Question

In: Economics

What specific actions did the Federal Reserve take in response to the 2007-2009 financial crisis: i)...

What specific actions did the Federal Reserve take in response to the 2007-2009 financial crisis: i) Using the lender of last resort tool? ii) Using the monetary policy tool?

Solutions

Expert Solution

Fed's actions in response to financial crisis of 2007-09 are as below:

1. Lender of last resort: Under this function a central bank offers loans to banks or other financial institutions facing financial difficulty. This option is called as last resort means that those financial institutins were not getting adequate money to continue with their operations therefore central bank provide this liquidity in the form of loans.

In financial crisis fed provided liquidity to :

a. Non recourse loan facility provided to Bank of America if the losses exceeded $18Bn on ring fence assets.

b. Assistance to AIG was provided in varoius forms like revolving credit facility, securities borrowing facility, life insurance securitization.

c. Fed provided funds and guarantees to JP morgan and chase in order to purchase Bear Sterns. Bridge loan was also provided to JP Morgan's subsidiary through which that money was loaned to Bear Sterns.

d. Fed provided loans to broker-dealer affiliates of four primary dealers.

2. Monetary policy tool:

a. Fed conducted Open market operations to ensure financial institutions will have necessary liquidity. In this Fed had announced $600 billion program to purchase the Mortgage Backed Securities of the government sponsored enterprise to help lower mortgage rate.

b. Discount rate was lowered to close to zero, therefore Fed was charging close to zero interest rate on short term loans it was providing.

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