Emergency Measures by Fed Hope to Boost Market Confidence

The Dow Jones industrial average set an intraday record by dropping a staggering 800 points during Monday. Traders breathed a sigh of relief when the Dow rallied just before closing, ending with a loss of 370 points at 9,955. This is the first time in four years that the Dow has closed at below 10,000 reflecting a decline of almost 30 percent in comparison with the all-time high of 14,164 experienced in October last year.

The late in the day rebound was likely fueled by speculation that the U.S. Federal Reserve would be forced to take more immediate financial rescue measures than the planned purchase of troubled mortgages in an effort to thaw out the credit freeze. So an announcement made by the Fed that it will immediately increase the money available to the nation’s banks by hundreds of billions of dollars, was welcome news. This move is seen as an acknowledgement by U.S. authorities that many key financial institutions need liquidity right now, and would not be able to hold out until the mortgage-buying plan was put into action by the Treasury. It is anticipated that this willingness to pump cash into the system, regardless of the risks associated with accepting troubled mortgages as collateral, will boost confidence in the government’s abilities to stabilize the shaky economy.

The Fed will make the money available to financial institutions via various means, including its “auction facility” which allows banks to bid for the rate they are willing to pay in order to borrow funds, while at the same time accepting a wider range of collateral against the loans than in more traditional forms of lending. The auction facility was put into practice in December 2007, with a set limit of $20 billion. By late May the amount was increased to $150 billion, and the announcement on Monday indicated that this would be doubled immediately to $300 billion, split between two different length loans, being 28-days and 84-days. Moreover, the Fed would begin to pay banks interest on their reserve holdings. This change had been in the pipeline to put into action in 2011, but was fast-forwarded to became part of the revised $700 bailout plan signed into law on Friday.

Some may see these emergency measures by the Federal Reserve as sufficient to get the economy back on track, thereby negating the need for the Treasury to implement the mortgage-buying bailout plan. However, experts agree that the Fed’s actions are only a short term measure aimed at treating the symptoms of the problems, whereas the Treasury would need to get to the root of the problem to strengthen the very foundations of the U.S. economy.