Understanding of What Happened in the US Economy over the Last Few Years

What makes this crisis different from the periodic cyclical downturns one witness during alternating periods of boom and bust is that this crisis has been caused by borrowing and lending practices that were highly questionable and on top of that excessive leveraging of the financial sector meant that the sector’s contribution. As Kevin Philips (2009) notes, “The principal wave of the credit card used for debt consolidation and consumption crested in 2005, but industry growth had been enormous. Over the period from 1990 to 2003, the number of card-holding Americans jumped by 75 percent—to 144 million from 82 million. However, the amount that they had charged quadrupled”.

Liquidity, debt, and leverage provided the essential structure of the Multi-bubble, and its principal architect, from 1987 to 2006, was Federal Reserve Board Chairman Alan Greenspan. He kept the liquidity flowing and declined to regulate the ultimate excesses, be they rogue derivatives, exotic mortgages, merger mania, margin-loan speculation, or a giddy succession of asset bubbles. Over his nearly two decades at the helm of U.S. monetary policy, total credit market debt in the United States quadrupled from under $11 trillion to a mind-numbing $44 trillion. The principal growth, moreover, came not in government debt but in private borrowing and credit—the unsung, but indispensable oxygen of grand-scale financial leverage and speculation.

The role of the Federal Reserve in managing the sub-prime crisis has revolved around a) Reduction in the base rates b) Open market operations c) Auction of Term auction facility d) Bail-out of Wall Street banks.

The Fed has been cutting the base rates at which it lends to other banks. These are the interest rates as policy instruments that determine the level of credit and the money supply in an economy. The Federal Funds rate (the rate at which the Fed loans money to other banks overnight) was cut from 5.25% to 2% over a period of six months starting from September 2007 through March 2008.