Question

Now, write a paragraph explaining how the Fed responded to the financial crisis that began in 2008.

Be sure to include how the Fed protected banks and why this was so important.

Answer 1

When the financial crisis began in 2008 the Federal Reserve moved quickly to stabilize the banking system and restore the flow of credit by cutting its policy (federal funds) rate to near zero, providing massive emergency liquidity, and buying large quantities of longer-term Treasury and mortgage-backed securities (the start of "quantitative easing"). Using existing tools and emergency authority under Section 13(3), the Fed extended liquidity through the discount window, created a series of term-lending facilities (for example, the Term Auction Facility, Primary Dealer Credit Facility and the Commercial Paper Funding Facility) and dramatically broadened the range of acceptable collateral; it also opened temporary swap lines with other central banks to ease dollar funding strains abroad. These actions effectively protected banks and other key counterparties from runs and sudden funding dry-ups, which was crucial because banks are central to payments and credit intermediation—if they had collapsed wholesale, lending to households and businesses would have frozen, magnifying the recession, causing widespread insolvencies and threatening the entire financial system. By backstopping banks and markets the Fed bought time for balance-sheet repair (and for fiscal programs like TARP) and helped prevent a far deeper economic collapse.