The economic debacle of 2008 brought the modern economic system to the brink of total collapse. In fact, there was a brief period of weeks in September and October of 2008 when the most powerful people in the world were unsure what was going to happen. The incredible shock and general mayhen that swept through the market when Lehman Brothers and Fannie and Freddie faced collapse resulted in frenzied selling and fear on a catastrophic level.
In response to these dire circumstances, Central Bank leaders around the world joined in a historically unprecedented move of unity as they all slashed short-term interest rates to historically low levels in order to ease credit markets and stimulate interbank lending. Magically, it somehow worked.
Ailing financial firms were artificially propped up in the United States through an emergency act of Congress, and record low interest rates proved to keep the economy from utter collapse. In fact, just a few months later in March 2009, the global economy bottomed out and global equity markets began quite a substantial bull run, which has lasted for about two years. Of course, the market is still below pre-2008 levels, but the rebound has been remarkable.
The question now is what can the Federal Reserve and regulators do to prevent another economic collapse?
Too Big To Fail
Most experts agree that the repeal of the Glass Steagall Act in the 90’s was a major contributor to the debacle of 2008. This basically made it possible for banks to operate in both commercial and investment banking industries, which means that commercial banks could suddenly take huge risks with cash on deposit.
Regulations have now been passed, however, that give regulators the power to break up firms that are too big to fail. If regulators see that a particular firm is structured in such a way that a collapse of the firm could bring down the entire U.S. economy, then the regulators have power to see that the firm is broken up into separate companies.
Congress worked with regulators and the Federal Reserve to pass the largest financial regulatory overhaul in July 2010. In response to the 2008 Crisis, Congress sought to bring greater accountability to the entire financial industry. The 2300 page bill signed into law by President Obama outlines numerous significant changes including how large firms can be liquidated.
These regulatory moves to bring stricter financial accountability to banks and other financial firms has not had a dramatic impact on the U.S. dollar yet. By far, the largest influencer of U.S. dollar price movement over the last year has been the Federal Reserve’s decision to move forward with a second round of Quantitative Easing. When the Fed began hinting toward a second round of Treasury security purchases, the U.S. dollar came under strong selling pressure in the EUR USD currency pair, as investors shifted capital out of the low yielding dollar and into the higher yielding euro. From July to November 2010, the U.S. dollar underperformed significantly as the forex market worked to price in QE2.
The Federal Reserve and regulators continue to work together to help foster an economic environment that possesses certain safeguards in order to prevent another economic debacle akin to that of 2008.