How Did We Get Here? The role of banks is to take the savings generated by people and generate more money by making loans and investments. Ideally, the banks will be making good investments and getting back more than what they put in. It is important to note that money does not need to be generated only within the country, but it can also be generated from foreign countries. In recent years, the US and other countries “have been the recipients of a great deal of foreign saving” which came from emerging market countries in Asia. In these emerging countries, these nations could not efficiently invest all of their revenue within their country, so they looked to go outside their nation’s borders to look for opportunities to invest. The US did the same, but sometimes the savings were not invested well and resulted in a loss. Banks reacted to these losses by competing aggressively for borrowers and credit became relatively cheap and easy to obtain. The housing boom in the US caused mortgage lending to rapidly expand which led to very nonchalant lending of money out to borrowers. This resulted in a lot of money being lent to the borrower without sufficient consideration of the borrower’s ability to pay back the money. People expected the price of their houses to rise, so they did not think too much about how they were going to pay back the banks. However, the price on their houses most likely decreased slowly over the years.
What Is the Fed Doing to Address the Situation? The reason the Fed exists is to “promote maximum sustainable employment and stable prices” and the Fed “is expected to contribute to financial stability by acting to contain financial disruptions and prevent their spread outside of the financial sector.” The Fed operates by controlling short-term interest rates that banks pay each other for overnight loans. Lower interest rates can be used to increase borrowing and spending to stimulate the economy when it is suffering. However, since this problem has been going on for a while, a mere change in interest rate is not enough to dig us out of this hole. The Fed has taken numerous steps to help the economy by encouraging the flow of credit to people. One of these steps include making short-term loans to banks. To be able to commit to long-term loans and investments, banks have to have enough funding to be able to do this. Short-term loans give banks ample funding and the Fed has guaranteed that it will give short-term credit to sound financial institutions. To complement these short-term loans, banks also have lowered the interest rate that they charge for short-term loans and extend the term of the loan for up to three months. This lending is restricted to healthy institutions, which will most likely guarantee a return and for further assurance, banks require borrowers to have a collateral "whose value exceeds the amount we are lending." Another strategy the Fed uses is targeting lending. The Fed often targets markets that are failing such as the commercial