securitized US mortgage markets to the interbank dollarfundingmarket, causing the latter to freeze up. Worries about the extentand distribution of the mortgage-related losses had become so extensive thatmarket participants no longer had faith in one another’s credit-worthiness,and the market that provides US banks and other dollar-based financial institutionswith their liquidity became illiquid as a result. An already very troubledfinancial system was imploding because the large commercial banks, investmenthouses, and insurance companies that were at the heart of the USfinancial system could not borrow short-term from one another, and thiswas happening just when a loss of confidence was sending liquidity preferencessoaring. Then in September 2008, the entire US banking and financialsystem collapsed as a social financial system in a period of acute turmoil asviolent and decisive as that of the 1931 banking crisis. From this pointforward, what, at first, appeared as a US-based “subprime mortgage marketcrisis” revealed itself to be a world economic crisis of major proportions.
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