Sep 19, 2008 @ 04:18 pm
NEW YORK - These are momentous times in the financial markets. That's why the Federal Reserve has been taking extraordinary steps to stabilize financial conditions--even to the point of stretching its own finances.
The central bank has been generously using taxpayer dollars to bail out ailing financial firms and keep liquidity flowing in the battered marketplace.
The latest handout came this week with the $85 billion loan promised to American International Group to prevent the corporate giant from collapsing under the weight of its insurance commitments on risky debt. Sure, the government is getting a hefty interest rate for its cash--one that tops 11.5 percent--but there is still no guarantee that such funds will be returned.
Long considered the lender of last resort, Ben Bernanke's Fed is up against one of the biggest financial crises in decades. That's why it has actively been trying to keep the financial system functioning through turmoil caused by massive losses on mortgage debt and other risky assets.
Not only has the Fed been using monetary policy to ease credit conditions and stimulate the economy--it has lowered overnight bank lending rates from 5.25 percent to 2 percent--it has also extended massive loans to financial companies, extended borrowing to banks and investment banks and changed some of its own rules to allow for more liquidity.
On Thursday, the Fed joined with other major central banks to inject as much as $180 billion into money markets in an attempt stave off the growing global financial crisis. In a separate action, it pumped another $55 billion into U.S. markets.
"We are in an emergency crisis. You suspend barriers. You lift rules," said David Kotok, chairman and chief investment officer at Cumberland Advisors. "That happens when you are staring in the face of contagion and a meltdown."
But this "sovereign wealth Fed," as some have jokingly referred to the central bank--after the foreign funds that have been scooping up U.S. assets--is feeling the financial impact of its role in this crisis.
As the year began, the Fed had close to $800 billion of Treasuries on its books. By last week, that dropped to $479 billion. Of that new amount, some $200 billion was pledged to the Fed's term securities lending facility, which auctions loans of Treasuries, according to Tony Crescenzi, chief bond market analyst at Miller Tabak & Co.
Subtract the $85 billion the Fed has said it would lend to AIG, and the Fed's Treasury holdings would dip below $200 billion. When levels get that low, "the Fed has to embark on a course to expand its balance sheet," Crescenzi said.
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