Financial Turmoil: Federal Reserve Policy Responses [December 4, 2008]   [open pdf - 424KB]

"The Federal Reserve (Fed) has been central in the response to the current financial turmoil that began in August 2007. It has sharply increased reserves to the banking system through open market operations and lowered the federal funds rate and discount rate on several occasions. As the turmoil has progressed without signs of subsiding, the Fed has introduced new policy tools to try to restore normality. Through new credit facilities, the Fed first expanded lending to the banking system and then extended lending to non-bank financial firms. Lending to non-banks is a major departure from past policy […]. As the crisis worsened, the Fed began providing credit directly to markets for commercial paper and asset-backed securities. As a result of these programs, the Fed's outstanding loans and private asset purchases have ranged from $0.5 trillion to $1 trillion in recent months. […] The primary policy issues raised by the Fed's actions are the issues of systemic risk and moral hazard. Moral hazard refers to the phenomenon where actors take on more risk because they are protected. The Fed's involvement in stabilizing Bear Stearns, AIG, and Citigroup stemmed from the fear of systemic risk (that the financial system as a whole would cease to function) if either were allowed to fail. In other words, the firms were seen as 'too big (or too interconnected) to fail.' The Fed's regulatory structure is intended to mitigate the moral hazard that stems from access to government protections. Yet Bear Stearns and AIG were not under the Fed's regulatory structure because they were not member banks."

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CRS Report for Congress, RL34427
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