The Federal Reserve in crisis

Tatom, John (2008): The Federal Reserve in crisis. Published in: Research Buzz , Vol. 4, No. 3 (31 March 2008): pp. 1-9.

Abstract

Since August 2007 the Board of Governors of the Federal Reserve System (Fed) has approached near panic in their adoption of multiple and inconsistent traditional policy measures and, since December 2007, they have multiplied these efforts by adopting major new policy tools, some of which may go well beyond their congressional mandate. These actions have been motivated, in the first instance, by an emerging mortgage foreclosure crisis that began in late-2006 and that the Fed first recognized in May 2007, in the second instance by a credit crisis that emerged in August in Europe and quickly moved on shore. This article summarizes and explains the Fed actions from August 2007 through March 2008, distinguishing its normal policy actions from a multitude of new facilities that it has created for policy response to illiquidity (or perhaps insolvency) in various corners of private credit markets. What stands out is that the Fed has aimed to target credit to various specific areas of the private financial market and as stridently aimed to insulate overall Fed credit, bank reserves, the federal funds rate or monetary aggregates from these novel responses. This campaign has involved creating numerous new facilities for the private sector and financing them largely by liquidating government securities held by the Fed. In the process, the Fed has transformed itself largely into a lender to the private sector rather than the government. It has violated the fundamental premise of central banking in a crisis to lend liberally at a premium and largely by lending against safe government securities and letting the marketplace direct new credit to solvent but illiquid institutions. It remains to be seen whether such an approach can stimulate a rebound on private credit markets and economic activity.

• Item Type: MPRA Paper
• Language: English
• Keywords: Foreclosure Crisis; Federal Reserve Policy; Sterilization; Central Banking
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

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___________, Federal Reserve Statistical Release H.4.1, August 2, 2007 and March 28, 2008 issues.

Federal Reserve Bank of St. Louis, U.S. Financial Data, March 21 issue.

Greenlaw, David, Jan Hatzius, Anil Kashyap, Hyun Song Shin, “Leveraged Losses: Lessons from the Mortgage Market Meltdown.” US Monetary Policy Forum, New York, New York (February 2008).

Greenspan, Alan, “We will never have a perfect risk model,” Financial Times, March 17, 2008.

Williams, Andrew, “Industry Risk-Summary of Terms and Conditions Regarding JPMorgan Chase Facility,” Today’s Risk eNews, Risk Center.com. March 25, 2008. www.garp.com/resources/newsfeed.asp?Category=6&MyFile=2008-02-25-16244.html