What did the ECB due to the crisis?

After the bubble burst of the US house market and the financial situation got more and more worst, the European Central Bank (ECB) and the Federal Reserve (FED) were ones of the first banks in the world which reacted immediately by pumping money to the financial market in august 2007.

Until now the ECB injected more than 150 billion Euros to reach liquidity between banks and to keep from bankruptcies in the financial world. Another reaction of the FED was to cut down the interest rates dramatically, in hope to get more money for the banks, but the ECB didn’t follow this example. It raised interest rates from 3.75 % to 4% in June 2007 and ever since it didn’t changed it anymore. The ECB is really observant according to inflation and with this dealing it tries to avoid it. The president Jean Claude Trichet said he will not change the rates because our economic is still relativly stabil; the employment is robust, the unemployment low and the profitability are sustained. Both institutions injecting money to the market to keep business working, but they acting differenty according to cutting interest rates. Thus, the ECB is more focusing on the economic health by retaining the interest rates whereas the FED is reacting directly to the events to avoid a deep recession by repairing the accured damages.

To understand the reason why the ECB is going another direction as the FED you have to look at their mission and structure. The FED is founded 1913 to foster a sound banking system for the USA. The board of Governors which oversee the 12 Federal Reserve Banks in Washington D.C. is made of seven members who are nominated by the president and confirmed by the senates. Thus, the FED is much closed to the USA government and its board members are subordinate under a high pressure to satisfy the government to be voted again and to satisfy the US banks, who have not always the same interest as the government. Thereby the decisions are often emotional rather than rational in a finance point of view.

The ECB is unlike the FED very young it was founded 1998 and is located in Frankfurt. Together with the national banks of the European member states it constitutes the central banking system of the euro area. The ECB is an independent institution according to governments, financial organisations and decision making. The board members (6) are not elected by the national governances and their period is for 8 years. They can only be elected for one period, thus they don’t dare under a pressure from the government. Therefore their decisions can be taken more rational.

A lot of economists complain that the FED is acting emotional and the ECB rational in case of handling the financial crisis. The mission of the ECB is to provide the highest level of integrity, competence, efficiency and transparency. Objectives are high level of employment and sustainable and also non- inflationary growth. There main objective is the stability of prices and with obtaining the interest rates they try to keep the prices stable.

Every 14 days the board of the ECB is holding a conference, the solutions and all important dealings are published to the member states and public. By transferring information’s due to statistics and reports, the involved public trust the system and spend the money to the banks which makes them more liquid in times like today. It also created 16 million jobs till 1999 and the euro is getting stronger and stronger even before the financial crisis. All together the ECB is enjoying a very high confidence and credibility.

At the end the two banks have other backgrounds, so everyone by itself is acting how it best fits for them in this situation and nobody can say which strategy is turning out positively and which one not. So it still will be interesting how the different central banks are dealing with the current financial situation and how deep the crisis, which started as an US property bubble, will effect the whole world economy.

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What did the US government and the Federal Reserve decide to do?

Nowadays it is not anymore a question of will the USA get into a recession, the question is how long and deep it will damage the US economy. The employment is decreasing 76.000 jobs in February 2008 and 80.000 in March. Due to a higher unemployment, encumbered citizen and flagging banks the economic growth will be weaker than in the years before. To stop or to diminish the coming recession the Federal Reserve and the US government tried to recover the markets by entrancing money and regulations.

In order to recuperate and to liquid the banks the Fed pumped 41 billion dollars into the market first November 2007 and than January, 2008 constantly 30 billion dollars monthly till 11 March, 2008, where they again decided to increase the amount to 100 billion dollars. Most economists assume that the reason is not only to keep circulating money it also should staved off the collapse of the Bank Stearns, the first bank that run into trouble in the sub-prime crisis. The Federal Bank will push more money into the global market if necessary.

At the end of October the Fed lowered for the first time the interest rates from 5.25% to 4.5 %. Now the interest rates reached 2.25% in March 2008. Cutting the rates give hope that the lenders will loose their anxiety to get some money back in the banks.

Furthermore the government decided to raise the taxes to get 150 billion dollars more for the market in 2008.

Another move to reduce the cost of high-end mortgages and to fill the financing gap is increasing the size of the loans FHA can insure, till now it is only a proposal of the government.

Other programs that the government started are called FHASecure and Paulson Plan. The FHASecure is designed to refinance borrowers with ARMs that are converting them into government insured FHA mortgages. The Paulson Plan is designed to streamline loan modifications that mean the borrowers with sub-prime ARMs can apply to get frozen interest rates at the loan start rate for 5 years.

With all these movements the USA try to calm down the credit crisis and to avoid a really bad recession, because economists claim this recession could be the worst after the World War II and maybe it is not causeless because there is already an estimated damage due to the credit crunch of 1.5 trillion dollar only in the USA and the credit market still not reached the safety zone, so unemployment and inflation is still rising what is the worst for an economy as we learned in class.

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Through to the subprime there are already losses more than 150 $ billion, which is a gigantic amount and frights almost the whole economic world, because America is still the main economy with the world currency, the dollar, and the countries are connected more or less with it.

How could the immobile crisis affect the economy of America and Europa?

After the first collapse in Banks due to the subprime crises the banks couldn’t trust each other anymore, because nobody knew which bank was affected of the immobile crises and which one not. Therefore they didn’t lend money to each other anymore which disturb the interbank system and the liquidity of the banks decreased which had a bad consequence for the financial and economic world.

In the present global world the banks are connected with each other e.g. the IKB ( Deutsche Industrie Bank), Dresdener Zentral Bank, UBS Zürich, NIBC Dutch Bank were the first banks in Europe which had incredible losses ( $ 382 million the UBS)due to the American credit crunch, therefore the banks in Europe had the same problem. They couldn’t trust each other anymore and their liquidity decreased as well.

In fact of the inability to lend money the economic growth, which was a permanent in the last 6 years, would be decrease, because e.g. small or big companies can not borrow money for their business so easy anymore, so they are not very liquid, too, what decreasing their operating activities and in fact their Revenues. This affects the GDP, because the companies are the basics in the economy. In America most afflicted economic sectors are furniture, construction, domestic help and gardener companies, which are affiliated to housing.

To rescue the banks or even to make them more liquidity the Federal Reserve pumped $41 billions into the bank market in November 2007. The same did the Bank of England in December 2007. It gave 20 billion pounds within 3 month to the banks.

Due to pumping money into the market, results an increasing of inflation, which weaken the dollar (actually on the low of 1.52 Euro) and increase the price of food and oil like in the last several month. A low dollar and a strong Euro is bad for the American but it is also bad for the European, because America is an important partner for our trade business and with a low dollar they are not able to buy products as much as before, therefore our exports will decrease and this influence our economy, our job market. Additional the Euro is coupled to the Dollar like almost all currencies in the world e.g. Japan, China. In fact that the Dollar is the world currency countries have there savings for international activities and bad cessions in Dollar, because international activities such as trade are constituent in today’s global business world.

At present the people are afraid of a new big recession that is why they are save money in America, which is not good because people don’t spend much money anymore and this affect a decrease in revenues and this push the unemployment and support the recession that will become true if the government and the banks can not stop it.

In Europe the Governments say that there will be no recession for Europe to calm the people, but the equity market reflect the insecure which is dominant at the present.

All together it is amazing how this at the beginning little immobile crisis in America could develop to a dredit crunch which affected the whole financing world and hopefully not the whole economic world.

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„ We had a bubble in housing (and) I really didn’t get it until very late in 2005 and 2006” said Alan Greenspan the chairman of the Federal Reserve System (Fed).

Today the bubble in housing isn’t any longer a problem of the American house market; it’s a problem that concerns the American financial market and therefore the whole financial world. How could such a big bubble developed without being recognizing.

Everything began with the terrorist attack on 11^th September 2001. Infect of the attack the American economists were angry about a recession, because the people became scared and saved their money for bad times, which affect the “ Circular flow model” that means the money wouldn’t flow anymore through all economic organisms and this disturb the economic circle.

To prevent such a recession the Fed decreased the interest rates from 6, 5% (2001) to 1% (2003). Therefore it was easier to getting money even for the people with a low income. So the measure of the Fed was successful, because the people took the chance to get easier money from banks and credit institutions and spend their money instead of saving it and America could avoid a recession.

At this time there was a high demand of houses, because lots of people in the USA want to live in a house with a little garden near by a big city, but the supply wasn’t as high as the demand and therefore houses were very expensive. Infect of the low interest rate a lot of American people took the chance to realize their dreams and took out a credit for buying their own house. Local banks and independence financing people gave credits to “subprime” people, people who have such a low income that it isn’t sure that they can pay back their interests let alone the debt, but the small institutions thought it is a good market with a risk, but also with large profits. So a lot of subprime people got credits for their house mortgages and it developed a house boom, especially in areas California, Florida, New York, Michigan and suburbs of Chicago and the bubble grew.

In August 2005 the boom ended. The supply caught the demand and the Fed started to increases the interest rates to correct the market, because the inflation growths more and more. After all this years, with low rates the Dollar lost on its value and there were a lot of more economic reasons for increasing the interest rates (e.g. war). In America the interest rates are usually fixed for 2 years so when the interest increased a lot of people as especially the subprime couldn’t pay anymore and there were a lot of people who couldn’t pay back, we are talking about billions of Dollars. Therefore the subprime people had to give back their houses to the investment organisations that they couldn’t sell it because of the higher interest rates, the unemployment which increases all the time and the losses of the value in houses infect of the inflation.

So the bubble burst, because the local banks or financing people sell the credits (from subprimers called as well as “fault credits”) to bigger banks and they, to national banks. The big banks crushed the credits into small peaces and mixed the “fault credits” with normal credits together in packages and sell the packages again to others, so that you couldn’t identify “fault credits” and “true credits” anymore. When the bubble burst no bank really knows if they had “fault credits”, too or not and no bank couldn’t trust another, because nobody knew if the other bank is able to pay. So basically the subprime credits gets into the whole financial world and Wall Street investment banks and financial institutions around the world have also been affected in 2006.

So the subprime crisis is a process which took years for develop and nobody really recognised it even the chairman of the Fed, but therefore after 2005 till now everybody knows about it, infect of the big damages and the fear that it will be not only affect the banks.