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By Glenn Hubbard, Hal Scott and John Thornton
Published: August 20 2009 19:55 | Last updated: August 20 2009 19:55
As leaders gather this week for the annual Jackson Hole symposium on the economy, they should consider the future of the Federal Reserve as lender of last resort. Over many decades and especially in this financial crisis, the Fed has used its balance sheet to be a classic lender of last resort. But its ability to do so depends upon its economic credibility and political independence, attributes the Fed has compromised in this crisis.
As the crisis worsened at the end of 2007, the Fed created new liquidity facilities, some of which involved new recipients, beyond depository institutions, such as investment banks and corporate commercial paper issuers. In addition, in 2008, the Fed made extraordinary "bail-out" loans to avoid the failure of systemically important institutions "“ a $30bn (£18bn, â?¬21bn) non-recourse loan, with a $1bn deductible, to assist JP Morgan Chase's acquisition of Bear Stearns and the creation of a two-year $85bn credit facility for AIG. Also, the Fed, in partnership with the Treasury and Federal Deposit Insurance Corporation, guaranteed $424bn of losses on pools of Citigroup and Bank of America bad assets.
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