TAILIEUCHUNG - The Credit Crunch of 2007-2008: A Discussion of the Background, Market Reactions, and Policy Responses

For the process of a credit-financed investment expansion described above, the financial sector is of crucial importance. The Keynesian-Schumpeterian investment-saving nexus can only work if the financial sector is able and willing to extend credit to companies which wish to expand production and investment. In order for the process to work, different levels of the financial sector thus have to interact smoothly and fulfil certain tasks. First, there are different types of financial institutions (private, state-owned) which interact with borrowers and savers (the lower tier of the financial system). They have to extend the loan and later provide households options. | The Credit Crunch of 2007-2008 A Discussion of the Background Market Reactions and Policy Responses Paul Mizen This paper discusses the events surrounding the 2007-08 credit crunch. It highlights the period of exceptional macrostability the global savings glut and financial innovation in mortgage-backed securities as the precursors to the crisis. The credit crunch itself occurred when house prices fell and subprime mortgage defaults increased. These events caused investors to reappraise the risks of high-yielding securities bank failures and sharp increases in the spreads on funds in interbank markets. The paper evaluates the actions of the authorities that provided liquidity to the markets and failing banks and indicates areas where improvements could be made. Similarly it examines the regulation and supervision during this time and argues the need for changes to avoid future crises. JEL E44 G21 G24 G28 Federal Reserve Bank of St. Louis Review September October 2008 90 5 pp. 531-67. The concept of a credit crunch has a long history reaching as far back as the Great Depression of the Ben Bernanke and Cara Lown s 1991 classic article on the credit crunch in the Brookings Papers documents the decline in the supply of credit for the 1990-91 recession controlling for the stage of the business cycle but also considers five previous recessions going back to the 1960s. The combined effect of the shortage of financial capital and declining quality of borrowers financial health caused banks to cut the loan supply in the 1990s. Clair and Tucker 1993 document 1 The term is now officially part of the language as one of several new words added to the Concise Oxford English Dictionary in June 2008 also included for the first time is the term sub-prime. that the phrase credit crunch has been used in the past to explain curtailment of the credit supply in response to both i a decline in the value of bank capital and ii conditions imposed by regulators bank supervisors or .

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