1. Crisis and Responses: The Federal Reserve and the Financial Crisis 2007-2008 Stephen G. Cecchetti - Economic Adviser and Head of the Monetary and Economic Department, Bank of International Settlements, Basel, Switzerland

2. Federal Reserve Policy Option  Balance sheet management  Includes changes in assets and liabilities  Policymakers control its size, increasing/decreasing money supply – changes in size affect interest rate  Central banks control its composition. Changes in composition do not affect the interest rate but may affect relative prices

3.  Composition of liabilities and reserve requirements  Changes in reserve requirements are not a tool used by the Federal Reserve today

5.  Open-Market Operations  FOMC- federal open market committee sets a target rate for Federal Funds rate – the price of borrowing reserves outright  Discount rate – primary lending rate, collateralized

6. Important Differences Any bank can borrow while only 19 primary lenders can perform open market operations Federal Reserve allows a discount loan to be collateralized by a very broad range of assets, while only a narrow set of very high quality securities qualify for repurchase in regular open market operations

7. List of the Primary Government Securities Dealers Reporting to the Government Securities Dealers Statistics Unit of the Federal Reserve Bank of New York BNP Paribas Securities Corp. Barclays Capital Inc. Cantor Fitzgerald & Co. Citigroup Global Markets Inc. Credit Suisse Securities (USA) LLC Daiwa Capital Markets America Inc. Deutsche Bank Securities Inc. Goldman, Sachs & Co. HSBC Securities (USA) Inc. Jefferies & Company, Inc. J.P. Morgan Securities LLC Merrill Lynch, Pierce, Fenner & Smith Incorporated Mizuho Securities USA Inc. Morgan Stanley & Co. Incorporated Nomura Securities International, Inc. RBC Capital Markets, LLC RBS Securities Inc. UBS Securities LLC.

8. Crisis  Feb. 2007 – several large subprime mortage lenders started to report losses  Aug. 2007 – BNP Paribus temporarily halted redemptions from 3 out of 4 funds because it could not reliably value the assets backed by U.S. subprime mortage debt held in those funds  Financial Firms began to question value of assets

9.  Result – sudden hoarding of cash and cessation of interbank lending  Contraction of short term funds caused overnight rate in Europe to shoot up  Fed injected reserves in banking system with one-day purchase agreements  No one was buying commercial paper and the lending market dried up

10.  Credit risks  Difficulty valuing complex securities

12. NO RETURN TO NORMALCY  Fed tried to prevent liquidity constraints from causing asset sales that further depress prices and causes crisis to broaden and deepen by providing term financing.  Banks were still unwilling to borrow from Fed – due to stigma associated with borrowing from Fed?  Normal tools of the Fed weren't working

13. New Tools  Term Auction Financing – get banks reserves they needed without the stigma associated with borrowing from Federal Reserve. - helped at first.

14.  In 2008 there was a scarcity of U.S. securities due to a shift from securities to repurchase agreements  Term Securities Lending Facility – primary dealers bid for Treasury securities. Changes the composition of the Fed’s asset holding without affecting the size. Aimed at gap between term and overnight interbank lending rates

15.  March 2008 – bailout by New York Federal Reserve of Bear Stearns -> Fiscal policy  Such policies ran run the risk of compromising central bgank independence if they become a regular occurrence

16. Conclusions  The Federal Reserve did what it could to given the tools at hand and innovated to create new tools when previous tools didn’t work