For obvious reasons–and as demonstrated very clearly by the recent global financial crisis–the health of a nation’s economy is tied directly to the health of its banks, which is why governments impose a number of regulations on the banking industry. One crucial aspect of United States banking regulation is that banks are required by law to maintain a minimum level of reserves, either through an account with the Fed or within their own vaults. This level is determined through a unique calculus for each bank, involving the size of the bank, as well as its assets and liabilities.

However, during the course of a bank’s regular business, it is possible for that bank’s reserves to drop below the mandated level—an otherwise secure loan request, for example, might require the bank to lend an amount beyond that minimum. Rather than simply deny the loan request on these grounds, however, banks are permitted to engage in interbank borrowing— a system that allows a bank to loan or invest more capital and then borrow the funds from another bank with a surplus, in order to maintain the reserve. Like any loan, however, it must eventually be paid back to the lender with interest. The interest rate that banks use when lending or borrowing money with each other is known as the federal funds rate.

During an interbank borrowing transaction, the borrowing and lending banks will determine the interest rate through their own negotiation. The average rate of all such interbank transactions in the nation is considered the federal funds effective rate. However, the Federal Open Market Committee (FOMC)—a division of the Fed—works to regulate this by establishing the federal funds target rate, and then influencing the money supply as a means of making the effective rate follow the target rate.

The target rate may change frequently, as the FOMC meets eight times a year to discuss the state of the economy and determine the best course of action for keeping that economy robust. Raising or lowering the federal funds rate acts as a control mechanism for bank activity. By raising the rate, the FOMC discourages interbank borrowing, and therefore provides a check on investment and lending. Conversely, a lower federal funds rate encourages bank activity when that increase is called for by the conditions of the economy.

In the past 55 years, the federal funds rate has gone as high as 18% (in the early 1980s) and as low as 0.25%. This latter rate reflected a direct response to the recent financial crisis by attempting to jumpstart the flow of the economy. It should be noted, however, that although the Fed will often lower the rate in anticipation of an economic slowdown, this action is not often a means of avoiding a recession as much as it an attempt to soften the blow, and to better stimulate the economy for a quick recovery. As with many such instruments of economic regulation, the best use of the federal funds rate is hotly debated by economists, and it is utilized differently depending on the policies of the current government.

The American economy, like most world economies today, is run on a system of fiat money, or money that is assigned its value by government decree. Since this money has no intrinsic value of its own, its value and supply must be carefully managed and regulated, not just within the nation’s borders but also in accordance with the economies of all other nations. In light of this need for careful stewardship of the economy, the United States maintains a central bank, called the Federal Reserve (or, more commonly, the Fed).

The Fed as it exists today is actually the United States’ fourth attempt at founding a central bank. In the midst of the Revolutionary War, America’s Continental Congress ratified the Articles of Confederation, which, among other edicts, gave Congress the power to issue bills of credit. A private national bank, modeled after the Bank of England, was established shortly thereafter, but was denied the opportunity to become a central national bank due to unease about foreign influence and other political concerns. The official First Bank of the United States was created in 1791, and lasted 20 years before being denied a renewal of charter by President James Madison. The Second Bank of the United States opened in 1816, and it too only lasted 20 years before President Andrew Jackson shut it down. Political opposition to the very idea of a central bank had been a chief culprit of these failures, and it would be almost a century before the United States would try again.

In 1907, a profound financial panic occurred, a direct result of a failed attempt by stock traders to corner the market on shares of the United Copper Company. The failure created a series of bank runs on those institutions that had backed the bid. As is often the case with bank runs, the atmosphere of worry spread nationwide, causing other banks to suffer runs and even leading to the collapse of, at the time, the third-largest financial trust in New York City, the Knickerbocker Trust Company. With no central bank in existence to attempt stabilization of the economy with an infusion of currency, the only reason that the crisis did not fling the country into irreparable economic turmoil was the work of private business tycoons such as J.P. Morgan, who banded together and contributed much of their own capital to bolster the banks. It was this barely dodged catastrophe that led to a series of financial reforms over the next few years, culminating in 1913 when Congress and President Woodrow Wilson passed the Federal Reserve Act.

In structure, the Federal Reserve is unique among the world’s central banks. Although it is designed to function as an entity “independent” of the federal government, thereby limiting its exposure to political influence, the Fed also employs a mixture of private and public sections in its operation—most similar banks in the world operate under either entirely private or entirely public ownership. It is also the only such bank to not make its own currency (which is instead printed by the United States Treasury). The Fed is managed by a Board of Governors, all of whom are presidential appointees, and is also comprised of the Federal Open Market Committee (FOMC) and representatives from twelve other Federal Reserve Banks located throughout the country.

The Fed has been reformed a number of times since 1913, especially so after the recovery from the Great Depression. Currently, its chief mandate is to provide the means to deal with bank panics, but it also sets interest rates, operates as a lender of last resort in case the banking system is in need of capital, and generally regulates the entire money supply by balancing the factors of employment rates and inflation. The importance of these functions to the American economy cannot be overstated. Any competent financial player in any market knows that a key component of success or ruin is an ability to observe, analyze, and possibly predict the actions of The Fed…and any competent Board of Governors is aware that The Fed is being closely watched.

Many of the laws and regulations in place within the housing market are designed to protect buyers from fraudulent practices or other malicious enterprises. However, investors and lenders also need some form of protection against financial loss when a buyer fails to hold up his or her end of the transaction. For these creditors, there is mortgage insurance.

Like other forms of insurance, the mechanism behind mortgage insurance—also known as a mortgage guaranty—is that the insurer receives a premium, which will then be used to cover losses in case the borrower defaults on their mortgage. Generally, a lender will require that mortgage insurance be purchased if the mortgage loan is higher than 80% of the property’s sale price. The lender will decide the amount of loss coverage, which can range from 20–50%, or possibly even higher. The borrower may see the mortgage insurance premium reflected as a part of their mortgage payments, or in some cases the lender will choose to pay these premiums.

Some form of mortgage insurance has existed in the United States since 1880, although it remained an unregulated entity until 1904, when the state of New York passed laws authorizing private companies to issue insurance. At the time, however, insurers were only allowed to cover payments on mortgages owned by the original lender. In 1911, this law was amended to allow lending institutions to purchase and resell loans, and insurers were then encouraged to guarantee the property title as well, to make the mortgages more attractive to investors. For the next two decades these private companies thrived as real estate values climbed, and lenders were pleased to discover that few defaulted properties would sell at a loss. However, the real estate market collapse at the start of the Great Depression severely tested the myriad of bad business practices within the mortgage insurance industry, and as a result, the industry failed.

This failure led to government involvement in the mortgage market, specifically through the creation of the Mutual Mortgage Insurance fund, managed by the Federal Housing Administration (FHA). The FHA uses the fund to insure their own loans to prospective homebuyers, and was expanded after World War II to include war veterans through the Veterans Administration (VA) department. However, both the FHA and VA mortgage insurance programs have legislatively mandated limits to their scope—underwriting guidelines often exclude many prospective homebuyers, for example, and there is a ceiling value past which mortgages may not be insured.

Today, private mortgage insurers succeed or fail based on their ability to identify mortgage risk and decide if they wish to cover it. They may decline to cover a certain mortgage, or adopt strict underwriting conditions based on the property, the buyer’s credit history and job status, or a number of other factors. Within state regulations, they may raise premiums on riskier sales or use methods such as reinsurance or risk pooling to mitigate potential loss. Some mortgage insurers will adopt a strategy of trying to help borrowers in danger of default, through credit counseling and debt management, with the understanding that foreclosure on a property tends to be an unpleasant and costly process for all parties involved.

A home is a major investment for its buyer, which is why smart homeowners purchase adequate insurance to shield them against disaster. The mortgage, however, is an investment by the lender in the dependability of the borrower—and as such, it’s equally as important for them to purchase mortgage insurance to provide a safety net in case the borrower is unable to pay back the loan. Such systems are in place in order to maintain the stability of the housing market, and when they work well, all parties benefit.

Signed into law by President Jimmy Carter in 1977, the Community Reinvestment Act followed in the footsteps of previous legislation, including the Fair Housing Act (1968), the Equal Credit Opportunity Act (1974), and the Home Mortgage Disclosure Act (1975). Although each act mandated a different set of regulations for various aspects of the housing market–the first two working to prohibit discrimination in property transactions, the latter to require transparency from mortgage and lending institutions–the CRA specifically regulates banks.

Any bank that receives FDIC insurance protection is bound under the CRA to submit to an examination of their lending practices, in order to assess whether they are offering loans and credit with consistent standards in all communities, regardless of income, in which they are chartered. Prior to the CRA, banks were free to discriminate against low- or moderate-income home buyers, who were often minorities. The CRA does not force banks to approve high-risk loans, but it does require them to answer for the credit applications they reject. Each bank is reviewed in the context of its community, and assigned an assessment rating that is used to monitor the bank’s record.

The CRA has been revised by legislative action a number of times since its passage. In some cases, the revision allowed for greater oversight of banks by public action groups as well as government regulators. In others, the FNMA and FHLMC (Fannie Mae and Freddie Mac) were mandated to devote a percentage of their lending to affordable housing. Most recently, in 2008, Congress passed the Higher Education Opportunity Act, which adds to CRA compliance criteria an examination of how and to whom the bank provides low-cost education loans. A number of other proposed revisions have been considered in recent years, particularly in light of the provisions in the American Recovery and Reinvestment Act (also known as the stimulus bill).

President Lyndon Johnson’s “Great Society” programs were a campaign to continue the domestic policy work of his predecessor, John F. Kennedy, who had been ready to initiate a number of reforms before his assassination in 1963. Johnson’s goals were to eliminate economic and racial disparities in society, leading him to pass such legislation as the Civil Rights Act in 1964. In 1965, Johnson created the Cabinet office of the Department of Housing and Urban Development, or HUD, to answer the challenge of poverty and homelessness in American cities.

HUD’s stated mission is “to create strong, sustainable, inclusive communities and quality affordable homes for all…to strengthen the housing market to bolster the economy and protect consumers; meet the need for quality affordable rental homes; utilize housing as a platform for improving quality of life; build inclusive and sustainable communities free from discrimination.” HUD administers or has administered a number of programs in urban markets, including financial incentives for home buyers in economically depressed communities, grants for renovation, and the provision of service workers for the elderly in order to allow them to remain in their own homes rather than be moved to a facility. They provide counseling services for new homebuyers and also function with enforcement authority regarding the Fair Housing Act, hearing and prosecuting complaints regarding housing discrimination. As a Cabinet-level department, HUD also oversees a number of other departments and corporations, including the Federal Housing Administration (FHA), which insures mortgages, and the Government National Mortgage Association (Ginnie Mae), which guarantees certain loans and makes mortgages more affordable to lower-income home buyers.

HUD operates its own department of Policy Development and Research to gather and analyze the statistical data from its own programs. They are then able to revise existing programs, phase out those that are clearly ineffective, or consider options for new ones. All of the information is made available for public examination via HUD USER, a web-based resource. HUD USER also publishes four periodicals: ResearchWorks, Breakthroughs, Cityscape, and U.S. Housing Market Conditions. ResearchWorks is devoted to case studies regarding housing; Breakthroughs looks at new strategies and resources, Cityscape spotlights innovative ideas or policies that will improve urban housing programs, and U.S. Housing Market Conditions gives regional and historical synopses of specific housing markets throughout the nation.

Today, HUD has taken a central role in resolving the economic crisis, much of which was caused by housing and lending practices. The Obama administration has devoted several million dollars to HUD in order to implement foreclosure-prevention programs and offer grants for housing counseling and development. The state of the housing market has been significantly destabilized by the financial downturn, and the high rate of unemployment has created a glut of loan defaults. HUD currently works to reverse the trend of the housing market and provide avenues for all citizens to own their own homes, even in the midst of such economic turmoil.