Financial Update (Second Quarter 2009)

Federal Reserve Actions Include Changes to Loan Program, Currency Swap Arrangements

photo of Fed Chairman Ben BernankeRecent Federal Reserve actions include the publication of information regarding an assessment of banks' capital positions, a change to an existing loan facility's interest rates, the creation of currency swap arrangements with other central banks, and the publication of the Reserve Banks' financial statements.

  • Federal banking supervisory agencies recently published a description of the agencies' processes and methodologies used to assess banks' capitalization. This white paper is intended to assist analysts and other interested parties in understanding the results of the Supervisory Capital Assessment Program, which is expected to be released in early May. All U.S. bank holding companies with year-end 2008 assets over $100 billion were required to participate in the assessment, which began February 25.

  • The Federal Reserve System has published the annual financial statements for the combined Federal Reserve Banks, the 12 individual Federal Reserve Banks, the limited liability companies (LLCs) that were created in 2008 to respond to strains in financial markets, and the Board of Governors for the years ended Dec. 31, 2008 and 2007.
    Summary of the Supervisory Capital Assessment Program off-site image
    Overview of Reserve Banks' financial statements off-site image
    Information about the TALF program off-site image
    Currency swap arrangement developments off-site image

  • The Federal Reserve Board recently announced two new interest rates applicable to loans extended under the Term Asset-Backed Securities Loan Facility (TALF). The rates apply to certain loans secured by asset-backed securities with weighted average lives to maturity of less than two years. The new rates will be based on one- and two-year London interbank offered (LIBOR) swap rates.

  • The Federal Reserve's policymaking arm, the Federal Open Market Committee, has authorized new temporary reciprocal currency arrangements, sometimes called foreign currency liquidity swap lines, with the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank. If drawn upon, these arrangements would support operations by the Federal Reserve to provide liquidity in sterling in amounts of up to 30 billion pounds, 80 billion euros, 10 trillion yen, and 40 billion Swiss francs. These foreign currency liquidity swap lines have been authorized through Oct. 30, 2009.

April 30, 2009

Fed Chairman Discusses Reasons for Recent Fed Actions

Tracing the events leading up to the economy's current condition, and the ways the Fed has responded to the economic challenges, Fed Chairman Ben Bernanke recently discussed the steps the Fed has taken and the role they play in fostering a recovery.

Text of speechoff-site image

In Atlanta on April 14, Bernanke spoke at Morehouse College and addressed four broad questions concerning the Fed's actions and their intended consequences:

How did the economy reach this point? In answering this question, Bernanke acknowledged the complex causes and its global scope, but he pointed to the crisis in the subprime mortgage market as a chief cause of the unraveling of the worldwide credit boom. "Mortgage delinquencies and defaults rose, and the downturn in house prices intensified, trends that continue today," he said. "Investors, stunned by losses on assets they had believed to be safe, began to pull back from a wide range of credit market and financial institutions—reeling from severe losses on mortgages and other loans—cut back their lending," he said. These events combined to trigger a "remarkably rapid and deep contraction."

How is the Fed addressing the situation? Bernanke responded to this question by citing the Fed's twin mandates: maximum sustainable employment and stable prices. "However, given the ongoing problems in credit markets, conventional monetary policy alone is not adequate to provide all the support that the economy needs," he said. He cited the programs that have been created to create that support including short-term loans to banks, auctions of funds to financial institutions, and targeted lending outside the banking system. "The Federal Reserve will continue to take the necessary steps to unclog the credit markets and strengthen the economy," he said.

Does the Fed's response risk inflation down the road? While Bernanke described the Fed's approach as aggressive, he said that some have raised the question of whether these actions could ignite future inflation. "We have a number of effective tools that will allow us to drain excess liquidity and begin to raise rates at the appropriate time," he said. "That said, unwinding or scaling down some of our special lending programs will almost certainly have to be part of our strategy for reducing policy stimulus once recovery is underway."

Why did the Fed and the U.S. Treasury prevent the bankruptcy of some major financial firms? Bernanke said he was addressing this question because it has bearing on the steps that have to be taken if the United States is to avoid a similar crisis in the future. "As a general rule, my strong preference is that any firm that cannot meet its obligations should bear the consequences of the marketplace," he said. He cited the example of the financial services firm AIG, which avoided failure through government involvement, adding that this action "sets a bad precedent" but that preventing the failure of AIG was the "best of the very bad options available." He added that marketplace oversight needs overhauling. "We must ensure that all types of financial institutions, especially large and interconnected ones like AIG, receive strong and effective government oversight," he said, adding that regulators need a new set of procedures for dealing with large financial organizations on the brink of failure. "The Federal Reserve strongly supports such reform efforts," Bernanke said.