The Effects of the Federal Reserve’s participation during the Recession





The Effects of the Federal Reserve’s participation during the Recession

The introduction and or expansion of more facilities and avenues that allow the provision of liquidity to the funding markets was one of the key actions that the Federal Reserve took as a response to the financial crisis. The liquidity facilities that were set up generated large sums of money in form of interests and fees incomes. The Federal Reserve also ensured that they limited their credit exposure, which they incurred due to the credit facilities. When the financial crisis started in late 2007, the reserve took important measure to help alleviate the adverse effect the crisis had on the financial markets. This included the expansion and the introduction of liquidity facilities. The facilities played a huge role in the alleviation of the effects of the crisis and the promotion of financial stability during the period.

This participation by the Federal Reserve was driven by the weakening of the United States economy during the period near end of the year 2007 and the beginning of 2008. The industries were falling apart financially, lending and credit facilities created tighter conditions and values for assets continued to reduce. Later into the year 2008, the economic times worsened as the end of the housing boom was marked and which triggered the problems in the mortgage market. Credit markets were affected not only in the United States but also globally. This affected asset values, confidence in consumers and businesses worldwide and the conditions for acquisition of credit.

Many companies that were on the verge of going down were acquired by competitors and some were given major liquidity boosts by the Federal Reserve. Short-term funding markets, particularly the commercial paper market became unstable causing investors to withdraw their investments in them. Risk taking by investors reduced drastically and securities and short-term lending markets plunged while others shut down. Unemployment levels were on the increase with companies reducing costs in labor and production. Businesses also developed cutbacks in spending both in terms of capital and in terms of revenue. The gross domestic product for the United States also dropped gradually since the beginning of the recession in 2007.

The liquidity facilities were properly designed using lending principles, they had proper collaterals and they were priced at a premium related to the cost of funds enabling them earn considerable interest. Here, income generation was not the main aim of the Federal Reserve, however, such income is used to cover the reserve’s expenses and excesses are turned over to the United States treasury. At the same time, the reserve takes many precautionary steps to make sure that the credit risk is kept at its lowest level. Some of the steps included provision of short-term loans, making adequate collateral a standard requirement and limiting the facilities to institutions that met the minimum requirements.

The facilities were not only offered to banks but also other institutions like dealers and other major players in the financial market. This reaction to the effects of the crisis was also extended to specific institutions. Such companies included the JPMorgan Chase Company and the American International Group (AIG). This extension of a helping hand via lending by the Federal Reserve meant that there was going to be a change in the structure of their balance sheet. Their balance sheet expanded largely in the assets and the liquidity facilities section.

The risk on the interest rates was quite low since the loans offered were quite short term and ranged from loans payable overnight to loans payable after three months. The risk was mitigated by the use of the three factors mentioned above. The steps taken by the Federal Reserve, foreign governments and other United States organizations run by the government have played a huge role in the restoration of a significant degree of financial stability in the financial sector. Corporate markets have been revived, and hope and trust is slowly returning to the minds of consumers. However, much work is yet to be done to improve the situation further.

Some institutions however, remain under considerable pressure and this causes the effects to be felt by individual businesses and persons. Financial institutions are also still under great pressure and lending is also not generously accessible to the small and medium enterprises and individuals. The Federal Reserve, the United States government and other institutions globally are working hand in hand to develop a gradual solution to the crisis since it cannot be solved in a day. The reserve predicts that the United States economy shall fall sharply and then enter into a path of steady and gradual recovery. The world economy is also expected to follow the same path and eventually start rising.

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