Fed Tackles Crisis With Sweeping Policy Changes

In Depth

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In its urgent effort to thaw the frozen credit markets, the U.S. Federal Reserve is moving aggressively to overhaul monetary policy — exerting an influence not felt since the Great Depression.

It pulled one of its biggest levers Wednesday, when the Fed joined with central banks in England, Canada, Sweden, Switzerland and China in lowering the benchmark rate.

The Fed dropped what is known as the federal funds target rate, or the amount its customers charge to lend money from their Federal Reserve accounts to other banks for very short periods. The rate went from 2 percent to 1.5 percent.

Historically, adjusting the interest rate has been the Fed's key mechanism for carrying out monetary policy. It's how the Fed insures that banks, businesses and individuals can get enough credit to keep the economy humming, without making money so easy to come by that the dollar falls in value and inflation takes hold. Nearly every small change in the rate makes major headlines.

But in the current full-blown credit crisis, the Fed has taken far more dramatic measures. The list includes:

Saving Fannie Mae, Freddie Mac And AIG: During the week of Sept. 7, the Federal Reserve worked with the U.S. Treasury to rescue the mortgage giants Fannie Mae and Freddie Mac and the enormous insurer AIG. For the first two, the Fed made available some $200 million to cover bad debts in the mortgage market. In the case of AIG, the Fed loaned $85 billion to keep the company from sinking under the weight of risky credit default swaps. On Oct. 8, the Fed announced it would lend AIG another $37.8 billion.

Loosening Rules For Bank Lending: The investment arms of so-called universal banks — those that also take retail deposits — had been banned from borrowing money from the savings branch of their own firms. The idea was to protect consumers against conflicts of interest. But as their portfolios of mortgages and mortgage-backed securities soured, investment banks began to have a hard time getting the quick loans they routinely use to keep operations going. In time for the markets to open on Sept. 15, the Fed changed the regulations to let them borrow money inside their own firms.

The $700 Billion Wall Street Bailout: On Sept. 18, the Fed teamed with the U.S. Treasury to request congressional approval for buying up troubled assets from banks. The plan struggled to pass Congress. The House of Representatives voted the plan down on Sept. 29. The Senate passed a much-modified version on Oct. 1, and the House gave its approval on Oct. 3. The Troubled Assets Relief Program gives the Treasury wide latitude in deciding what and how to purchase. The idea is to help banks clear their portfolios of so-called toxic waste, largely mortgages or bundles of mortgages that are nearly impossible to properly price in a market where no one wants to buy them. Eventually, say backers of the plan, the government will be able to sell those holdings and recoup at least some of the taxpayer investment. The plan also raises the ceiling for insurance on bank deposits to $250,000. And it allows the government to buy stock in firms directly, a process known as stock injection.

Opening 'Swap Lines': This week the Fed made $600 billion available to the central banks of other countries, another attempt to get money flowing through the global economy again. Countries tap their "swap lines" to trade currencies with other nations. It's a complicated system, but in the end Fed gets back the money it placed into circulation.

Lending Directly To Businesses: On Oct. 7, the Fed announced it would offer short-term loans to stable companies — the first time the Fed has taken that step since the Great Depression.

As banks have grown wary of lending, businesses have found themselves unable to borrow the very large sums of money over very short periods that make commerce possible. Under normal circumstances, a company can get a loan for several hundred million dollars by selling what's known as commercial paper — basically, a type of IOU. These short-term loans are made overnight or for a few months.

But the credit crunch has made such loans harder and more expensive to come by. The Fed's move allows businesses that rely on commercial paper for day-to-day operations to sell it directly to the central bank. The goal is to restore confidence and encourage more lending in the commercial paper market, which is key to the real economy.

With additional reporting by Maria Godoy

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