Kenneth R. Szulczyk
internationally to other banks abroad. Consequently, a banking crisis in one country can spread
and trigger a banking crisis in another. Thus, one central bank cannot contain a financial crisis.
Leaders of central banks and government finance ministries push for coordination and
restrictions on deposit insurance. For instance, deposit insurance in the United States insures up
to $250,000 for each person. Other countries do not have generous deposit insurance. Currently,
U.S. banks pay modest premiums only on domestic deposits. If the Federal Deposit Insurance
Corporation (FDIC) requires U.S. banks to pay deposit insurance on all accounts, including
foreign accounts, then their premiums would increase. Furthermore, governments have two
problems coordinating international deposit insurance. First, many regulatory agencies in other
countries lack the FDIC’s monitoring power. Second, only three countries in Europe,
Netherlands, Spain, and United Kingdom, have laws requiring the government to step in and
fund the deposit insurance if the insurance premiums cannot cover all accounts during a bank
failure.
The United States and many countries were deregulating, when the 2008 Financial Crisis
struck the world economy. The United States, Ireland, Spain, and many countries experienced a
strong real estate bubble that deflated in 2007. As the unemployment rate soared, businesses lay
off many people, and the unemployed could not find jobs. Subsequently, some people stopped
paying their mortgages, harming the banks financially. Banks stopped granting new mortgages,
and brand new housing construction has halted. Afterwards, the housing prices began falling as
the banks foreclose on houses that are losing value.
The U.S. government responded quickly, using the identical response many other countries
had used.
The U.S. government purchased preferred stock in the largest banks in the United States,
infusing the banks with funds. The first time the U.S. government started ownership in a
business directly. The Federal Reserve bought many of the toxic mortgage loans from the banks, removing
the bad debt from their books. A toxic loan is a bank granted a mortgage to a family or
person with no credit history or poor credit. Toxic loans became the first loans to sour as
the world’s economy entered the 2007 Great Recession. Toxic loans were called subprime
loans before the financial crisis because banks earned enormous profits. The Federal Reserve is rapidly expanding the money supply to offset the declines in the
U.S. economy. The Federal Reserve also granted trillions of dollars in emergency loans to
the U.S. banks. The Federal Reserve became the lender of the last resort for the developed world. Central
banks from Britain, European Union, and Japan can borrow U.S. dollars from the Federal
Reserve through the U.S. dollar liquidity swap. A U.S. dollar liquidity swap is a central
bank can borrow U.S. currency from the Federal Reserve by giving its own currency as
collateral. Then on the maturity date, the central bank repays its loan in U.S. dollars, and
the Fed returns the currency. This is similar to a forward-forward transaction.