Release Date: October 24, 2008

For release at 11:00 a.m. EDT

The factors that gave rise to high-poverty neighborhoods, and the challenges these communities face, are the focus of a Systemwide Federal Reserve research effort that examines the diverse landscape of concentrated poverty in America.

The report, "The Enduring Challenge of Concentrated Poverty: Case Studies from Communities Across the U.S.," explores how pockets of extreme poverty manifest in communities.  Some of the themes highlighted are common across all of the low-income communities that were studied--lack of human capital development, high rates of unemployment, inadequate housing.  However, the varying social and economic contexts in which concentrated poverty occurs imply the need for tailored strategies to ensure a better future for these communities and their residents.

Motivating the project was the recognition that the problems faced by many of the poor communities devastated by Hurricane Katrina in 2005 were shared by residents of neighborhoods across the United States.  While concentrations of poor people living in poor neighborhoods have been observed in large Midwestern and Northeastern cities, concentrated poverty also exists in smaller cities, immigrant gateways, suburban municipalities and rural counties.  The need for a deeper understanding of the relationship between poverty, people, and place led the Federal Reserve to join with the Brookings Institution's Metropolitan Policy Program.  The resulting report contains case studies, undertaken by the Federal Reserve System's Community Affairs Offices, of 16 high-poverty communities across the United States.  The studies cover communities in places as diverse as Cleveland, Ohio; El Paso, Texas; and the Blackfeet Reservation in Montana.

The report sought to answer the following questions:

• What factors are associated with the development and persistence of concentrated poverty?
• What challenges does it pose for families and communities?
• What is the capacity of local organizations to turn things around? and
• What strategies are the public and private sectors employing to ameliorate concentrated poverty and its effects?

While the case study communities collectively were diverse, four factors emerged consistently from each.  First, it is evident that history matters.  Poverty and disadvantage have tended to concentrate there over time and decades of disinvestments are difficult to turn around.  Second, high-poverty communities are isolated.  Residents are often physically, socially, racially, and linguistically separated from the larger economy and community, and local organizations often lack the resources and capacity to respond to the wide range of community needs.  Third, many of these neighborhoods have experienced significant demographic changes, such as a rise in immigrant households, a rise in single-parent families, or both.  Finally, these communities of concentrated poverty exist within both weak and strong regional economies.

The report contains case studies of the following high-poverty communities:  Albany, Ga.; Atlantic City, N. J.; Austin, Tex.; Blackfeet Reservation, Mont.; Cleveland, Ohio; El Paso, Tex.; Fresno, Calif.; Greenville, N.C.; Holmes County, Miss.; Martin County, Ky.; McDowell County, W.Va.; McKinley County, N.M.; Miami, Fla.; Milwaukee, Wis.; Rochester, N.Y.; and Springfield, Mass.  The report's findings will contribute to the Federal Reserve's understanding of low-income communities and their needs in carrying out ongoing community development partnerships in these areas. The report also identifies issues for future research.

The report is available online at:  http://www.frbsf.org/cpreport/.  Single copies of the publication are free from:  Publications, Mail Stop 127, Federal Reserve Board, 20th and C Streets, N.W., Washington, DC  20551; 202-452-3245.

Governor Elizabeth A. Duke

Foreclosure prevention efforts and market stability

Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate

October 23, 2008

Chairman Dodd, Senator Shelby, and other members of the Committee, I appreciate this opportunity to discuss recent actions taken to stabilize financial markets and foreclosure prevention efforts.

Financial markets have been strained for more than a year, as house prices declined, economic activity slowed, and investors pulled back from risk-taking.  These strains intensified in recent weeks.  Lending to banks and other financial institutions beyond a few days virtually shut down.  Withdrawals from money market mutual funds and prospects that net asset values would fall further severely disrupted commercial paper and other short-term funding markets.  Longer-term credit also became much more costly as credit spreads for bonds jumped and interest rates rose.  The problems in credit markets and increasing concerns about the state of the economy caused equity prices to swing sharply and decline notably.

Policymakers here and in other countries have taken a series of extraordinary actions in recent weeks to restore market functioning and improve investor confidence, with the aim ultimately to increase the availability of credit and the value of savings.  The Federal Reserve has continued to address ongoing problems in interbank funding markets by expanding its existing lending facilities, and recently increased the quantity of term funds it auctions to banks and accommodated greater demand for funds from banks and primary dealers.  We also increased our currency swap lines with foreign central banks.  To alleviate pressures on money market mutual funds and commercial paper issuers, we implemented several important temporary facilities, including one to provide financing to banks to purchase high-quality asset-backed commercial paper from money funds, and another to provide a backstop to commercial paper markets by purchasing highly rated commercial paper directly from businesses at a term of three months.  On Tuesday of this week, we announced another program in which we will provide senior secured financing to conduits that purchase certain highly rated commercial paper and certificates of deposit from money market mutual funds.

The financial rescue package recently enacted by Congress, the Emergency Economic Stabilization Act (EESA), provides critically important new tools to address financial market problems.  EESA authorized the Troubled Asset Relief Program (TARP), which allows the Treasury to buy troubled assets, to provide guarantees, and to inject capital to strengthen the balance sheets of financial institutions.  As provided in the Act, the Federal Reserve Board and its staff are consulting with the Treasury regarding the TARP.  In addition, Chairman Bernanke serves as the Chairman of the oversight board for TARP that will, among other things, review the policies that are implemented and make recommendations, as appropriate, regarding the use of authorities under TARP.  EESA also temporarily raised the limit on the deposit insurance coverage provided by the Federal Deposit Insurance Corporation (FDIC) from $100,000 to $250,000 per account.

Last week, the first use of TARP funds was announced.  In particular, the Treasury announced a voluntary capital purchase program, and nine of the nation’s largest financial institutions have agreed to participate.  The program is open to financial institutions of all sizes.  Under the program, the Treasury would acquire capital of financial institutions on terms that are attractive to the institutions and with features that protect the taxpayer.  At the same time, the Federal Reserve Board, the FDIC, and the Secretary of the Treasury in consultation with the President, determined that there were significant risks to the stability of the financial system.  With this determination, the FDIC used its authority to expand for a specified period, insurance to non-interest-bearing transactions accounts, such as payroll accounts, and a guarantee for newly issued senior unsecured debt of FDIC-insured depository institutions, including their associated holding companies.

A second, complementary, use of TARP funds will be to purchase mortgage assets, including mortgage-backed securities and whole loans.  These purchases are designed to remove uncertainty from lenders’ balance sheets and to restore confidence in their viability.  Another objective is to improve the modification efforts of servicers on these loans to more effectively prevent avoidable foreclosures.

The Federal Reserve System is also working to develop solutions to rising foreclosures.  Preventing avoidable foreclosures is good for borrowers, communities, and the economy.

A number of efforts are underway.  The Federal Reserve has worked with other agencies to put in place the standards and procedures for the new Hope for Homeowners (H4H) program, and I serve on the Oversight Board.  These loans can help borrowers who might otherwise face foreclosure because the new loan payments are more affordable and the homeowners get some equity in their homes.  Lenders and servicers are analyzing their borrowers for good candidates for the H4H program, and the FHA and its authorized lenders are poised to process applications.  We appreciate the additional flexibility provided to the program by Congress in EESA, in particular allowing up-front payments to junior lien holders that agree to release their claims.

For some time, we have called upon lenders, investors, and servicers to aggressively pursue sustainable loss mitigation activities.  For example, last year the Federal Reserve and the other banking agencies issued supervisory guidance to encourage mortgage lenders and servicers to pursue prudent loan workouts.  We continue to support industry-led efforts, especially those of HOPE NOW, in pursuing flexible approaches to stem the rise in foreclosures and to deal with their effects.  Earlier this year, we embarked on a joint effort with NeighborWorks America on neighborhood stabilization to help communities develop strategies for addressing increases in foreclosures and vacant properties.

The Federal Reserve System is strategically utilizing its presence around the country through its regional Federal Reserve Banks and their branches to address foreclosures.  Our history of working closely at the local level with communities enables us to tailor activities to the specific needs of that area.  Our efforts have taken a variety of forms.  We have employed economic research and analysis to target scarce resources to the communities most in need of assistance.  We have provided community leaders with detailed analyses identifying neighborhoods at high risk of foreclosures.  This information is helping local groups to better focus their borrower outreach and counseling efforts. 

In addition, we have sponsored or supported a wide range of activities in local communities.  For example, the Federal Reserve System has sponsored a series of “Recovery, Renewal, Rebuilding” forums in cities around the country in which key experts discussed the challenges related to real-estate owned inventories and vacant properties in strong and weak housing markets, and explored effective neighborhood stabilization policies.  Four events were held in various parts of the country earlier this year, and the series concluded with a fifth meeting of experts this past Monday in Washington.  This series is just an example of many events.  All told, the Federal Reserve System has sponsored or co-sponsored more than 80 events related to foreclosures since last summer, reaching more than 6,000 attendees including lenders, counselors, community development specialists, and policymakers.

We also have supported events that bring together borrowers with counselors, lenders, and servicers.  In August, the Federal Reserve Bank of Boston partnered with the HOPE NOW Alliance, NeighborWorks America, the Kraft family, and the New England Patriots Charitable Foundation, among many others, and held an event at Gillette Stadium.  More than 2,100 borrowers seeking help attended.  Twenty servicers and twenty non-profit counseling agencies took part, with staff at the event and on dedicated phone lines.  Although we do not yet know the outcomes for these homeowners, we are monitoring the results and other Federal Reserve Banks are considering holding similar events.

In conclusion, the Federal Reserve has taken a range of actions to stabilize financial markets and to help borrowers and communities.  Taken together, these measures should help rebuild confidence in the financial system, increase the liquidity of financial markets, and improve the ability of financial institutions to raise capital from private sources.  Efforts to stem avoidable foreclosure and help borrowers through H4H and more aggressive modifications, as well as to develop effective strategies for dealing with foreclosed-upon properties, I believe, will also help homeowners and communities.  These steps are important to help stabilize our financial institutions and the housing market, and will facilitate a return to more-normal functioning and extension of credit.

Return to top

Release Date: October 21, 2008

For immediate release

The Federal Reserve Board on Tuesday released a Statement concerning its action of October 12, 2008, approving the proposal by Wells Fargo & Company, San Francisco, California, to acquire Wachovia Corporation, Charlotte, North Carolina.

Attached is the Board's Statement relating to this action.

Attachment (125 KB PDF)

Chairman Ben S. Bernanke

Economic outlook and financial markets

Before the Committee on the Budget, U.S. House of Representatives

October 20, 2008

Chairman Spratt, Representative Ryan, and other members of the Committee, I appreciate this opportunity to discuss recent developments in financial markets, the near-term economic outlook, and issues surrounding the possibility of a second package of fiscal measures.

Financial Developments
As you know, financial markets in the United States and some other industrialized countries have been under severe stress for more than a year. The proximate cause of the financial turmoil was the steep increase and subsequent decline of house prices nationwide, which, together with poor lending practices, have led to large losses on mortgages and mortgage-related instruments by a wide range of institutions.  More fundamentally, the turmoil is the aftermath of a credit boom characterized by underpricing of risk, excessive leverage, and an increasing reliance on complex and opaque financial instruments that have proved to be fragile under stress. A consequence of the unwinding of this boom and the resulting financial strains has been a broad-based tightening in credit conditions that has restrained economic growth.

The financial turmoil intensified in recent weeks, as investors' confidence in banks and other financial institutions eroded and risk aversion heightened.  Conditions in the interbank lending market have worsened, with term funding essentially unavailable.  Withdrawals from prime money market mutual funds, which are important suppliers of credit to the commercial paper market, severely disrupted that market; and short-term credit, when available, has become much more costly for virtually all firms.  Households and state and local governments have also experienced a notable reduction in credit availability.  Financial conditions deteriorated in other countries as well, putting severe pressure on both industrial and emerging-market economies.  As confidence in the financial markets has declined and concerns about the U.S. and global economies have increased, equity prices have been volatile, falling sharply on net.

In collaboration with governments and central banks in other countries, the Treasury and the Federal Reserve have taken a range of actions to ameliorate these financial problems.  To address ongoing pressures in interbank funding markets, the Federal Reserve significantly increased the quantity of term funds it auctions to banks and accommodated heightened demands for funding from banks and primary dealers.  We have also greatly expanded our currency swap lines with foreign central banks.  These swap lines allow the cooperating central banks to supply dollar liquidity in their own jurisdictions, helping to reduce strains in global money markets and, in turn, in our own markets.  To address illiquidity and impaired functioning in the market for commercial paper, the Treasury implemented a temporary guarantee program for balances held in money market mutual funds, helping to stem the outflows from these funds.  The Federal Reserve put in place a temporary lending facility that provides financing for banks to purchase high-quality asset-backed commercial paper from money market funds, thus providing some relief for money market funds that have needed to sell their holdings to meet redemptions.  Moreover, we soon will be implementing a new Commercial Paper Funding Facility that will provide a backstop to commercial paper markets by purchasing highly rated commercial paper from issuers at a term of three months.

The recently enacted Emergency Economic Stabilization Act provided critically important new tools to address the dysfunction in financial markets and thus reduce the accompanying risks to the economy.  The Troubled Asset Relief Program (TARP) authorized by the legislation will allow the Treasury to undertake two highly complementary activities.  First, the Treasury will use TARP funds to provide capital to financial institutions.  Indeed, last week, nine of the nation's largest financial institutions indicated their willingness to accept capital from the program, and many other institutions, large and small, are expected to follow suit in coming weeks.  Second, the Treasury will purchase or guarantee troubled mortgage-related and possibly other assets held by banks and other financial institutions.  Taken together, these measures should help rebuild confidence in the financial system, increase the liquidity of financial markets, and improve the ability of financial institutions to raise capital from private sources.

As another measure to improve confidence, the act also temporarily raised the limit on the deposit insurance coverage provided by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration from $100,000 to $250,000 per account, effective immediately.  Unfortunately, the loss of confidence in financial institutions became so severe in recent weeks that additional steps in this direction proved necessary.  The FDIC, the Federal Reserve Board, and the Secretary of the Treasury in consultation with the President determined that significant risks to the stability of the financial system were present.  With this determination, the FDIC was able to use its authority to provide, for a specified period, unlimited insurance coverage of funds held in non-interest-bearing transactions accounts, such as payroll accounts.  In addition, the FDIC announced that it would guarantee the senior unsecured debt of FDIC-insured depository institutions and their associated holding companies.  In taking the dramatic steps of providing capital to the banking system and expanding guarantees, the United States consulted with other countries, many of whom have announced similar actions.  Given the global nature of the financial system, international consultation and cooperation on actions to address the crisis are important for restoring confidence and stability.

These measures were announced less than a week ago, and, although there have been some encouraging signs, it is too early to assess their full effects.  However, I am confident that these initiatives, together with other actions by the Treasury, the Federal Reserve, and other regulators, will help restore trust in our financial system and allow the resumption of more-normal flows of credit to households and firms.  I would like to reiterate the critical importance of the recent legislation passed by the Congress; without that action, tools essential for stabilizing the financial system and thereby containing the damage to the broader economy would not have been available.  That said, the stabilization of the financial system, though an essential first step, will not quickly eliminate the challenges still faced by the broader economy.

Economic Outlook
Even before the recent intensification of the financial crisis, economic activity had shown considerable signs of weakening.  In the labor market, private employers shed 168,000 jobs in September, bringing the total job loss in the private sector since January to nearly 900,000.  Meanwhile, the unemployment rate, at 6.1 percent in September, has risen 1.2 percentage points since January.  Incoming data on consumer spending, housing, and business investment have all showed significant slowing over the past few months, and some key determinants of spending have worsened:  Equity and house prices have fallen, foreign economic growth has slowed, and credit conditions have tightened.  One brighter note is that the declines in the prices of oil and other commodities will have favorable implications for the purchasing power of households.  Nonetheless, the pace of economic activity is likely to be below that of its longer-run potential for several quarters.

As I noted, the slowing in spending and activity spans most major sectors.  Real personal consumption expenditures for goods and services declined over the summer and apparently fell further in September.  Although the weakness in household spending has been widespread, the drop-off in purchases of motor vehicles recently has been particularly sharp.  Increased difficulty in obtaining auto loans appears to have contributed to the decline in auto sales.  Consumer sentiment has been quite low, reflecting concerns about jobs, gasoline prices, the state of the housing market, and stock prices.

In the business sector, orders and shipments for nondefense capital goods have generally slowed, and forward-looking indicators suggest further declines in business investment in coming months.  Outlays for construction of nonresidential buildings, which had posted robust gains over the first half of the year, also appear to have decelerated in the third quarter.  Although the less favorable outlook for sales has undoubtedly played a role, the softening in business investment also appears to reflect reduced credit availability from banks and other lenders.

As has been the case for some time, the housing market remains depressed, with sales and construction of new homes continuing to decline.  Indeed, single-family housing starts fell 12 percent in September, and permit issuance also dropped sharply.  With demand for new homes remaining at a low level and the backlog of unsold homes still sizable, residential construction is likely to continue to contract into next year.

International trade provided considerable support for the U.S. economy over the first half of the year.  Domestic output was buoyed by strong foreign demand for a wide range of U.S. exports, including agricultural products, capital goods, and industrial supplies.  Although trade should continue to be a positive factor for the U.S. economy, its contribution to U.S. growth is likely to be less dramatic as global growth slows. 

The prices of the goods and services purchased by consumers rose rapidly earlier this year, as steep increases in the prices of oil and other commodities led to higher retail prices for fuel and food, and as firms were able to pass through a portion of their higher costs of production.  These effects are now reversing in the wake of the substantial declines in commodity prices since the summer.  Moreover, the prices of imports now appear to be decelerating, and consumer surveys and yields on inflation-indexed Treasury securities suggest that expected inflation has held steady or eased.  If not reversed, these developments, together with the likelihood that economic activity will fall short of potential for a time, should bring inflation down to levels consistent with price stability.

Over time, a number of factors are likely to promote the return of solid gains in economic activity and employment in the context of low and stable inflation.  Among those factors are the stimulus provided by monetary policy, the eventual stabilization in housing markets that will occur as the correction runs its course, improvements in our credit markets as the new programs take effect and market participants work through remaining problems, and the underlying strengths and recuperative powers of our economy.  The time needed for economic recovery, however, will depend greatly on the pace at which financial and credit markets return to more-normal functioning.  Because the time that will be needed for financial normalization and the effects of ongoing credit problems on the broader economy are difficult to judge, the uncertainty currently surrounding the economic outlook is unusually large.

Fiscal Policy
I understand that the Congress is evaluating the desirability of a second fiscal package.  Any fiscal action inevitably involves tradeoffs, not only among current needs and objectives but also--because commitments of resources today can burden future generations and constrain future policy options--between the present and the future.  Such tradeoffs inevitably involve value judgments that can properly be made only by our elected officials.  Moreover, with the outlook exceptionally uncertain, the optimal timing, scale, and composition of any fiscal package are unclear.  All that being said, with the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate.

Should the Congress choose to undertake fiscal action, certain design principles may be helpful.  To best achieve its goals, any fiscal package should be structured so that its peak effects on aggregate spending and economic activity are felt when they are most needed, namely, during the period in which economic activity would otherwise be expected to be weak.  Any fiscal package should be well-targeted, in the sense of attempting to maximize the beneficial effects on spending and activity per dollar of increased federal expenditure or lost revenue; at the same time, it should go without saying that the Congress must be vigilant in ensuring that any allocated funds are used effectively and responsibly.  Any program should be designed, to the extent possible, to limit longer-term effects on the federal government's structural budget deficit.

Finally, in the ideal case, a fiscal package would not only boost overall spending and economic activity but would also be aimed at redressing specific factors that have the potential to extend or deepen the economic slowdown.  As I discussed earlier, the extraordinary tightening in credit conditions has played a central role in the slowdown thus far and could be an important factor delaying the recovery.  If the Congress proceeds with a fiscal package, it should consider including measures to help improve access to credit by consumers, homebuyers, businesses, and other borrowers.  Such actions might be particularly effective at promoting economic growth and job creation.

Thank you.  I would be pleased to take your questions.

Return to top

Governor Randall S. Kroszner

At the Risk Management Association Annual Risk Management Conference, Baltimore, Maryland

October 20, 2008

Strategic Risk Management in an Interconnected World

It is not an overstatement to say that we are in the midst of a fundamental transformation in financial services, with market-wide ramifications. At the heart of that transformation lies a much more intense emphasis on funding and liquidity. Additionally, we are all witnessing the extent to which banking and financial markets are interconnected.

The current environment certainly presents some fundamental challenges for banking institutions of all types and sizes.¹ Their boards of directors and senior management, who bear the responsibility to set strategy and develop and maintain risk management practices, must not only address current difficulties, but must also establish a framework for the inevitable uncertainty that lies ahead. Notably, the ongoing fundamental transformation in financial services offers great potential opportunities for those institutions able to integrate strategy and risk management successfully, and I will argue that survival will hinge upon such an integration in what I will call a "strategic risk management framework."

In the remainder of my remarks, I plan to discuss the necessity for institutions to improve the linkage between overall corporate strategy and risk management, and how they can develop concrete strategic risk management frameworks. I will argue that in the highly interconnected financial world, funding and liquidity need to be at the center of such frameworks. But before doing so, I will briefly review recent events.

Recent Events in Financial Markets
We are indeed witnessing dramatic shifts in the structure of financial markets. These are quite extraordinary times that have required extraordinary responses from the Federal Reserve, the Treasury, and other governmental bodies in the United States and around the world. Since last summer, there had been a continuous deterioration of conditions in financial markets, becoming much more acute since March of this year. For instance, we have seen significant disruption in several key sectors of our financial system, such as normally creditworthy companies having difficulty issuing commercial paper, dramatic increases in interbank lending rates, and significant concerns about money market funds "breaking the buck." These are sectors usually considered to be relatively low risk and quite liquid, so disruptions here have signaled the extent and depth of this turmoil and the lack of confidence among financial market participants.

The Federal Reserve has responded to these developments in two broad ways. First, following classic tenets of central banking, the Federal Reserve has provided large amounts of liquidity to the financial system to cushion the effects of tight conditions in short-term funding markets. Second, to reduce the downside risks to growth emanating from the tightening of credit, the Fed, in a series of moves that began last September, has significantly lowered its target for the federal funds rate. Indeed, earlier this month, in an unprecedented joint action with five other major central banks and in response to the adverse implications of the deepening crisis for the economic outlook, the Federal Reserve again eased the stance of monetary policy. We will continue to use all the tools at our disposal to improve market functioning and liquidity, to reduce pressures in key credit and funding markets, and to complement the steps the Treasury and foreign governments will be taking to strengthen the financial system.

As a result of these ongoing upheavals, we are witnessing substantial institutional changes, in which some long-standing financial institutions have either failed, sought government assistance, or were forced to merge with other institutions. What were the major U.S. investment banks have essentially disappeared, such as by merging with bank holding companies or becoming bank holding companies themselves. Other major banks and thrifts have been absorbed into other banking organizations. Financial institutions and investors have placed much more emphasis on the banking charter, likely driven by banks' more stable funding and deposit insurance, even before the recently announced government support of the banking system.

Over the past year, there has been increasing concern among financial institutions and other counterparties about the health of some financial institutions. Uncertainty about the value of assets and other exposures, as well as uncertainty about the ability of institutions to sustain continued access to funding, has caused financial institutions to operate with great caution and hoard funds. What was once a healthy, active interbank market has become frozen from time to time, as some institutions feel that conditions are so uncertain that they cannot even lend to long-standing clients or counterparties. In quite a dramatic shift from just 18 months ago, there is much more scrutiny being placed on capital adequacy, with financial institutions trying to retain as much capital as they can, raise as much as possible, and demonstrate that their capital positions are not impaired. The Capital Purchase Plan by the U.S. Treasury Department under the Emergency Economic Stabilization Act is focused on improving capital adequacy and, hence, improving confidence in the interbank market.

Perhaps one of the most pressing issues, as I mentioned briefly earlier, is the intense emphasis on funding. This dramatic shift in concerns about a financial institution's funding base results in much more focus on the stability of funding sources--one of the reasons that the bank charter has become so attractive. Indeed, we are seeing the emphasis on funding driving many other factors that affect financial institutions, including the viability of various aspects of firms' business models. And problems with liquidity have affected capital levels, which in turn have further exacerbated liquidity concerns. It is indeed quite remarkable how this "flight to liquidity" has brought about so many institutional and structural changes, and become essentially the most important factor (at least now) for the viability of a financial institution.

Over the past year there have been a number of studies analyzing the causes of the current turmoil, which include shortcomings in the risk management practices of financial institutions.² It is absolutely clear that many financial institutions need to undertake a fundamental review of risk management. They now realize that ignoring risk management in any aspect of the banking business usually creates problems later on. Risk management shortcomings need to be addressed not only to improve the health and viability of individual institutions, but also to maintain stability for the financial system as a whole.

Framework for Strategic Risk Management
At this time, I would like to explain a bit more about what I mean by a "strategic risk management framework." In my view, an effective overall corporate strategy combines a set of activities a firm plans to undertake with an adequate assessment of the risks included in those activities. Unfortunately, many firms have forgotten the second part of that definition. In other words, there can be no real strategic management in financial services without risk management, hence my use of the term "strategic risk management." Risk management needs to be interwoven into all aspects of the firm's business and should be part of the calculus for all decision-making. Strategic decisions about what activities to undertake should not be made unless senior management understands the risks involved; assessing potential returns without fully assessing the corresponding risks to the organization is incomplete, and potentially hazardous, strategic analysis.

Ensuring that risk management permeates an entire organization may require some fundamental changes for certain firms. And this lesson applies not just to the prominent organizations mentioned in the headlines of late, but also to smaller firms. Even if smaller firms have been less affected by the recent turmoil (and perhaps have even won back some market share as customers seek more "traditional" places to put their money), their managements must understand that the financial landscape has changed and needs to be surveyed anew because events outside of their control in market-wide flight to liquidity, for example, can have direct impacts on them. Of vital importance will be incorporating into strategic risk management the lesson that funding and liquidity will be a major determinant of institutions' success going forward.

Building a rigorous strategic risk management framework requires an institution to reexamine both its internal practices and its external environment, and to understand how closely the two are connected. In other words, external factors have an impact on internal practices, but those internal practices, because financial markets are so interconnected, can in turn have an impact on how the institution is viewed externally--and even have an impact on the marketplace more broadly. We have witnessed several such examples of late, in which an institution encountered severe liquidity needs, which then affected funding for other institutions. Institutions need to understand better that a number of factors affecting their business are beyond their control, and that events can have secondary or tertiary "knock-on" effects. The real art is to realize that while all institutions may be affected by external factors, each is affected in its own way.

Now that I have laid out a general framework for strategic risk management, I would like to offer a few examples of its application.

Funding and liquidity
As I noted, the clear driver of the fundamental transformation in financial services is the increased importance of funding and liquidity. The ability to secure funding is a fundamental task in banking, and banks have been managing expected liquidity demands since the beginning of banking itself. In times of stress, such as now, having a solid and reliable funding structure becomes much more important, in some cases so much so that it affects most other banking activities.

The current turmoil has brought about substantial deleveraging in financial services. Managing this process is an immediate challenge for banking institutions, as they must consider the need to reduce leverage at their own institution as well as understand the consequences of deleveraging at other firms. This is clearly an example of external factors affecting internal practices, and vice versa. From a strategic perspective, bank directors must examine their current and future funding situation in light of recent deleveraging, its near-term prospects, and the state of overall liquidity in financial markets.

Financial institutions rely on external funding in some fashion--either through retail deposits, interbank lending, or debt offerings. Therefore, they must understand that their funding can be subject to the vagaries of the market, such as sudden shortages of market liquidity or rapid swings in investor sentiment. For example, banks may benefit in the near term in attracting deposits and thereby improve their funding positions, but they also may experience more difficulty securing other sources of funds and find that situation persisting for some time. Additionally, counterparty reactions to changes in the business mix or risk profile of an institution (or even the perceived change in its risk profile) could suddenly hamper the ability to find funding.

In recognizing the inherent leverage in the business of banking, institutions must examine longer-term implications of funding and liquidity, and begin to build those into the overall strategic plan for their organizations. The market for external funding is an international one, so liquidity troubles in one market can have repercussions in others. Accordingly, banks should be prepared for a range of adverse situations related to funding and market liquidity that can be precipitated by a range of sources.

Bank directors and senior management need to anticipate potential difficulties in funding the bank, and demand that solid contingency plans are in place--and are regularly updated--for a variety of funding and liquidity problems. Such plans should include the potential for external factors to generate a funding squeeze for the institution, even if its own positions and risk profile have not materially changed. Preparing for sudden changes in the pricing and availability at any price of funding sources is something that, leading up to the current turmoil, most banks did not fully consider. Instead, their managements focused mostly on building market share, growing revenues, and realizing the short-term profitability of their activities--a telling example of banks not properly including risk management in their overall corporate strategy. As the Senior Supervisors Group Survey of major financial institutions pointed out, there have been numerous examples of failures of strategic risk management and these must be rectified going forward.

Finally, strategic risk management for funding and liquidity needs to consider potential liquidity problems on both sides of the balance sheet. We saw such examples recently when there were draws on liquidity commitments to structured investment vehicles and commercial paper conduits, and when banks faced difficulty selling exposures in illiquid markets. When there is a marketwide scramble for liquidity, a bank must be prepared to manage funding challenges and unplanned asset expansions simultaneously. Developing a strong strategic risk management framework that recognizes the vital importance of funding and liquidity to both sides of the balance sheet is one way in which directors and senior management can help ensure that their institutions are ready for such outcomes. They should also ensure that they fully understand that funding and liquidity issues will drive many of the activities in which they will be able to engage, something to which I will now turn.

Choice of financial services activities
While the financial landscape is by no means settled, certain emerging trends will affect which activities make sense, which exposures should be assumed, and which risks should be undertaken. One immediate trend is that much of the future of business activities of banking organizations will be driven by the increased focus on funding and liquidity. Accordingly, this trend must be integrated into a strategic risk management framework. For instance, there may be less opportunity to pursue activities that were quite prolific under the previous "originate-to-distribute" model, such as securitizations, given current disruptions or longer-term uncertainties about the reliability of market liquidity. For similar reasons, other activities, such as investing in collateralized debt obligations or structured investment vehicles--which typically relied on relatively easy maturity transformation--may not be as viable in this new environment.

Whether transactions take place on an organized exchange or in the so-called over the counter market is another important aspect of the strategic risk management choices undertaken by an organization. When contracts are traded on an exchange, clearing and settlement, for example, may have less uncertainty associated with them. In addition, an exchange that has a centralized counterparty--perhaps the clearinghouse of the exchange--can reduce uncertainty about counterparty risk and help to avoid market dislocations that can arise from such uncertainty, not only for an individual firm but, potentially, more broadly in that market. Thus, market infrastructure and its impact on how organizations are connected to each other can have a large impact on market confidence in times of stress.

Of course, we have seen that uncertainty, fear, and lack of trust among key counterparties can dramatically affect trading in some products across markets in many countries, again an example of the impact of interconnectedness. These days, institutions are seeking more assurance that their counterparties will not default from one day to the next. Whether there is a shift to more trading on clearinghouses will be driven by firms' analysis of counterparty credit risk and the extent to which they are comfortable doing business with leveraged counterparties about which they have limited information. Firm managers should take these infrastructure and interconnectedness issues into account in undertaking their own strategic risk management choice about what activities to undertake and the risks posed by each. This is a clear example of how external structures should be taken into account in a firm's strategic planning.

In their strategic risk management frameworks, institutions should also understand the broader issue of potential gravitation to a model in which most or all types of financial services are brought together in single institutions. That is, institutions have to prepare for the possibility that they could lose customers and/or be less competitive if they are unable to provide the full set of financial products. Importantly, however, bank directors and senior management, in assembling their strategic risk management framework, should fully understand the complications associated with offering multiple products and engaging in a wide array of activities--such as reputational risk. And they should not automatically assume that engaging in multiple activities in multiple geographic markets will provide so-called "natural diversification." As I just noted, different financial markets and different types of financial services are quite interconnected, and during times of stress all can experience losses concurrently.

Of course, there may also be an opportunity for some institutions to benefit from more traditional, "bread-and-butter banking," with exposures and risks tied more closely to bank balance sheets. This potential opportunity for niche banking could have certain benefits, as clients and investors, because of the fear of contagion, seek institutions that are specifically not involved in multiple markets and activities. And local banks can often provide more personalized service and have a better understanding of their clients' needs. In such cases, however, institutions conducting specialized or local business must understand the inherent risks, such as potential risk concentrations.

Compensation
As many of you know, as an economist I am particularly interested in the impact that compensation has on incentives for bank management.³ I am pleased that the industry has also begun to address this issue, as reflected in a recent report by the Institute of International Finance.⁴ Clearly, the industry needs to better understand the link between compensation and risk management, as in the past those two areas have usually been addressed in isolation.

Generally, investors analyze financial institutions on a risk-adjusted basis, interpreting profits based on the amount of risk taken. Management at financial firms should do the same thing with regard to their business units and their employees. A risk-sensitive compensation framework will help provide the right incentives for employees, and establish a better link between the actions of those employees and the firm's overall risk profile. Institutions should be particularly sensitive to employee activities that could either directly or indirectly impair access to funding or disrupt liquidity.

Clearly, bank directors have an influential role to play in setting compensation, and they should exercise their authority to establish a more risk-sensitive compensation framework while embedding it in the broader strategic risk management framework of the institution. Directors should understand the consequences of providing too many short-term and one-sided incentives. There are many ways that this risk sensitivity could be accomplished, and it is up to the firms themselves to arrive at solutions. One possibility, for example, is to include more types of deferred compensation, since the risks of certain investments or trades may not manifest themselves in the near term. It makes sense to try to match the tenor of compensation with the tenor of the risk profile and, thus explicitly, take into account the longer-run performance of the portfolio or division in which the employee operates. A good risk-sensitive compensation regime, properly embedded in a strong strategic risk management framework, can bring about changes in behavior so that the firm's employees refrain from taking on risk beyond the firm's stated risk appetite. Perhaps most importantly, such a compensation regime must give the appropriate incentives to take risks fully into account during good times, when many often underestimate longer-term risks.

Conclusion
I have tried to lay out the importance for banking institutions to develop and maintain a strategic risk management framework that fully incorporates all the risks they face--both internal and external--when making choices about what activities and markets in which they will operate. Indeed, having a corporate strategy that does not include risk management at its core is not really a strategy at all. Market infrastructure, which affects not only the ways in which firms are connected to each other but also the types of shocks to confidence that they may encounter, is an important external factor that should be taken into account in strategic risk management.

As a concluding point, I will offer a few comments on one additional area to which banking institutions must pay particular attention: the regulatory and supervisory structure in which banks operate. Banking is an industry that is subject both to market competition and considerable regulation. Therefore, banking institutions must not only evaluate potential changes in the competitive financial landscape (as I noted earlier), but must also pay attention to potential changes on the regulatory side.

Over the past year, there have been a number of suggestions for possible statutory changes in U.S. financial services regulation, so bank directors must be prepared for whichever outcomes such changes might imply for the regulatory structure in the United States. For example, the Congress may wish to undertake legislative action to effect regulatory changes, or there may be changes to the existing authority and responsibility of certain regulatory bodies. In any event, there will likely be some type of adjustments in regulatory structure simply given the changes in the financial services landscape. Given the fluid situation in which we find ourselves today, bank directors and senior management in their strategic planning have to anticipate a range of potential outcomes in the regulatory sphere in both the short and long term.

Since banking and financial markets are so interconnected, the fundamental transformation in financial services is affecting all types of financial institutions, even those less directly affected by recent events. Importantly, in developing strategic risk management frameworks, institutions must not only understand the direct consequences to their own firms of such shifts, but must also recognize that consequences to other firms can have effects on the broader market. The heightened importance of funding and liquidity is a clear example of a major change that has far-reaching ramifications and, thus, has to be appropriately addressed in assembling any credible strategic risk management framework in an interconnected world.

Footnotes

1. In my remarks, I will use the terms "banks," "banking institutions," and "banking organizations" interchangeably. Return to text

2. One example is a report entitled “Observations on Risk Management Practices during the Recent Market Turbulence,” issued by the Senior Supervisors Group, which included supervisory agencies from France, Germany, Switzerland, the United Kingdom and the United States. Return to text

3. Randall S. Kroszner, 2008, "Improving Risk Management in Light of Recent Market Events," speech delivered at the Global Association of Risk Management Professionals Annual Risk Convention, New York, February 25. Return to text

4. Institute of International Finance, 2008, "Final Report of the IIF Committee on Market Best Practices: Principles of Conduct and Best Practice Recommendations," July, http://www.iif.com/regulatory. Return to text

Return to top

Agencies Encourage Participation in Treasury's Capital Purchase Program, FDIC's Temporary Liquidity Guarantee Program

The federal banking and thrift regulatory agencies encourage all eligible institutions to use the Treasury Department's Capital Purchase Program and the Federal Deposit Insurance Corporation's Temporary Liquidity Guarantee Program.  On October 14, 2008, the U.S. government announced a series of initiatives to strengthen market stability, improve the strength of financial institutions, and enhance market liquidity.  Treasury announced a voluntary Capital Purchase Program to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.  Under the program, Treasury will purchase up to $250 billion of senior preferred shares on standardized terms. 

Treasury's Capital Purchase Program and the FDIC's Temporary Liquidity Guarantee Program complement one another.  Through these programs, fresh capital and liquidity are available to foster new lending in our nation's communities. 

Under Treasury's Capital Purchase Program, eligible institutions will be able to sell equity interests to Treasury in amounts equal to 1 percent to 3 percent of the institution's risk-weighted assets.  These equity interests will constitute Tier 1 capital for the eligible institution.

Treasury and the agencies on Monday issued application guidelines and other documents for the Capital Purchase Program.  Those documents are attached.  If regulated by the Federal Reserve, contact your local Reserve Bank about the program.  If regulated by the FDIC, contact the appropriate regional office for your institution.  If regulated by the Office of the Comptroller of the Currency, contact Fred Finke (fred.finke@occ.treas.gov) for more information and send applications to HQ.Licensing@occ.treas.gov or OCC Director of Licensing, 250 E St. SW, Mail Stop 7-13, Washington DC, 20219-0001.  If regulated by the Office of Thrift Supervision, contact the appropriate regional office for your institution.

Nine large financial organizations already have agreed to participate in the Capital Purchase Program.  We encourage other institutions to take advantage of the benefits of the Capital Purchase Program by contacting their primary federal regulator and appropriate bank holding company regulator if applicable for details about the program, conditions, and eligibility.  The deadline to apply is November 14, 2008. 

All eligible institutions are automatically covered by the FDIC's Temporary Liquidity Guarantee Program without charge for the first 30 days.  The Treasury's Capital Purchase Program and FDIC’s Temporary Liquidity Guarantee Program share a common goal--to restore capital flows to the consumers and businesses that form the core of our economy.  The federal bank and thrift regulatory agencies encourage eligible institutions to participate in that common goal.

Attachments:

• Application guidelines and form (85 KB PDF)
• FAQs (15 KB PDF)

Release Date: October 20, 2008

For immediate release

The Federal Reserve Board on Monday approved final amendments to Regulation C that revise the rules for reporting price information on higher-priced mortgage loans.  The changes are intended to improve the accuracy and usefulness of data reported under the Home Mortgage Disclosure Act.     

Regulation C currently requires lenders to collect and report the spread between the annual percentage rate (APR) on a mortgage loan and the yield on a Treasury security of comparable maturity if the spread is greater than 3.0 percentage points for a first lien loan or greater than 5.0 percentage points for a subordinate lien loan.  This difference is known as a rate spread. Under the final rule, a lender will report the spread between the loan's APR and a survey-based estimate of APRs currently offered on prime mortgages of a comparable type ("average prime offer rate") if the spread is equal to or greater than 1.5 percentage points for a first lien loan or equal to or greater than 3.5 percentage points for a subordinate-lien loan.  The Board will publish average prime offer rates based on the Primary Mortgage Market Survey® currently published by Freddie Mac.  The Board will conduct its own survey if it becomes appropriate or necessary to do so.

In setting the rate spread reporting threshold, the Board sought to cover subprime mortgages and generally avoid covering prime mortgages.  Applying the new, market survey-based benchmarks in place of Treasury security yields should better achieve this purpose and ensure more consistent and more useful data.

The changes to Regulation C conform the threshold for rate spread reporting to the definition of higher-priced mortgage loans adopted by the Board under Regulation Z (Truth in Lending) in July of 2008.  By implementing the same pricing threshold test under both regulations, the Board is reducing the overall regulatory burden on mortgage lenders.

The final rule is effective October 1, 2009.   The Board's Federal Register notice is attached.

Attachment (86 KB PDF)

Agencies Announce Decision on Regulatory Capital Impact of Emergency Economic Stabilization Act of 2008 on Fannie Mae and Freddie Mac Preferred Stock

The federal banking and thrift regulatory agencies announced today that they will allow banks, bank holding companies, and thrifts (collectively, "banking organizations") to recognize the effect of the tax change enacted in Section 301 of the Emergency Economic Stabilization Act of 2008 (EESA) in their third quarter 2008 regulatory capital calculations.

Section 301 of EESA provides tax relief to banking organizations that have suffered losses on certain holdings of Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) preferred stock by changing the character of these losses from capital to ordinary for federal income tax purposes.  However, because the EESA was not enacted until October 3, 2008, banking organizations will not be able to recognize the tax effects of the ordinary losses resulting from Section 301 of EESA in financial statements prepared in accordance with generally accepted accounting principles until the fourth quarter of 2008.  Today's decision by the agencies will allow banking organizations to recognize the economic benefits of the change in the tax treatment of losses on Fannie Mae and Freddie Mac preferred stock under Section 301 of the EESA in the third quarter of 2008 for regulatory capital purposes.

The agencies plan to provide regulatory reporting instructions to banking organizations describing how the effect of the tax change enacted in Section 301 of EESA should be reflected in the measurement of regulatory capital in their regulatory reports for September 30, 2008.

Release Date: October 16, 2008

For immediate release

The Federal Reserve on Thursday issued enhanced guidance that refines and clarifies its programs for the consolidated supervision of bank holding companies and the combined U.S. operations of foreign banking organizations (FBOs). The Federal Reserve also released guidance clarifying supervisory expectations with respect to firmwide compliance risk management.

While initiation of these efforts predated the recent period of considerable strain in the financial markets, these enhanced approaches to consolidated supervision and firmwide compliance risk management emphasize several elements that should support a more resilient financial system. 

The Federal Reserve continues to work, both independently and in conjunction with other supervisors and functional regulators, on a number of initiatives to strengthen supervisory approaches and reinforce expectations for sound practices in response to market events.

"This supervisory guidance on consolidated supervision and compliance risk management will better equip our supervisory staff, working closely with other U.S. and foreign supervisors and regulators, to understand and assess the full range and scope of a banking organization's operations and risks," said Federal Reserve Board Governor Randall S. Kroszner. 

"This guidance should not only provide greater clarity regarding our longstanding responsibilities as a consolidated supervisor, but is also responsive to ongoing developments in the financial sector. The objectives of fostering financial stability and deterring or managing financial crises will be furthered by the Federal Reserve having a more complete view of firmwide risks and controls," Governor Kroszner said.     

The continuing growth in the size and complexity of many banking organizations exposes these firms to a wide array of potential risks, while at the same time making it more challenging for a single supervisor to have a comprehensive perspective on the firm as a whole. In this regard, the consolidated supervision guidance is designed to foster consistent Federal Reserve supervisory practices and assessments across institutions with similar activities and risks. 

The guidance describes how Federal Reserve staff develops an understanding and assessment of the consolidated operations of a bank holding company and the U.S. operations of an FBO through continuous monitoring activities, discovery reviews, and testing activities, as well as through interaction with, and reliance to the fullest extent possible on, other relevant supervisors and functional regulators.   

The separate compliance risk management guidance endorses the principles set forth in the April 2005 paper issued by the Basel Committee on Banking Supervision entitled Compliance and the compliance function in banks. This guidance clarifies certain Federal Reserve supervisory policies regarding compliance risk management programs and oversight at large banking organizations with complex compliance profiles.

The supervisory guidance on both consolidated supervision and compliance risk management is attached.

SR Letter 08-8/CA Letter 08-11

SR Letter 08-9/CA Letter 08-12

Release Date: October 16, 2008

For immediate release

The Federal Reserve Board on Thursday announced its approval of the proposal by Caja de Ahorros y Monte de Piedad de Madrid and Caja Madrid Cibeles S.A., both of Madrid, Spain, and CM Florida Holdings, Inc., Coral Gables, Florida, to acquire 83 percent of the voting securities of City National Bancshares, Inc. and thereby acquire control of its subsidiary bank, City National Bank of Florida, both of Miami, Florida.

Attached is the Board's Order relating to this action.

Attachment (495 KB PDF)

Release Date: October 16, 2008

For immediate release

The Federal Reserve Board on Thursday announced the execution of a Written Agreement by and between Alliance Bancshares California, a registered bank holding company, and the Federal Reserve Bank of San Francisco.

A copy of the Written Agreement is attached.

Attachment (235 KB PDF)

Release Date: October 16, 2008

For immediate release

The Federal Reserve Board on Thursday announced the execution of a Written Agreement by and among AmericasBank, Towson, Maryland, a state chartered member bank, the Federal Reserve Bank of Richmond, and the Maryland Division of Financial Regulation.

A copy of the Written Agreement is attached.

Attachment (426 KB PDF)

Vice Chairman Donald L. Kohn

At the Georgetown University Wall Street Alliance, New York, New York

October 15, 2008

Economic Outlook

We gather in difficult times for our financial markets and our economy. Recent weeks have seen a sharp intensification of the turmoil in financial markets: There has been a broad-based pullback in risk-taking and a virtual seizing up of term lending to many banks and other financial institutions; interest rates have risen for many borrowers, and credit availability has significantly diminished; and equity prices have fallen sharply, on net. The authorities have responded with a series of forceful and innovative measures that promise to rebuild confidence and free up lending. Tonight I will try to put these developments in the context of the recent course of our economy and its prospects for the future.¹

Before commenting on the current situation and its economic implications, I thought it might be useful to begin by giving you my perspective on where the economy stood prior to the recent intensification of financial turmoil. Overall economic activity--as measured by the growth of real gross domestic product (GDP)--held up surprisingly well over the first half of 2008 given the ongoing stresses in broader financial markets and the further rise in oil prices. At the same time, however, a number of disquieting signs lay underneath the surface of the aggregate growth figures. Conditions in housing markets, as had been widely expected, were continuing to deteriorate, with further declines in home sales, new construction, and house prices in most markets. And, while consumer spending posted moderate gains during the spring, it seemed likely that much of that strength stemmed from the sizable tax rebate checks that began to go out to households at the end of April. Meanwhile, on the business side, employers had been reducing payrolls since the turn of the year, industrial production fell from February through May, and many corporations were seeing their profits squeezed by rising costs and weak demand.

During the summer, it became increasingly clear that a downshifting in the pace of economic activity was in train. In particular, the long list of negative factors weighing on domestic demand--including high prices for oil and other commodities, tight credit conditions, and the housing downturn--were beginning to take a significant toll on the economy.

The deterioration was led by a noticeable retrenchment in consumer spending. Although rebate checks continued to provide a boost to incomes in June and July, households were facing some stiff headwinds. Ongoing job losses and sharp increases in energy and food prices subtracted from household purchasing power, declining home prices and falling equity values led to a further drop in household wealth, and consumers remained extremely downbeat about prospects for jobs and income. At the same time, credit became more difficult to obtain as lenders became increasingly concerned about the prospects for loan performance in a softening economy. Many banks and other creditors tightened standards for credit cards and other consumer loans, and some lenders either reduced borrowing limits on or eliminated home equity lines of credit. As a result of all these influences, real consumer outlays fell from June through August, putting real consumer spending for the third quarter as a whole on track to decline for the first time since 1991.

Business investment also appears to have slowed over the summer. Orders and shipments for nondefense capital goods have weakened, on net, in recent months, pointing to a decline in real outlays for new business equipment. Similarly, outlays for nonresidential construction projects edged lower in July and August after rising at a robust pace over the first half of this year. Although the deteriorating sales outlook and increased uncertainty about the economy undoubtedly played a role, the softening in business outlays also appeared to reflect reduced credit availability from banks and other lenders.

In addition, conditions in housing markets have remained on a downward trajectory. Sales and construction of new homes continued to decline over the summer, and while existing home sales showed signs of stabilizing at low levels, many of the sales that did occur appear to have been stimulated by sharp price reductions for distressed properties. National indexes of house prices continued to post sizable declines.

Unfortunately, our trading partners have proven not to be immune from financial turmoil and economic weakness. Incoming data indicate that the pace of activity in many foreign economies slowed in recent quarters, reflecting many of the same forces of credit contraction, rising energy prices, and housing market decelerations that have affected the U.S. economy. This weakening in foreign activity suggests that the support to domestic production from net exports that was evident in the first half of this year is likely diminishing. We can see evidence of this in manufacturing production outside of motor vehicles, which had benefited from the earlier decline in the dollar and strong foreign growth; it fell for a third consecutive month in August, and indications for September suggest a further decline last month, even after excluding the effects of the recent hurricanes and the strike at Boeing.

Meanwhile, inflation remained uncomfortably high through much of the summer. The sharp increases in the prices of oil and many agricultural commodities showed through to consumer food and energy prices, and producers passed through some of their higher input costs into retail prices for "core" goods and services. More recently, however, the prices of oil and other commodities have posted substantial declines, non-oil import prices have edged down, and the prospect of greater slack in resource markets and weak demand seems likely to restrain labor cost pressures and pricing power. Reflecting these developments, inflation expectations appear to have eased a bit.

The weakening U.S. economy and ongoing declines in house prices, with their implications for credit performance, put further pressure on exposed financial institutions over the summer. Investors lost confidence in some of these institutions, which then saw their access to liquidity dry up, causing some to fail and others to require government assistance or to consolidate via their acquisition by healthier institutions.

The speed with which these developments occurred, along with worries about losses throughout the financial system, led banks and other lenders to pull back from extending credit except at the very shortest maturities. As a result, conditions in funding markets deteriorated substantially further in September and early October, with interbank lending rates moving up sharply from already-high levels and spreads over comparable-maturity overnight index swaps widening to unprecedented levels.

In addition, the commercial paper market became severely disrupted as money market mutual funds, the largest investors in that market, substantially reduced their demand in response to outflows and the difficulty of liquidating commercial paper in secondary markets. As a result, yields on commercial paper skyrocketed for most issuers, and funding became increasingly concentrated in paper with overnight maturities. Similarly, interest rates on longer-term corporate bonds rose sharply even for investment-grade firms, and bond markets were closed off to many issuers. These developments quickly led to sharp declines in equity prices more generally, as well as to widespread disruptions in other markets, including the markets for municipal bonds. Market distress fed on itself, as efforts by lenders to protect themselves triggered calls for increased margins, sales of assets that accentuated price declines, large increases in volatility in an uncertain and unfamiliar environment, and a sharp cutback in the willingness to extend credit. Financial stresses have intensified in major foreign economies as well, with many also experiencing a drying up of liquidity in financial markets, sharp increases in the cost of short-term credit, and steep declines in equity prices.

The net result of the erosion of confidence, declines in asset prices, and freezing up of many financial markets has been a marked deterioration in the outlook for economic growth both here and abroad. Already, the latest readings on the U.S. economy have become more downbeat. In the labor market, private payroll employment fell 170,000 in September, a faster pace of decline than had been evident in preceding months, and the Institute for Supply Management survey of conditions in the manufacturing sector turned down sharply. In addition, motor vehicle sales fell to a 12-1/2 million unit pace in September, and today's report on retail sales indicated that purchases of other goods also dropped sharply last month. Meanwhile, pressures in financial markets have undoubtedly further restricted the availability of credit to households and businesses. Indeed, many of our contacts for the Beige Book, which was published today, highlighted tight and tightening credit conditions, and, in increasing numbers, indicated that a lack of credit availability is negatively affecting their customers' ability to spend or impairing their own ability to maintain the normal working capital they need to manage their day-to-day operations.

To combat the increased stresses in financial markets and their effects on the economy, the U.S. authorities, as well as those of many foreign governments, have taken a number of forceful and innovative steps in recent weeks. Of greatest consequence was the passage of the Emergency Economic Stabilization Act (EESA) with its authority for the government to use up to $700 billion to support financial markets. Importantly, the U.S. Treasury has indicated that a significant share of this authority will be used to inject capital into financial institutions. As the turmoil has persisted and deepened, it has become increasingly clear that the fear and uncertainty gripping markets stems from questions about the exposure of many financial intermediaries to losses on mortgages and other loans. Banks and other lenders need greater capital cushions to reassure their counterparties that they will be able to meet their obligations, and they need it soon. The capital purchase plan announced by the Treasury yesterday is a start on building capital and confidence, and, by strengthening lenders, should make it easier for them to access the private capital they also require. In addition, the troubled asset purchase program should help by counteracting the effect of forced sales and impaired market liquidity on asset prices.

Although capital is the bedrock of confidence, it probably will take some time for enough to be raised to completely reassure those who extend funds to many intermediaries. In the meantime, the inability of lenders to fund themselves beyond the very near term creates vulnerability in the financial system and impedes their capacity to make loans to households and businesses to finance the purchases of cars, houses, and business capital. To bridge the gap to stronger capital, the Federal Deposit Insurance Corporation (FDIC) is offering banks and their holding companies an opportunity to issue guaranteed obligations for the next nine months. This guarantee covers the obligations most likely to be withdrawn when confidence erodes, but it is also structured to encourage banks to lengthen the maturity of their borrowing to provide stability, rebuild confidence, and stimulate lending. The FDIC program will operate alongside the earlier Treasury guarantee of money market fund balances designed to stabilize investments in those accounts and hence reduce the need for these funds to liquidate assets.

For its part, the Federal Reserve has greatly expanded its provision of liquidity to banks here and abroad and to other borrowers. We could do so in part because the EESA accelerated the authority for the Federal Reserve to pay interest on reserves. With that power, we can expand our lending and still maintain the federal funds rate target established by the Federal Open Market Committee (FOMC). Under normal circumstances, we face no tension between supplying liquidity and achieving our interest rate objective, because we supply a relatively small amount of funds to the private sector through our open market operations with primary dealers and discount window lending to banks. Over the past 15 months, however, as lenders have become increasingly reluctant to lend to each other, the Federal Reserve has had to take on a much greater role in the financial system to carry out its public policy responsibilities to provide a backstop source of liquidity. At first, we did this by expanding the amount and lengthening the maturity of our lending to banks at the discount window and through our traditional open market operations with dealers. Then, we found that we needed to supply credit against a greater variety of collateral to primary dealers so we opened the discount window to them and expanded our securities lending facilities. And just within the past few weeks we determined that, with normal intermediation increasingly disrupted, economic and financial stability required us to lend to firms that issued commercial paper. At the same time, we have greatly expanded our dollar swaps with foreign central banks to help them meet the dollar funding needs of their domestic banks--needs that have been adding to pressures on our markets here at home.

By opening and expanding these facilities, we are trying to assure banks, dealers, and commercial paper issuers that they can extend credit without worrying about whether they will be able to borrow to fund those loans. We are also trying to assure those who lend to these firms that the borrowers will have a source of funding to pay them back. Clearly, the willingness of the Federal Reserve to lend substantial amounts to more counterparties over longer periods has not, by itself, been sufficient to unlock private credit flows; but Federal Reserve credit has been a critical ingredient in the mix of policy tools.

As I noted earlier, the troubles in the financial markets have spilled over to the economy. Indeed, fear of economic weakness and the associated deterioration in credit quality contributed to the adverse dynamics in credit markets. To counter this dynamic and adjust its policy to the evolving economic outlook, the FOMC reduced the target federal funds rate 50 basis points last week. To be sure, the effects of the easier stance of policy on the cost and availability of credit were overwhelmed last week by the further erosion in confidence. But, over time, lower rates will help to support asset prices and reduce the cost of capital to encourage spending, economic expansion, and job creation.

Importantly, this easing action was taken alongside similar actions by many other central banks. Financial markets are connected around the world by the free flow of capital, and the freezing up of credit has occurred, to one degree or another, in many foreign economies as well as our own. In these circumstances, measures to address financial market problems within each country are likely to be more effective if other countries are also taking similar steps, as they are doing not only in monetary policy but also in their efforts to recapitalize banks, guarantee bank obligations, and shore up the confidence of lenders.

I am optimistic that this multipronged approach is laying the groundwork for a return to more normal functioning in financial markets and a restoration of vigorous economic growth. The initial reaction has been positive, but it will take some time before we know to what extent the current stresses in the financial sector are being resolved. Over time, financial firms will need to bolster profits to offset losses and attract capital, to delever by reducing debt relative to equity, and in many cases to consolidate through mergers and acquisitions. All of this points to a prolonged period of cautious lending and a high cost of capital relative to benchmark interest rates like the federal funds rate, even as market functioning improves.

Similarly, although the adjustment in housing markets is well under way, it likely still has further to go. House prices will probably continue to fall for a while, and inventories of unsold homes, while decreasing, will remain elevated. At some point, however, house prices will begin to stabilize, demand will be bolstered by the lower level of prices and low interest rates, and inventories will come into better alignment with sales. To be sure, any rebound in housing activity will likely be modest, but even a stabilization in housing markets will remove what has been a significant drag on the U.S. economy.

Given the likely drawn-out nature of the prospective adjustments in housing and financial markets, I see the most probable scenario as one in which the performance of the economy remains subpar well into next year and then gradually improves in late 2009 and 2010. As credit restraint abates, the low level of policy interest rates will begin to show through into more accommodative financial conditions. This improvement in financial conditions, together with the gradual stabilization of housing markets and the stimulative effects of lower oil and commodity prices, should lead to a pickup in jobs and income, contributing to a broad recovery in the U.S. economy.

At the same time, inflation seems likely to move onto a downward track. If sustained, the recent declines in commodity prices should soon lead to a sharp reduction in headline inflation. In addition, I expect core inflation to slow from current levels as lower commodity prices and greater economic slack moderate upward pressures on costs. Similar reductions in inflation abroad, as well as the recent appreciation of the dollar, should restrain increases in the prices of imported goods.

I would caution, however, that the uncertainty around my forecast is substantial. The path of the economy will depend critically on how quickly the current stresses in financial markets abate. But these events have few if any precedents, and thus we can have even less confidence than usual in our economic forecasts.

Here's what I do know: The authorities around the world have brought to bear on this situation an array of actions that are unprecedented in scope and force; these actions show every promise of being successful in restoring confidence in lending institutions and freeing the flow of credit to households and businesses; and governments in the United States and elsewhere have shown themselves able to work across political parties and across international boundaries to craft new approaches to problems. As Chairman Bernanke has often remarked, at the Federal Reserve we will utilize all the tools at our disposal to meet our responsibilities for fostering high employment and stable prices. I also know that the U.S. economy has proven itself over the years to be flexible and resilient as well as innovative and productive, qualities which enable it to rebound from serious economic shocks. I am confident that we will emerge from this episode with a stronger and more robust financial system and with a restoration of solid and sustainable economic growth.

Footnotes

1. The views expressed are my own and do not necessarily represent the views of other members of the Board or the Federal Open Market Committee. William Wascher, of the Board’s staff, contributed to these remarks. Return to text

Return to top

Chairman Ben S. Bernanke

At the Economic Club of New York, New York, New York

October 15, 2008

Stabilizing the Financial Markets and the Economy

Good afternoon. I am pleased once again to share a meal and some thoughts with the Economic Club of New York. I will focus today on the economic and financial challenges we face and why I believe we are well positioned to move forward. The problems now evident in the markets and in the economy are large and complex, but, in my judgment, our government now has the tools it needs to confront and solve them. Our strategy will continue to evolve and be refined as we adapt to new developments and the inevitable setbacks. But we will not stand down until we have achieved our goals of repairing and reforming our financial system and restoring prosperity.

The crisis we face in the financial markets has many novel aspects, largely arising from the complexity and sophistication of today's financial institutions and instruments and the remarkable degree of global financial integration that allows financial shocks to be transmitted around the world at the speed of light. However, as a long-time student of banking and financial crises, I can attest that the current situation also has much in common with past experiences. As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets. The crisis will end when comprehensive responses by political and financial leaders restore that trust, bringing investors back into the market and allowing the normal business of extending credit to households and firms to resume. In that regard, we are, in one respect at least, better off than those who dealt with earlier financial crises: Generally, during past crises, broad-based government engagement came late, usually at a point at which most financial institutions were insolvent or nearly so. Waiting too long to respond has usually led to much greater direct costs of the intervention itself and, more importantly, magnified the painful effects of financial turmoil on households and businesses. That is not the situation we face today. Fortunately, the Congress and the Administration have acted at a time when the great majority of financial institutions, though stressed by highly volatile and difficult market conditions, remain strong and capable of fulfilling their critical function of providing new credit for our economy. This prompt and decisive action by our political leaders will allow us to restore more normal market functioning much more quickly and at lower ultimate cost than would otherwise have been the case. Moreover, we are seeing not just a national response but a global response to the crisis, commensurate with its global nature.

This financial crisis has been with us for more than a year. It was sparked by the end of the U.S. housing boom, which revealed the weaknesses and excesses that had occurred in subprime mortgage lending. However, as subsequent events have demonstrated, the problem was much broader than subprime lending. Large inflows of capital into the United States and other countries stimulated a reaching for yield, an underpricing of risk, excessive leverage, and the development of complex and opaque financial instruments that seemed to work well during the credit boom but have been shown to be fragile under stress. The unwinding of these developments, including a sharp deleveraging and a headlong retreat from credit risk, led to highly strained conditions in financial markets and a tightening of credit that has hamstrung economic growth.

The Federal Reserve responded to these developments in two broad ways. First, following classic tenets of central banking, the Fed has provided large amounts of liquidity to the financial system to cushion the effects of tight conditions in short-term funding markets. Second, to reduce the downside risks to growth emanating from the tightening of credit, the Fed, in a series of moves that began last September, has significantly lowered its target for the federal funds rate. Indeed, last week, in an unprecedented joint action with five other major central banks and in response to the adverse implications of the deepening crisis for the economic outlook, the Federal Reserve again eased the stance of monetary policy. We will continue to use all the tools at our disposal to improve market functioning and liquidity, to reduce pressures in key credit and funding markets, and to complement the steps the Treasury and foreign governments will be taking to strengthen the financial system.

Notwithstanding our efforts and those of other policymakers, the financial crisis intensified over the summer as mortgage-related assets deteriorated further, economic growth slowed, and uncertainty about the financial and economic outlook increased. As investors and creditors lost confidence in the ability of certain firms to meet their obligations, their access to capital markets as well as to short-term funding markets became increasingly impaired, and their stock prices fell sharply. Prominent companies that experienced this dynamic most acutely included the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, the investment bank Lehman Brothers, and the insurance company American International Group (AIG).

The Federal Reserve believes that, whenever possible, the difficulties experienced by firms in financial distress should be addressed through private-sector arrangements--for example, by raising new equity capital, as many firms have done; by negotiations leading to a merger or acquisition; or by an orderly wind-down. Government assistance should be provided with the greatest reluctance and only when the stability of the financial system, and thus the health of the broader economy, is at risk. In those cases when financial stability is broadly threatened, however, intervention to protect the public interest is not only justified but must be undertaken forcefully and without hesitation.

Fannie Mae and Freddie Mac present cases in point. To avoid unacceptably large dislocations in the mortgage markets, the financial sector, and the economy as a whole, the Federal Housing Finance Agency put Fannie and Freddie into conservatorship, and the Treasury, drawing on authorities recently granted by the Congress, made financial support available. The government's actions appear to have stabilized the GSEs, although, like virtually all other firms, they are experiencing effects of the current crisis. We have already seen benefits of their stabilization in the form of lower mortgage rates, which will help the housing market.

The difficulties at Lehman and AIG raised different issues. Like the GSEs, both companies were large, complex, and deeply embedded in our financial system. In both cases, the Treasury and the Federal Reserve sought private-sector solutions, but none was forthcoming. A public-sector solution for Lehman proved infeasible, as the firm could not post sufficient collateral to provide reasonable assurance that a loan from the Federal Reserve would be repaid, and the Treasury did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman's acquisition by another firm. Consequently, little could be done except to attempt to ameliorate the effects of Lehman's failure on the financial system. Importantly, the financial rescue legislation, which I will discuss later, will give us better choices. In the future, the Treasury will have greater resources available to prevent the failure of a financial institution when such a failure would pose unacceptable risks to the financial system as a whole. The Federal Reserve will work closely and actively with the Treasury and other authorities to minimize systemic risk.

In the case of AIG, the Federal Reserve and the Treasury judged that a disorderly failure would have severely threatened global financial stability and the performance of the U.S. economy. We also judged that emergency Federal Reserve credit to AIG would be adequately secured by AIG's assets. To protect U.S. taxpayers and to mitigate the possibility that lending to AIG would encourage inappropriate risk-taking by financial firms in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm's owners, managers, and creditors.

AIG's difficulties and Lehman's failure, along with growing concerns about the U.S. economy and other economies, contributed to extraordinarily turbulent conditions in global financial markets in recent weeks. Equity prices fell sharply. Withdrawals from prime money market mutual funds led them to reduce their holdings of commercial paper--an important source of financing for the nation's nonfinancial businesses as well as for many financial firms. The cost of short-term credit, where such credit has been available, jumped for virtually all firms, and liquidity dried up in many markets. By restricting flows of credit to households, businesses, and state and local governments, the turmoil in financial markets and the funding pressures on financial firms pose a significant threat to economic growth.

The Treasury and the Fed have taken a range of actions to address financial problems. To address illiquidity and impaired functioning in commercial paper markets, the Treasury implemented a temporary guarantee program for balances held in money market mutual funds to help stem the outflows from these funds. The Federal Reserve put in place a temporary lending facility that provides financing for banks to purchase high-quality asset-backed commercial paper from money market funds, thus reducing their need to sell the commercial paper into already distressed markets. Moreover, we soon will implement a new, temporary Commercial Paper Funding Facility that will provide a backstop to commercial paper markets by purchasing highly rated commercial paper directly from issuers at a term of three months when those markets are illiquid.

To address ongoing problems in interbank funding markets, the Federal Reserve has significantly increased the quantity of term funds it auctions to banks and accommodated heightened demands for temporary funding from banks and primary dealers. Also, to try to mitigate dollar funding pressures worldwide, we have greatly expanded reciprocal currency arrangements (so-called swap agreements) with other central banks. Indeed, this week we agreed to extend unlimited dollar funding to the European Central Bank, the Bank of England, the Bank of Japan, and the Swiss National Bank. These agreements enable foreign central banks to provide dollars to financial institutions in their jurisdictions, which helps improve the functioning of dollar funding markets globally and relieve pressures on U.S. funding markets. It bears noting that these arrangements carry no risk to the U.S. taxpayer, as our loans are to the foreign central banks themselves, who take responsibility for the extension of dollar credit within their jurisdictions.

The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding and thus is supporting their lending to nonfinancial firms and households. Nonetheless, the intensification of the financial crisis over the past month or so made clear that a more powerful, comprehensive approach involving the fiscal authorities was needed to address these problems more effectively. On that basis, the Administration, with the support of the Federal Reserve, asked the Congress for a new program aimed at stabilizing our financial markets. The resulting legislation, the Emergency Economic Stabilization Act, provides important new tools for addressing the distress in financial markets and thus mitigating the risks to the economy. The act allows Treasury to buy troubled assets, to provide guarantees, and to inject capital to strengthen the balance sheets of financial institutions. The act also raises the limit on deposit insurance from $100,000 to $250,000 per account, effectively immediately.

The Troubled Asset Relief Program (TARP) authorized by the legislation will allow the Treasury, under the supervision of an oversight board that I will head, to undertake two highly complementary activities. First, the Treasury will use the TARP funds to help recapitalize our banking system by purchasing non-voting equity in financial institutions. Details of this program were announced yesterday. Initially, the Treasury will dedicate $250 billion toward purchases of preferred shares in banks and thrifts of all sizes. The program is voluntary and designed both to encourage participation by healthy institutions and to make it attractive for private capital to come in along with public capital. We look to strong institutions to participate in this capital program, because today even strong institutions are reluctant to expand their balance sheets to extend credit; with fresh capital, that constraint will be eased. The terms offered under the TARP include the acquisition by the Treasury of warrants to ensure that taxpayers receive a share of the upside as the financial system recovers. Moreover, as required by the legislation, institutions that receive capital will have to meet certain standards regarding executive compensation practices.

Second, the Treasury will use some of the resources provided under the bill to purchase troubled assets from banks and other financial institutions, in most cases using market-based mechanisms. Mortgage-related assets, including mortgage-backed securities and whole loans, will be the focus of the program, although the law permits flexibility in the types of assets purchased as needed to promote financial stability. Removing these assets from private balance sheets should increase liquidity and promote price discovery in the markets for these assets, thereby reducing investor uncertainty about the current value and prospects of financial institutions. Unclogging the markets for mortgage-related assets should put banks and other institutions in a better position to raise capital from the private sector and increase the willingness of counterparties to engage. With time, the provision of equity capital to the banking system and the purchase of troubled assets will help credit flow more freely, thus supporting economic growth.

These measures will lead to a much stronger financial system over time, but steps are also necessary to address the immediate problem of lack of trust and confidence. Accordingly, also announced yesterday was a plan by the Federal Deposit Insurance Corporation (FDIC) to provide a broad range of guarantees of the liabilities of FDIC-insured depository institutions, including their associated holding companies. The guarantee covers all newly issued senior unsecured debt, including commercial paper and interbank funding, and it will also cover all funds held in non-interest-bearing transactions accounts, such as payroll accounts. This broad guarantee will be effectively immediately, and fees for coverage will be waived for 30 days. After the 30-day grace period, banks may continue to participate in the guarantee program by paying reasonable fees.

I would like to stress once again that the taxpayers' interests were very much in our minds and those of the Congress when these programs were designed. The costs of the FDIC guarantee are expected to be covered by fees and assessments on the banking system, not by the taxpayer. In the case of the TARP program, the funds allocated are not simple expenditures, but rather acquisitions of assets or equity positions, which the Treasury will be able to sell or redeem down the road. Indeed, it is possible that taxpayers could turn a profit from the program, although, given the great uncertainties, no assurances can be provided. Moreover, the program is subject to extensive controls and to oversight by several bodies. The larger point, though, is that the economic benefit of these programs to taxpayers will not be determined primarily by the financial return to TARP funds, but rather by the impact of the program on the financial markets and the economy. If the TARP, together with the other measures that have been taken, is successful in promoting financial stability and, consequently, in supporting stronger economic growth and job creation, it will have proved itself a very good investment indeed, to everyone's benefit.

Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away. Economic activity had been decelerating even before the recent intensification of the crisis. The housing market continues to be a primary source of weakness in the real economy as well as in the financial markets, and we have seen marked slowdowns in consumer spending, business investment, and the labor market. Credit markets will take some time to unfreeze. And with the economies of our trading partners slowing, our export sales, which have been a source of strength, very probably will slow as well. These restraining influences on economic activity, however, will be offset somewhat by the favorable effects of lower prices for oil and other commodities on household purchasing power. Ultimately, the trajectory of economic activity beyond the next few quarters will depend greatly on the extent to which financial and credit markets return to more normal functioning.

Inflation has been elevated recently, reflecting the steep increases in the prices of oil, other commodities, and imports that occurred earlier this year, as well as some pass-through by firms of their higher costs of production. However, expected inflation, as measured by consumer surveys and inflation-indexed Treasury securities, has held steady or eased, and prices of imports now appear to be decelerating. These developments, together with the recent declines in prices of oil and other commodities as well as the likelihood that economic activity will fall short of potential for a time, should lead to rates of inflation more consistent with price stability.

This past weekend, the finance ministers and central bank governors of the Group of Seven industrialized countries met in Washington. We committed to work together to stabilize financial markets and restore the flow of credit to support global economic growth. We agreed to use all available tools to prevent failures that pose systemic risk. We affirmed we will ensure our deposit insurance programs instill confidence in the safety of savings. We agreed to ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources. We further agreed that we would take all necessary steps to unfreeze interbank and money markets, and that we will act to restart the secondary markets for mortgages and other securitized assets. Finally, we recognized that we should take these actions in ways that protect taxpayers and avoid potentially damaging effects on other countries. I believe that these are the right principles for action, and I see the steps announced by our government yesterday as fully consistent with them.

I have laid out for you today an extraordinary series of actions taken by policymakers throughout our government and around the globe. Americans can be confident that every resource is being brought to bear to address the current crisis: historical understanding, technical expertise, economic analysis, financial insight, and political leadership. I am not suggesting the way forward will be easy, but I strongly believe that we now have the tools we need to respond with the necessary force to these challenges. Although much work remains and more difficulties surely lie ahead, I remain confident that the American economy, with its great intrinsic vitality and aided by the measures now available, will emerge from this period with renewed vigor.

Return to top

Release Date: October 14, 2008

For immediate release

The Federal Open Market Committee has authorized an increase in the size of its temporary reciprocal currency arrangement (swap line) with the Bank of Japan, so that the Bank of Japan can provide U.S. dollar funding in quantities sufficient to meet demand.

Following on the joint announcement by central banks on October 13, the Bank of Japan announced Tuesday that it will conduct tenders of U.S. dollar funding for full allotment at pre-announced fixed rates. As in Europe, counterparties in Japan will be able to borrow any amount they wish against appropriate collateral.

Accordingly, the size of the swap line between the Federal Reserve and the Bank of Japan will be increased to accommodate whatever quantity of U.S. dollar funding is demanded. On October 13, the Federal Reserve made the same announcement with respect to its swap lines with the Bank of England, European Central Bank, and Swiss National Bank.

These arrangements have been authorized through April 30, 2009.

Information on the action by the Bank of Japan is available at its website:

Bank of Japan

Joint Statement by Treasury, Federal Reserve, and FDIC

Washington, DC-- The following statement was made by Treasury Secretary Henry M. Paulson, Jr, Federal Reserve Chairman Ben Bernanke and FDIC Chairman Sheila C. Bair:

Today we are taking decisive actions to protect the U.S. economy, to strengthen public confidence in our financial institutions, and to foster the robust functioning of our credit markets. These steps will ensure that the U.S. financial system performs its vital role of providing credit to households and businesses and protecting savings and investments in a manner that promotes strong economic growth in the U.S. and around the world. The overwhelming majority of banks in the United States are strong and well-capitalized.  These actions will bolster public confidence in our system to restore and stabilize liquidity necessary to support economic growth.

Last week, the President’s Working Group on Financial Markets announced that the U.S. government would deploy all of our tools in a strategic and collaborative manner to address the current instability in our financial markets and mitigate the risks that instability poses for broader economic growth. This past weekend, we and our G7 colleagues committed to a comprehensive global strategy to provide liquidity to markets, to strengthen financial institutions, to prevent failures that pose systemic risk, to protect savers, and to enforce investor protections.

We welcomed the steps announced by our European colleagues this weekend to implement the action plan, and ensure financial institutions in Europe can finance economic growth.  Today we are implementing our strategy with three important actions. 

First, Treasury is announcing a voluntary capital purchase program. A broad array of financial institutions is eligible to participate in this program by selling preferred shares to the U.S. government on attractive terms that protect the taxpayer. Second, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Paulson signed the systemic risk exception to the FDIC Act, enabling the FDIC to temporarily guarantee the senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts. Regulators will implement an enhanced supervisory framework to assure appropriate use of this new guarantee.

We are pleased to announce that nine major financial institutions have already agreed to participate in both the capital purchase program and the FDIC guarantee program. We appreciate that these healthy institutions are taking these steps to strengthen their own positions and to enhance the overall performance of the U.S. economy. By participating in these programs, these institutions, along with thousands of others to come, will have enhanced capacity to perform their vital function of lending to U.S. consumers and businesses and promoting economic growth. They have also committed to continued aggressive actions to prevent unnecessary foreclosures and preserve homeownership.

Third, to further increase access to funding for businesses in all sectors of our economy, the Federal Reserve has announced further details of its Commercial Paper Funding Facility (CPFF) program, which provides a broad backstop for the commercial paper market. Beginning October 27, the CPFF will fund purchases of commercial paper of 3 month maturity from high-quality issuers. 

Together these three steps significantly strengthen the capital position and funding ability of U.S. financial institutions, enabling them to perform their role of underpinning overall economic growth. These actions demonstrate to market participants here and around the world the strength of the U.S. government’s commitment to take all necessary steps to unlock our credit markets and minimize the impact of the current instability on the overall U.S. economy. The actions taken today are a powerful step toward restoring the health of the global financial system.

Remarks by Chairman Ben S. Bernanke at the President’s Working Group Market Stability Initiative announcement

Release Date: October 14, 2008

For release at 8:30 a.m. EDT

The Federal Reserve Board on Tuesday announced additional details regarding the Commercial Paper Funding Facility (CPFF), including that it would begin funding purchases of commercial paper on October 27, 2008.

The Board authorized the CPFF on October 7, 2008 under Section 13(3) of the Federal Reserve Act to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF is intended to improve liquidity in short-term funding markets and thereby increase the availability of credit for businesses and households.

Under the CPFF, the Federal Reserve Bank of New York will finance the purchase of unsecured and asset-backed commercial paper from eligible issuers through its primary dealers. The CPFF will finance only highly rated, U.S. dollar-denominated, three-month commercial paper.

The attached terms-and-conditions and questions-and-answers documents describe the terms and operational details of the facility, which were determined after consultation with commercial paper issuers and dealers.

Commercial Paper Funding Facility
Terms and conditions
FAQs

Chairman Ben S. Bernanke

Remarks

At the President’s Working Group Market Stability Initiative Announcement

October 14, 2008

Good morning. Before I begin, I want to express my appreciation of my colleagues, Secretary Paulson and Chairman Bair, for their efforts in what has been an extraordinary collaboration. As Americans well know, the challenges evident in the financial markets and in the economy are large and complex, but I believe that the steps taken today will help us to overcome them. Our strategy will continue to evolve and be refined as we adapt to new developments and the inevitable setbacks. But we will not stand down until we have achieved our goals of repairing and reforming our financial system and thereby restoring prosperity to our economy.

Over the past year, the Federal Reserve has actively used all its powers and authorities to try to help our economy through this difficult time. And central banks around the world have consulted closely and cooperated in unprecedented ways to reduce strains in financial markets and to bolster our economies. We will continue to do so. However, clearly the time had come for a more comprehensive and broad-based solution.

History teaches us that government engagement in times of severe financial crisis often arrives very late, usually at a point at which most financial institutions are insolvent or nearly so. Waiting too long to act has usually led to much greater direct costs of the intervention itself and, more importantly, magnified the painful effects of financial turmoil on households and businesses. That is not the situation we face today. Fortunately, the Congress and the Administration have acted at a time when the great majority of financial institutions, though stressed by highly volatile and difficult market conditions, remain capable of fulfilling their critical function of providing new credit for our economy. The Congress's prompt and decisive action in passing the financial rescue legislation made possible the critical steps that have been announced this morning. I also find it heartening that we are seeing not just a national, but a global response to the crisis, commensurate with its global nature. Indeed, this past weekend, the finance ministers and central bankers of the Group of Seven industrialized countries announced a set of principles embodying a comprehensive approach to dealing with the crisis. The steps we are taking today are fully consistent with those principles.

As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets, which has had cascading and unwelcome effects on the availability of credit and the value of savings. The actions today are aimed at restoring confidence in our institutions and markets and repairing their capacity to meet the credit needs of American households and businesses. The voluntary equity purchase program will strengthen financial institutions' capacity and willingness to lend. The guarantee of the senior debt of all FDIC-insured depository institutions and their holding companies will restore the confidence of these institutions' creditors and reinvigorate the crucial inter-bank lending markets. Additionally, the Federal Reserve is pressing forward with its facility to provide a broad backstop for the commercial paper market, so vital to the functioning of our businesses.

Policymakers here and around the globe have taken a series of extraordinary steps. Americans can be confident that every resource is being brought to bear: historical understanding, technical expertise, economic analysis, and political leadership. I am not suggesting the way forward will be easy. But I strongly believe that the application of these tools, together with the underlying vitality and resilience of the American economy, will help to restore confidence to our financial system and place our economy back on a path to vigorous, healthy growth.

Return to top

Release Date: October 14, 2008

For immediate release

The Federal Reserve Board on Tuesday announced the execution of a Written Agreement by and among Irwin Financial Corporation, Columbus, Indiana, a registered bank holding company, Irwin Union Bank and Trust Company, Columbus, Indiana, a state chartered member bank, the Federal Reserve Bank of Chicago, and the Indiana Department of Financial Institutions.

A copy of the Written Agreement is attached.

Attachment (420 KB PDF)

Release Date: October 12, 2008

For immediate release

The Federal Reserve Board on Sunday announced its approval of the application and notice under sections 3 and 4 of the Bank Holding Company Act by Wells Fargo & Company, San Francisco, California, to acquire Wachovia Corporation and its subsidiary banks, Wachovia Bank, National Association, both of Charlotte, North Carolina, and Wachovia Bank Delaware, National Association, Wilmington, Delaware, and the nonbanking subsidiaries of Wachovia Corporation.

Attached is the Board's Order relating to this action.

Attachment (31 KB PDF)

Release Date: October 8, 2008

For immediate release

The Federal Reserve Board has authorized the Federal Reserve Bank of New York to borrow securities from certain regulated U.S. insurance subsidiaries of the American International Group (AIG), under section 13(3) of the Federal Reserve Act.

Under this program, the New York Fed will borrow up to $37.8 billion in investment-grade, fixed-income securities from AIG in return for cash collateral. These securities were previously lent by AIG’s insurance company subsidiaries to third parties.

As expected, drawdowns to date under the existing $85 billion New York Fed loan facility have been used, in part, to settle transactions with counterparties returning these third-party securities to AIG. This new program will allow AIG to replenish liquidity used in settling those transactions, while providing enhanced credit protection to the New York Fed and U.S. taxpayers in the form of a security interest in these securities.

Release Date: October 8, 2008

For release at 7:00 a.m. EDT

Joint Statement by Central Banks

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability. 

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

Federal Reserve Actions
The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1-1/2 percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures. 

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation. 

The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability. 

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. 

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-3/4 percent.  In taking this action, the Board approved the request submitted by the Board of Directors of the Federal Reserve Bank of Boston.

Information on Actions Taken by Other Central Banks
Information on the actions that will be taken by other central banks is available at the following websites:

Bank of Canada   
Bank of England  
European Central Bank
Sveriges Riksbank (Bank of Sweden)
Swiss National Bank (51 KB PDF) 

Statements by Other Central Banks
Bank of Japan (65 KB PDF)