us credit crisis and feds response 1229898176101407 2

8/11/2019 Us Credit Crisis and Feds Response 1229898176101407 2

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US Credit Crisis and Feds

Response


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Table of Contents

Banking System in US - FED

What were the main reasons of crisis What was the impact on leading companies

How Fed responded


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Banking System in US

The Federal Reserve System (informally The Fed) is

the central banking system of the United States.

The primary motivation for creating the Federal

Reserve System was to address banking panics.Other purposes are to furnish an elastic currency, to

afford means of rediscounting commercial paper, to

establish a more effective supervision of banking in

the United States.


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FEDs Functions

Primary purpose is to address banking panics

To strike a balance between private interests of banks and the centralized

responsibility of government

To supervise and regulate banking institutions

To protect the credit rights of consumers

To manage the nation's money supply through monetary policy to achieve thesometimes conflicting goals of

maximum employment

stable prices

moderate long-term interest rates

To maintain the stability of the financial system and contain systemic risk in

financial markets

To provide financial services to depository institutions, the U.S. government, and

foreign official institutions, including playing a major role in operating the nations

payments system

To facilitate the exchange of payments among regions

To respond to local liquidity needs


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About the crisis

Post 2001, the US government had encouraged

US banks to lend money to people, to

encourage spending & investing mainly for the

purpose of buying houses

These banks granted loans to large number of

borrowers despite having lower income levels,

unsure employment status, unscrupulous credit

history, etc.

Huge number of borrowers availed of bank

credit without evaluating their repaymentcapacities. The economy was flush with

liquidity & stock markets were booming


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The bubble burst

A silent storm brewed in international financial

markets with origins in the US housing market,

which witnessed an unprecedented boom since

2001

The boom was led by rising housing prices, low

interest rates & aggravated by financial

innovation viz. MBS, CDO and CDS

Housing prices in USA began to drop in 2006.

Rising interest rates & falling housing prices led

to rise in sub prime mortgage delinquencies &resultant foreclosure

Result: The housing bubble burst in Aug 2006


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Sequence of events


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During 2007, nearly 1.3 million U.S.housing properties were subject toforeclosure activity, up 79% from

2006. Major banks and otherfinancial institutions around theworld have reported losses of

approximately US$435 billion as of17 July 2008. During the week ofSeptember 14, 2008 the crisis

accelerated, developing into aglobal financial crisis.resulting inthe bankrupcy of some of theworlds biggest financial institutes..


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Impact of Sub Prime Crisis in USA

Initial impact was felt in March 2008, wheninvestment bank, Bear Stearns was

acquired by J.P. Morgan Chase, acommercial bank, for US$1.2 billion

September 2008, witnessed majorshakeouts in the US financial sector. The

drama began with Lehman Brothersdeclaring bankruptcy on 15 September2008, facing a refusal by the federalgovernment to bail it out

Washington Mutual is closed by the USgovernment in the largest failure of a USbank. Its banking assets are sold to J.P.Morgan Chase for US$1.9 billion


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US Federal Reserve provided an emergencyloan of US$85 billion to insurance major,

American International Group(AIG), whichwill be repaid by selling off assets of AIG

Investment bank, Merrill Lynchwas acquiredby Bank of America in September 2008 for

$50 billion

US Federal Reserve granted approval toinvestment banks, Goldman Sachs andMorgan Stanley to convert themselves intocommercial banks

US Treasury Department confirmed that bothFannie Mae and Freddie Mac, would beplaced into conservatorship with thegovernment taking over their management


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Wachovia Corp agrees to sell most of itsassets to Citigroup Inc in a deal brokered by

regulators. However, Wells Fargo, acommercial bank, drafted an agreement toacquire assets of Wachovia for US$15.1 blln

The deal forced Wachovia to backtrack from

the Citigroup deal worth US$2.2 billion whichwas backed by the US Government

US Government releases a US$700 billionbailout package for its financial industry

Dow Jones posts its largest point decline everwhile the S&P 500 had its worst day since1987 with an 8.8% drop


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Citigroup

11.7 billion

wrote-off, in Q2

2008 55.1 billion write

down in total

asset


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Top 10 Bankruptcies


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What Steps Has the

Federal Reserve

Taken to Address the

Credit Crisis?

Term Auction Facility (TAF) Term Securities Lending Facility (TSLF)

Primary Dealer Credit Facility (PDCF)

Commercial Paper Funding Facility (CPFF)

Swap Lines


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What Steps Has the

Federal Reserve


Credit Crisis?




Swap Lines


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What Steps Has the

Federal Reserve


Credit Crisis?

Term Securities Lending Facility (TSLF)

The Term Securities Lending Facility (TSLF) wasthe second new facility created by the Fed.

Fed established the TSLF to allow primary dealersto give their troubled assets to the FederalReserve Bank of New York in exchange for moreliquid Treasury Securities.


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What Steps Has the

Federal Reserve


Credit Crisis?




Swap Lines

h h


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What Steps Has the

Federal Reserve


Credit Crisis?


PDCF allowed primary dealers to borrow directlyfrom the Fed - like a bank would borrow from the

discount window.

h h


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What Steps Has the

Federal Reserve


Credit Crisis?

Term Auction Facility (TAF)




Swap Lines

Wh S H h


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What Steps Has the

Federal Reserve


Credit Crisis?

The Commercial Paper Funding Facility (CPFF) -October 7, 2008

To prevent the U.S. economy from coming to agrinding halt due to lack of cash, the Fedestablished the CPFF to buy short-termcommercial paper from major corporations.


Wh S H h


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What Steps Has the

Federal Reserve


Credit Crisis?

Term Auction Facility (TAF)




Swap Lines

Wh t St H th


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What Steps Has the

Federal Reserve


Credit Crisis?

Swap Lines

Fed has temporarily removed all limits on its swaplines with major central banks in Europethe

Bank of England (BOE), the European CentralBank (ECB), the Swiss National Bank (SNB) andothersand in other parts of the world.


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Other Responses

Between September 18, 2007 and April 30,

2008, the target for the Federal funds rate was

lowered from 5.25% to 2% and the discount

rate was lowered from 5.75% to 2.25%,through six separate actions.

In addition, the term of loans was extended

twice and changed from overnight to up to 90days.


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Summary

To response the serious credit crisis, the U.S. Federal

Reserve (Fed) increased money supply, decreased interest

rate, ease the condition for raising funds. The responses

took by U.S. fed did ease the stress in financial market to

reduced the liquidity risk faced by banks. Unlike the

expectation, the U.S inflation was continuously stronger

and U.S. dollar was depreciated. The outlook of economic is

still pessimistic. Meanwhile, this strategy might increase the

risk of moral hazard due to the survival of those banks with

high credit risk investments.


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us credit crisis and feds response 1229898176101407 2

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