Us Credit Crisis and Feds Response 1229898176101407 2

US Credit Crisis and Feds
Response
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

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.
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 the
sometimes 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

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 repayment
capacities. The economy was flush with
liquidity & stock markets were booming

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
Sequence of events
During 2007, nearly 1.3 million U.S.
housing properties were subject to
foreclosure activity, up 79% from
2006. Major banks and other
financial institutions around the
world have reported losses of
approximately US$435 billion as of
17 July 2008. During the week of
September 14, 2008 the crisis
accelerated, developing into a
global financial crisis.resulting in
the bankrupcy of some of the
worlds biggest financial institutes..
Impact of Sub Prime Crisis in USA
Initial impact was felt in March 2008, when
investment bank, Bear Stearns was
acquired by J.P. Morgan Chase, a
commercial bank, for US$1.2 billion

September 2008, witnessed major
shakeouts in the US financial sector. The
drama began with Lehman Brothers
declaring bankruptcy on 15 September
2008, facing a refusal by the federal
government to bail it out

Washington Mutual is closed by the US
government in the largest failure of a US
bank. Its banking assets are sold to J.P.
Morgan Chase for US$1.9 billion
US Federal Reserve provided an emergency
loan of US$85 billion to insurance major,
American International Group (AIG), which
will be repaid by selling off assets of AIG

Investment bank, Merrill Lynch was acquired
by Bank of America in September 2008 for
$50 billion

US Federal Reserve granted approval to
investment banks, Goldman Sachs and
Morgan Stanley to convert themselves into
commercial banks

US Treasury Department confirmed that both
Fannie Mae and Freddie Mac, would be
placed into conservatorship with the
government taking over their management
Wachovia Corp agrees to sell most of its
assets to Citigroup Inc in a deal brokered by
regulators. However, Wells Fargo, a
commercial bank, drafted an agreement to
acquire assets of Wachovia for US$15.1 blln

The deal forced Wachovia to backtrack from
the Citigroup deal worth US$2.2 billion which
was backed by the US Government

US Government releases a US$700 billion
bailout package for its financial industry

Dow Jones posts its largest point decline ever
while the S&P 500 had its worst day since
1987 with an 8.8% drop
Citigroup
11.7 billion
wrote-off, in Q2
2008
55.1 billion write
down in total
asset
Top 10 Bankruptcies
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

What Steps Has the
Federal Reserve
Credit Crisis?

TAF was the first new facility - December 12, 2007
Fed allows banks to annonymously borrow money
from the TAF.
What Steps Has the
Federal Reserve
Credit Crisis?
Swap Lines

What Steps Has the
Federal Reserve
Credit Crisis?
The Term Securities Lending Facility (TSLF) was
the second new facility created by the Fed.
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.

What Steps Has the
Federal Reserve
Credit Crisis?
Swap Lines

What Steps Has the
Federal Reserve
Credit Crisis?
PDCF allowed primary dealers to borrow directly
from the Fed - like a bank would borrow from the
discount window.
What Steps Has the
Federal Reserve
Credit Crisis?
Swap Lines

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 a
grinding halt due to lack of cash, the Fed
established the CPFF to buy short-term
commercial paper from major corporations.
What Steps Has the
Federal Reserve
Credit Crisis?
Swap Lines

What Steps Has the
Federal Reserve
Credit Crisis?
Swap Lines
Fed has temporarily removed all limits on its swap
lines with major central banks in Europethe
Bank of England (BOE), the European Central
Bank (ECB), the Swiss National Bank (SNB) and
othersand in other parts of the world.
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 90
days.
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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