FINANTiCS

The Federal Reserve Announcement

1. Beginning of the American Debt Crisis -

            American Banks gave loan on mortgage to various home owners, and later securitized those loans on their balance sheet (i.e. sold the loan standing on their balance sheet to some other agency) that agency procured loan by putting those loan assets as security and gave loan to more home owners and so on. One fine day the property prices started to come down and as the first people to take loan by mortgaging their assets defaulted in payment all the other started defaulting because of sudden decrease in the price of real estate which again was because of people not being able to pay their loans and banks were selling out their homes. Thus , a chain of defaults started. These defaults lead to closure of many banks, including the likes oh Lehman Brothers and Bear sterns which were more than 100 years old and among some of the largest banks in the world. this lead to a crash in the equity and debt markets all over the world, our SENSEX fell from a high of 21200 to almost 7000 in just a matter of months. people were losing jobs so they were saving money, which lead to a drop in consumption, thus companies were producing lesser and thus cutting even more jobs. We were caught not in a cycle but in a cyclone.

2.  Federal Reserves coming in to save the economy -

To save the economy from the crash in the credit markets, as mentioned above, US federal reserve started buying these defaulting loan assets from the balance sheets of banks. This allowed banks to feel comfortable again and they started lending to each other and people as well. To do this the Federal Reserve had to buy assets worth more than $1.5 Trillion, which was more than the GDP of India then in 2009-10. But even that could not get the US economy come out of the recession which let millions of people unemployed. Thus the Fed decided to infuse another $30 Billion in the economy every month by buying bonds from the corporates (as the Fed bought bonds at very low rate of interest rates, it was giving money to these companies which were in turn investing or spending this money, ultimately the money was finding its way into the pockets of the consumer). But even this was not enough, thus the Fed increased the bond buying program to $85 Billion per month. Since then the economy has improved quite a bit, and thus now it may consider to reduce the amount or stop it going sometime forward. But, by now the world markets have become habituated of this extra money coming in every month, and people are scared what will it lead to when the amount reduces or stops completely.

3. How does it impacted our lives

The liquidity (money) injected by the Federal Reserve in the system was not absorbed completely by the US economy only, people their when got this money they invested it all over the world, that lead to a rise in the equity markets in almost every country across the globe. In 2013 only we received an investment of almost Rs.75000 Crores in our Equity markets. But now if the Federal reserve decides to reduce the amount of liquidity injection, the investments coming to country like ours will be the first to get impacted. As soon as the FII (Foreign Institutional Investors) Inflows reduces, it will reduce the pace of growth of our GDP as well, thus our lives will get a direct punch. If you are studying or pursuing employments then all our prospects will get impacted, if we wanted to tale loan the rate of interest would be impacted.

4. Hence the importance of yesterday’s Federal reserve Announcement

If in yesterday’s announcement Federal reserve decided to finish its Bond Buying program, that may bring the foreign investments down, it will also increase the value of US$ because it will be lesser in supply, thus our imports could become more expensive, leading to a rise in  inflation, thus rise in interest rates, and thus our lives will feel the pain !

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