More Relief for the Credit Crunch?


The head of the New York Fed, Timothy Geithner, hinted at further actions to restore banking confidence but offered no specifics

Central bankers made news for a third day in a row on Dec. 13 when the president of the New York Fed said that more action to relieve the credit crunch may be in store. In the text of his speech posted on the bank's Web site, Timothy Geithner said "efforts are under way" both within the Fed and at other central banks to determine whether "we need additional instruments that would better enable us to mitigate marketwide liquidity problems."

Geithner spoke at a conference sponsored jointly by the Federal Reserve Bank of New York and Princeton University. His remarks were closely followed because the bank he runs is the most powerful of the Fed system's 12 regional banks. Moreover, Geithner is a close adviser to Fed Chairman Ben Bernanke.

Market Remains Jittery

Central bankers around the world have been struggling to restore confidence in the banking system, which has been shaken by the meltdown in the U.S. housing market and the decline in value of housing-related assets such as securities backed by subprime mortgages. One key measure of nervousness is that the rates on loans between banks, which are usually considered nearly risk-free, are running well above the federal funds rate and other rates controlled by central banks.

Geithner's mention of possible "additional instruments" to deal with illiquidity was brief and lacking in detail. Geithner gave no sense that some initiative is in the offing. Still, the remark indicates that central bankers feel their work isn't necessarily done.

Investors have reacted poorly to this week's actions by the Fed and others. On Dec. 11 the Dow Jones industrial average fell more than 2% after the Federal Open Market Committee cut the fed funds rate and the discount rate each by a quarter-point. Investors had been hoping, if not quite expecting, a bigger cut, especially in the discount rate.

Central Banks' Plan

A day later, markets rallied strongly but then lost most of their ground after the Federal Reserve and the central banks of Europe, England, Switzerland, and Canada announced a coordinated plan to increase confidence (BusinessWeek, 12/13/07) in the banking system by accepting a broad range of banks' assets as collateral for loans, possibly including subprime loans and mortgage-backed securities.

Geithner devoted most of his comments to explaining the plan announced Dec. 12 (BusinessWeek.com, 12/12/07). According to his prepared text, the New York Fed chief said central bankers are concerned about a snowball of fear in the markets, or what he called "the risk of an adverse, self-reinforcing dynamic in which concerns about overall liquidity magnify concerns about credit problems."

Geithner acknowledged that central bankers haven't done anything to shore up banks' weakened balance sheets—the heart of the problem. But he said, "by providing a more effective form of access to liquidity, these new measures can help reduce the uncertainty that gives institutions the incentive to secure liquidity in ways that might lead to a further deterioration on market conditions."

Coy is BusinessWeek's Economics editor.

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