Tuesday, October 07, 2008

Amid Continuing Market Woes, Federal Reserve Offers Attempted Solutions

Fed to Start Buying Commercial Paper, Financial Times
Saying Outlook Has Worsened, Fed Hints at Cut, New York Times

Despite last week's passage by Congress of the $700 billion financial rescue package, stock markets across the world marked major declines early this week. The Dow Jones Industrial Average, NASDAQ, London's FTSE, Tokyo's Nikkei, and numerous other global markets plunged--many in excess of five percent--on Monday and Tuesday. In response to the continued trouble in the markets and the exacerbation of investors' worries, the Federal Reserve formally announced one intervention strategy and hinted at another.

First, in an unprecedented move the Federal Reserve announced on Tuesday that it was forming a new Commercial Paper Funding Facility. The formation of this new entity will dramatically expand the Federal Reserve's role as a lender to American banks and financial institutions, by allowing the purchase of certain types of short-term debt, or "commercial paper."

Even after the Federal Reserve's announcement of its new foray into the commercial paper market, American stock markets continued their significant declines on Tuesday. Perhaps in response to the lack of market reaction to the commercial paper announcement, Federal Reserve chairman Ben Bernanke strongly indicated that a cut in interest rates is a very likely outcome of the Fed's late October meeting.

The multi-billion dollar investment in commercial paper, the potential interest rate cut, and the Federal Reserve's other interventions in the global credit crisis are mirrored by recent actions of other governments and central banks, most recently those in Spain, the United Kingdom, and the Benelux countries, all of which recently implemented massive bailout packages or cash infusions in their respective financial markets.

Discussion Questions:
1) Why have investors not reacted as positively as expected to last week's bailout plan? To the formation of the Federal Reserve's Commercial Paper Purchase Facility?

2) Is a cut in interest rates an appropriate next step on the part of the Federal Reserve?

3) What is the ideal role of the Federal Reserve and central banks in the continuing Global Credit Crisis?

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