Financial Intermediation And The 2007-2009 Financial Crisis

Financial Intermediation and the 2007-2009 Financial Crisis Student’s Name Institutional Affiliation Financial Intermediation and the 2007-2009 Financial Crisis The United States of America faced one of the greatest financial crisis in its economy from the year 2007 to 2009. It was brought about by various changes in the sector, beginning from the refinancing of the house markets to the increase in money supply (Acharya, Philippon, Richardson, & Roubini, 2009). All this was as a result of the failure of financial intermediation within the banking industry. The Federal Reserve aggravated the situation by making bad decisions in an effort to solve the financial crisis. Financial intermediation refers to the balance between borrowing from savers and those who have more and lending to the borrowers. Alongside that, the banking industry sets a high rate when lending out and charges a low rate to depositors. The financial crisis led to inflation of prices of goods and services and ultimately to retrenchment in many companies because wages increased the company’s liability (Flannery, Kwan, & Nimalendran, 2013). Proper financial intermediation ensures a steady flow of funds and maintains balance in the economy. As such, understanding it opens the gateway to internalize the 2007-2009 financial crisis and its causes and effects. It also allows for the development of crisis management policies in both short term and long term. The financial predicament commenced in 2006, when the economy experienced a change in the housing markets. However, its effects deeply set in 2007. The Central Bank made a decision to refinance the subprime mortgages in an effort to increase their value. This would best happen if they were grouped into subsets, meaning similar mortgages were grouped together (Adrian & Shin, 2010). Unfortunately, this backfired and led to a rise in home prices. Houses became too expensive and the rent became magnified. Mortgage companies began to declare their bankruptcy, case in point, the Ownit Mortgage Solutions Company. Soon after, major hedge funds in the economy dropped. These included the asset-backed securities (ABS) and the collateralized debt obligations (CDOs). The investment and banking industry benefited wholesomely from ABS. A company X could trade its auto loans to ABS and in turn get more funds with which they gave out loans to their customers. Funds were transferred from the company’s balance sheet to that of the ABS. CDOs were initially for corporate debt, but gradually began to encompass mortgage-based securities (Ben-David, Franzoni, & Moussawi, 2012). The financial market made it difficult for these loan and fund transfers in these hedge funds. During that time, Bear Sterns managed the ABS and CDOs. Bear Sterns was an investment company located in New York. However, due to the recession, it sold out to JP Morgan Chase. Another significant event that took place during this 2007-2009 financial crisis was the Federal Reserve stepping in and taking control over financial intermediation. It took control of all the liquidity of banks and loaned it to those in possession of treasuries and credit securities. As a result, there was a gradual increment in cash holdings and later, a reduction in balance sheets in the bankin...