Microeconomic Aspects of the Financial Crisis Essay

Microeconomic Aspects of the Financial Crisis Essay

The financial crisis has necessitated the intervention of the federal government to help in shielding the country from the negative effects of the crisis. The decision making process by the government has seen the application of microeconomic aspects. The economics of information and game theory have played a significant role in the steps that the government has taken to deal with the crisis. This paper will discuss some of the examples in relation to these microeconomic aspects.

After assessment of the trend in the financial industry, the government is chipping in to avail financial assistance to some organizations. The U.S government has bailed out several businesses in a bid to maintain economic growth (Myer, 12). This is an application of economics of information in that the decisions are based on the fact that the collapse of these companies could lead to detrimental effects due to their strategic position in the country’s economy. An example is the AIG company which is largest insurance life insurance company in the U.S. Collapse of this company could lead to major losses both to the citizens and the country economy as a whole (Coll et al, 1). This is because of the number of policies and credit default swaps held by the bank. Other companies that have received federal bail out include Citibank, Fannie Mae and Freddie Mac among others (Myer, 12). In the same context, the game theory has been applied in the allocation of funds to ailing companies. For example, when Lehman’s Brothers a security company filed for financial help under the increased financial hardships, the government did not grant the request. Surprisingly, only two days after Lehman collapsed, AIG received aid from the government (Myer, 13). This is a question of making a choice based on the outcome that brings in the maximum benefits as suggested in the game theory (Andrean, 95). The government could not afford to lose AIG because the financial markets were likely to suffer a great deal the effect of Lehman Brother’s collapse was much lesser.

The government has come up with lending facilities so that the Federal Reserve can lend to banks and non-bank firms at lower interest rates (Coll et al, 1). An example is the Term Asset-Backed Securities Loan Facility (LATF). In this decision, economics of information apply since the government clearly understands that lower interest rates will attract more borrowings leading to increase in money supply in the economy. Consequently, the inflation can be reduced. This is perfect information and Smith (136) notes that with such kind of information, decisions can be made with ease.

The legacy loan and legacy securities programs have been established where the government is purchasing legal securities from financial organizations that qualify (Coll et al, 2). This is a way of providing debt capital and equity capital to these companies hence helps them in absorbing the effects of the financial crisis. The same idea of increasing money supply is applied although this time round open market operations is applied.

Another way in which the government has tried to deal with the crisis is through economic stimulus. The Economic Stimulus Act was signed in 2008. President Bush approved $168 billion which would act as a stimulus package. The amount was to be covered by tax payers. The American Recovery and Reinvestment Act is another economic stimulus act that was signed in 2009 by President Barrack Obama. $800 billion is to be obtained from spending cuts and tax cuts to help the economy recover. This is an application of game theory in using available options to gain from an action. By altering taxation and government spending, money can be spared to help in reducing the effect of the crisis.

Works Cited

Andrean, Phillip. Game theory and Applications. London: SAGE., 2000

Coll, Richard et al. The Evolving Government Response to the Credit Crisis. Retrieved on June 15, 2009 from http://www.dlapiper.com/the-evolving-us-government-response- to-the- credit-crisis/

Myer, P., U.S Government Attempts to deal with the Financial Crisis. The Guradian, April 18, 2009.

Smith, Paul. Introduction to Microeconomics. New York: Taylor and Francis., 2003

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