Fed Responds to Risky Business

Conn Carroll / March 17, 2008

Despite the Fed’s bold and timely moves, the U.S. economy overall has at best entered a period of slow growth, and may be teetering on the edge of recession if one is not already at hand. Two major sectors of the economy – housing and financial markets – are in severe recession, and it is unclear that the other elements of the economy, especially business investment and the health care and net trade sectors will be sufficient to stave off an actual overall contraction.

While the underlying fundamentals of the economy strongly suggest that it will recover and return to robust growth, the length and depth of this period of weakness is unclear, and will depend significantly on the actions of the Federal Reserve in the days and weeks ahead.

To date, the Fed is to be commended innovative actions to keep financial markets operating in very difficult circumstances. A good example is the Fed’s husbanding over the weekend of the sale of the investment firm Bear Stearns to J.P. Morgan. In this event the Fed properly used it powers to fold an investment bank whose weakness posed a potential risk to the financial system. In a further move that was not as widely commented upon, the Fed also established a new Primary Dealer Credit Facility that will allow it to directly offer liquidity assistance to certain investment banks that were not previously eligible for it. This move signals the Fed’s determination to strengthen certain investment banks and avoid a potential panic about the overall condition of the financial system. (more…)