Macroeconomics

The Financial System: Markets, Intermediaries, 

and the Crisis of 2008–2009

between the two sides of the market and helps

direct financial resources toward their best use.

Banks are the best-known type of financial inter-

mediary. They take deposits from savers and use

these deposits to make loans to those who have

investments to make. Other examples of financial

intermediaries include mutual funds, pension

funds, and insurance companies. Unlike in finan-

cial markets, when a financial intermediary is

involved, the saver is often unaware of the invest-

ments that his saving is financing.

In 2008 and 2009, the world financial system

experienced a historic crisis. Many banks and other

financial intermediaries had previously made loans

to homeowners, called mortgages, and had purchased

many mortgage-backed securities (financial instru-

ments whose value derives from a pool of mort-

gages). A large decline in housing prices throughout

the United States, however, caused many homeown-

ers to default on their mortgages, which in turn led

to large losses at these financial institutions. Many

banks and other financial intermediaries found

themselves nearly bankrupt, and the financial sys-

tem started having trouble performing its key func-

tions. To address the problem, the U.S. Congress in

October 2008 authorized the U.S. Treasury to

spend $700 billion, which was largely used to put

further resources into the banking system.

In Chapter 11 we will examine more fully the

financial crisis of 2008 and 2009. For our pur-

poses in this chapter, and as a building block

for further analysis, representing the entire

financial system by a single market for loanable

funds is a useful simplification.

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P A R T   I I

Classical Theory: The Economy in the Long Run