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Monetary Policy:
Contemporary
Issues
ECO 473 - Dr. Dennis Foster
W.A. Franke College of Business
Financial Crises
• Asset price crash
 The end of a bubble.
 Subprime housing market.
 Prime loans with ARMs.
• Financial institution insolvency
 Due to rising loan defaults.
 Can be banks or others.
• Liquidity crisis
 Runs on otherwise solvent banks.
 Deterred by FDIC insurance.
• Rolled into the Recession of 2008/2009.
Anatomy of Financial Crisis
What does the
Fed Want?
• A healthy & strong economy
with low unemployment and
low inflation.
• Policy? Stimulate spending by
reducing interest rates.
• Why? They are Keynesians.
• Effect? Creates housing boom.
Federal Funds rate of interest, 1995 to 2004
30 year mortgage rate, 1995 to 2004
Median home prices, 1999 to 2006
Home sales, 1999 to 2006
Sept.
2005
The Bear Stearns Story
• $133.20 - 52 week high prior to collapse.
• 2007 - Lost billions in collapsing subprime
market; slowly recovering.
• March 2008 - Assets/equity = 35
 Lots of assets in MBS.
• Spring 2008 - Clients pulling out funds.
• 3/10/08 - Turned down for $2 b. loan
$400 b.
Assets
 Continued loss of confidence in Bear all week.
• 3/13/08 – Cash  from $10 b. to $2 b.
The Bear Stearns Story
• Tried to get LOC w/JPM for $25 b.
• 3/14/08 – Fed lends $13 b. for 3 days.
• JP Morgan deal - $2 per share!
• Fed creates Maiden Lane LLC
– Fed loans ML $30 b.
– JPM “sells” bad assets to ML.
• 3/24/08 - New stock deal - $10/share.
• Cost to the Fed?
• Was Bear TBTF? Yes!
– What about Lehman?
The Three Failures:
IndyMac WaMu Lehman
• IndyMac
$32 b.
Assets
– Spun off from Countrywide.
– Not a “mac”
– Overleveraged on “Alt A” loans.
• WaMu
$300 b.
Assets
$640 b.
Assets
– Shut down 100’s of offices 2007-08.
– Sub-prime victim.
– Final 10 days lost $17 b. in cash w/d
• Lehman Brothers
– Losses = $7 b. in Q2 & Q3
– Final day: $1 b. in cash
Stock prices collapse
Did the Fed see this coming?
Did the Fed see this coming?
What did the Fed do?
• Cut interest rates.
• Lend to everyone.
• Quantitative Easing.
Federal Funds rate of interest, 2004 to 2014
Fed Lending Programs: 2008-2010
Term Auction Credit
Primary Dealer Credit
Commercial Paper MMMF
Asset-backed Securities
The Quantitative Easing Programs
+644%
+162%
+44%
The Fed charts new territory.
$4 tr.
$2.7 tr.
Monetary
Base
$2.5 tr.
US T
XS R
$1.7 tr.
MBS
Housing Revisited
30 year mortgage rate, 2004 to 2014
Housing Revisited
Median home prices, 1999 to 2014
Housing Revisited
Home sales, 1999 to 2014
The Problem with Policy
• The FED will have two choices:
• Continue policy  hyperinflation
• Halt policy  recession
• Or . . . Wage/Price controls?
Monetary Policy:
Contemporary
Issues
ECO 473 - Dr. Dennis Foster
W.A. Franke College of Business