The Federal Reserve’s Response to the Credit Crisis

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We have been reading a lot lately about what the U.S. Congress, at the request of the Treasury Secretary, has done to try and help end the Credit Crisis because of its huge price tag—$750 billion. But what has the Federal Reserve (The Fed) been doing to help end/prevent the Credit Crisis?

[VIDEO] The Federal Reserve’s Response to the Credit Crisis

Actually, the Fed has been working overtime creating new lending facilities and injecting money into the financial system to try and stem the effects of the Credit Crisis. Take a look at the following actions the Fed has taken—without needing any approval from Congress:

– Term Auction Facility (TAF)

– Term Securities Lending Facility (TSLF)

– Primary Dealer Credit Facility (PDCF)

– Commercial Paper Funding Facility (CPFF)

– Swap Lines

Term Auction Facility (TAF)

The Term Auction Facility (TAF) was the first new facility—December 12, 2007—the Fed created to try and inject more money into the system. By this point, banks had stopped lending to each other because they were afraid of other banks defaulting on their loans. Banks were also unwilling to go to the Fed’s Discount Window to borrow funds because borrowing money from the Discount Window is often seen as a sign of weakness and financial instability—the last thing a bank wants to acknowledge in the middle of a credit crisis. To combat these problems, the Fed allows banks to anonymously borrow money from the TAF.

Term Securities Lending Facility (TSLF)

The Term Securities Lending Facility (TSLF) was the second new facility created by the Fed. Whereas the TAF allows banks to borrow money from the Fed, primary dealers—those dealers with whom the Fed deals directly in its open market operations—had nowhere to go to gain access to the capital they needed to remain solvent. To combat this problem, the Fed established the TSLF to allow primary dealers to give their troubled assets to the Federal Reserve Bank of New York in exchange for more liquid Treasury Securities.

Primary Dealer Credit Facility (PDCF)

The Primary Dealer Credit Facility (PDCF) was the third new facility created by the Fed. When the Fed saw that the TSLF was not giving primary dealers access to enough capital, it decided to allow primary dealers to borrow directly from the Fed—like a bank would borrow from the discount window. Previously, primary dealers were not allowed to borrow directly from the Fed.

Commercial Paper Funding Facility (CPFF)

The Commercial Paper Funding Facility (CPFF) was the fourth new facility created by the Fed—October 7, 2008. When the money markets froze, major corporations were cut off from a major source of funding. Major corporations use the money markets to issue short-term debt that allows them to cover payroll, accounts payable and other liabilities in the short term. Without access to these short-term funds, major corporations would not be able to operate. To prevent the U.S. economy from coming to a grinding halt due to lack of cash, the Fed established the CPFF to buy short-term commercial paper from major corporations.

Swap Lines

Swap lines are not new to the Federal Reserve, but the Fed has increased their use as of late. A swap line is an agreement between the Fed and another central bank that allows either party to exchange its base currency for an equivalent amount of the other central bank’s base currency. In the past, these swap lines have always had limits on them so one central bank or another would not abuse the relationship. However, the Fed has temporarily removed all limits on its swap lines with major central banks in Europe—the Bank of England (BOE), the European Central Bank (ECB), the Swiss National Bank (SNB) and others—and in other parts of the world. This means these central banks have access to as many U.S. dollars as they need, which will allow them to inject these U.S. dollars into their own economies to try and loosen the credit markets.