Dealing with the Crisis
Human nature is such that every time there is a crisis, people react by brushing it aside and convincing themselves as also others that it would go away. 2008 US financial crisis was also dealt upon in the same manner, at least initially. Only when the financial institutions continued to tumble without any sign of recovery that it dawned on everyone that not only was the crisis here to stay but was also likely to aggravate further into a recession.
Having realized the consequences, the respective governments did not waste time in taking appropriate steps much of which was aimed at reviving economic growth and cushioning the financial loss. Stimulus was provided through provision of substantial financial packages and effective crisis management.
Response from the US Government
On behalf of the US Government, three main regulatory bodies namely Federal Reserve, Securities & Exchange Commission and Treasury combined their efforts and issued a number of short-term and long-term regulations in order to control the situation.
Between 2008 and 2009, the US Government released approximately $1 trillion in multiple packages to bail out firms that had incurred huge losses. Given that lack of money led to deflation which in turn resulted in lower wages and rise in unemployment, the government decided to pump money into the system through Federal Reserve in the hope of avoiding a full-blown panic.
The first step entailed injecting life into the crumbling financial system and the Federal Reserve achieved this by injecting money into the market in what many regarded as being the most dramatic as also large-scale response in the history of the world. This was followed by an attempt to avoid the liquidity trap by adopting a monetary policy that helped create currency. To this effect, the Federal Reserve provided the banks with funds amounting to $600 billion with the hope that they would encourage domestic loans and once again commence the mortgage cycle.
Overall, the objective of the Federal Reserve was to alleviate the climate of insecurity and stigma that was hovering in the air due to collapse of financial institutions. It set out to fulfill this goal by implementing short term reforms wherein financial institutions were not just able to access liquidity but also had some degree of flexibility as to how to use it.
By 2009, the economic climate had improved significantly owing to the short-term policies yielding results and it was time for President Barack Obama to implement more stringent and long-term measures.
Proposals, popularly referred to as 'Volcker Rules' courtesy of having been put forth by Paul Volcker, dwelt on consumer protection, financial cushioning for banks, subjecting the shadow banking system to regulations and establishing yardstick for executive pay. Following these proposals, the reform bill was passed in May, 2010, wherein most of the suggestions were translated into legislative law, the only exception being that of prohibition of proprietary trading.
Following are some of the bills that the US Congress introduced as a part of the reform process in 2009 -
Bill H.R.4173, Wall Street Reform and Consumer Protection Act of 2009 was cleared by the House on 11th December, 2009.
Bill S.3217, Restoring American Financial Stability Act of 2010, was introduced by the Senate on 15th December, 2010.
Dodd-Frank Wall Street Reform and Consumer Protection Act was officially enacted on 21st July, 2010.
Europe was witness to introduction of Basel III banking reforms which caused an increase in capital ratio, placed a limit on leverage, new set of eligibility requirements to qualify for liquidity and placing of limit on counter-party risk.
However, rather than quelling fears, implementation of Basel III has only served to fuel critics who argue that it does not address the core issue namely that of faulty analysis of risk. Another argument against it states that it is one of the regulations that has encouraged lending to countries with not so sound economies.
Reaction to the 2008 crisis in Asian countries was manifested in form of depreciation of the particular currency against the US Dollar. Plans to stimulate the economy were introduced and implemented in several countries and revolved around a monetary policy that was based on low rates.
China, Indonesia and India were some of the first Asian countries that felt the tremors of the crisis occurring in US and reacted immediately. While China cut down its interest rate, something that it had not done since 2002, Indonesia brought down its overnight repo-rate from 12.25% to 10.25% and India, through its Reserve Bank, injected $1.32 billion into the economy. Taiwan reacted by cutting down its Required Reserve Ratio and injecting foreign currency to the tune of $3 billion into the market via its central bank.
It was for the first time that G-20 assumed a status of significance wherein all 20 member countries pledged economic support and coordination to each other while shedding protectionist measures.