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Loanable Funds

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Loanable Funds
The mortgage crisis in 2007 caused the financial system in the United States to become down. The issue began when people started defaulting on their loans. When people started defaulting this caused lenders to toughen their credit criteria for people requesting loans. The mortgage companies had to make the criteria tougher because they were not receiving funds from households. Due to them not receiving funds, the interest rates for mortgages rose; this allowed the mortgage companies to still receive a profit. According to the Loanable Funds theory, mortgage companies such as Freddie Mac and Fannie Mae had to raise their interest rates because they had less supply to loan out. When this happened, individuals and businesses lowered their demand for loanable funds. This caused the financial system to remain still with surplus units not wanting to lower their interest rates because they were in fear of taking a loss. Mortgage rates have declined ranging from 30 and 15 year fixed rates. The 30-year fixed rate had fallen 8 basis points to 5.29% and the 15-year fixed rate fell 2 basis points to 4.86%. The lowering of the mortgage interest rates is due to the Federal Reserve and the U.S. government stepping in and buying mortgage backed securities. This is the main reason for the interest rates to be lowered and for the loanable funds market to be readily available to loan out money.
“The loanable funds market is a hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders” (Krugman & Wells, 2009, p. 678). If more money is available in the loanable funds market then the interest rates will be lower. When the Federal Reserve and the U.S. government purchased mortgage-backed securities, this increased the supply of loanable funds that the lenders are able to give out. When there is more money to give out, this then drives down the interest rates.

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Krugman, P.


References: Krugman, P. & Wells, R. (2009). Economics. (2nd ed.). New York, NY: Worth Publishers. Rineburg, G. (2009). Mortgage Rates Decreasing and the Loanable Funds Theory Retrieved from http://www.babeled.com/2009/03/31/mortgage-rates-decreasing-and-the-loanable-funds-theory/
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