17 March 2008
U.S. Central Bank Takes Sweeping Action to Avert Financial Crisis
Federal Reserve supports a troubled firm’s takeover, lowers interest rates
Washington -- The U.S. Central bank, the Federal Reserve, has moved with unusual aggressiveness to inject liquidity and stability into world financial markets reeling from the effects of the U.S. mortgage crisis.
Over the weekend of March 15-16, the Federal Reserve facilitated a takeover of a faltering Wall Street investment firm, cut the interest rate on direct loans to banks and provided a new line of credit to security dealers.
Federal Reserve Chairman Ben Bernanke told reporters March 16 that the central bank was “working to promote liquid [and] well-functioning financial markets. These steps will provide financial institutions with greater assurance of access to funds.”
The Federal Reserve approved a $30 billion credit line to facilitate the takeover of Bear Stearns, an investment giant stricken by the mortgage crisis, by J.P. Morgan Chase, another mammoth U.S. investment house. According to news reports, the Federal Reserve's action effectively covered the Bear Stearns mortgage portfolio, which J.P. Morgan Chase had been unwilling to accept.
A few days earlier, the Federal Reserve extended emergency loans to Bear Stearns, the first such action toward an investment house since the 1960s, but this did not deter investors from a massive volume of selling of their Bear Stearns stocks. Investors feared that the company was hurtling toward bankruptcy.
In a related move during the weekend, the Federal Reserve cut the discount interest rate by a quarter of a percentage point to 3.25 percent. Reflecting the urgency of the situation, the Federal Reserve made this move two days ahead of the regularly scheduled meeting of its interest-rate-setting committee. The discount rate is the interest rate the Federal Reserve charges banks when the banks are temporarily short of funds. The central bank’s move is intended to insure that commercial banks have access to adequate funds.
In its third decisive action, the Federal Reserve, for the first time, authorized large investment companies that serve as “primary dealers” of Treasury securities to borrow directly from the central bank at the discount rate. Under the new program, investment houses can use as collateral a broad range of investment-grade securities, including mortgage-backed assets, the Federal Reserve officials said. By accepting mortgage-backed assets, which have plunged in value along with U.S. home sales and prices, the Federal Reserve is vouching for the credit-worthiness of those assets, according to private economists.
The new program has no limit on the amount of loans, according to Federal Reserve officials.
Earlier in March, the bank announced it would provide $200 billion in loans to major Wall Street investment banks and expand its short-term loan program for the big commercial banks.
The Federal Reserve's actions are aimed at preventing a downward, mutually reinforcing spiral of falling collateral values, tighter bank credit and slackening economic activity, according to private economists.
Although the U.S. government has neither the authority nor the tools to intervene directly in financial markets, Treasury Secretary Henry Paulson has been engaged in discussions with market participants and Federal Reserve officials about the best ways to deal with the crisis. He was involved in the Bear Stearns takeover negotiations and was consulted about the Federal Reserve moves.
Paulson, appearing on several TV news programs March 16, emphasized, “the [U.S.] government is prepared to do what it takes to maintain the stability of our financial system." He said the Bush administration is intent on maintaining market stability and the president is kept updated on developments.
Praising the actions by the Federal Reserve and Paulson, Bush said, “You've shown the country and the world that the United States is on top of the situation.”
The full text of the Federal Reserve’s statement is available on the U.S. central bank Web site. President Bush’s statement is available on the White House Web site.
