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I N S I D E T H E F E D
Federal Reserve Lender-of-Last-Resort Facilities
During the 2007–2009 Financial Crisis
The onset of the 2007–2009 financial crisis in August
of 2007 led to a massive increase in Federal Reserve
lender-of-last-resort facilities to contain the crisis.
In mid-August 2007, the Federal Reserve lowered
the discount rate to just 50 basis points (0.5 percent-
age point) above the federal funds rate target from
the normal 100 basis points. In March 2008, it nar-
rowed the spread further by setting the discount rate
at only 25 basis points above the federal funds rate
target. In September 2007 and March 2008, it
extended the term of discount loans: Before the crisis
they were overnight or very short-term loans; in
September the maturity of discount loans was
extended to 30 days and to 90 days in March.
In December 2007, the Fed set up a temporary
Term Auction Facility (TAF) in which it made discount
loans at a rate determined through competitive auc-
tions. This facility carried less of a stigma for banks
than the normal discount window facility. It was more
widely used than the discount window facility
because it enabled banks to borrow at a rate less
than the discount rate and because the rate was
determined competitively, rather than being set at a
penalty rate. While the TAF was a new facility for the
Fed, the European Central Bank already had a simi-
lar facility. The TAF auctions started at amounts of
$20 billion, but as the crisis worsened, the amounts
were raised dramatically, with a total outstanding of
over $400 billion.
On March 11, 2008, the Fed created the Term
Securities Lending Facility (TSLF) in which it would
lend Treasury securities to primary dealers for terms
longer than overnight, as in existing lending pro-
grams, with the primary dealers pledging other secu-
rities. The TSLF’s purpose was to supply more
Treasury securities to primary dealers so it had suffi-
cient Treasury securities to act as collateral, thereby
helping the orderly functioning of financial markets.
On the same day, the Fed authorized increases in
reciprocal currency arrangements known as swap
lines, in which it lent dollars to foreign central banks
(in this case, the European Central Bank and the
Swiss National Bank) in exchange for foreign curren-
cies so that these central banks could in turn make
dollar loans to their domestic banks. These swap
lines were enlarged even further during the course of
the crisis.
On March 14, 2008, as liquidity dried up for
Bear Stearns, the Fed announced that it would in
effect buy up $30 billion of Bear Stearns’s mortgage-
related assets in order to facilitate the purchase of
Bear Stearns by J.P. Morgan.* The Fed took this
extraordinary action because it believed that Bear
Stearns was so interconnected with other financial
institutions that its failure would have caused a mas-
sive fire-sale of assets and a complete seizing up of
credit markets. The Fed took this action under an
obscure provision of the Federal Reserve Act,
section 13(3), that was put into the act during the
Great Depression. It allowed the Fed under “unusual
and exigent circumstances” to lend money to any
individual, partnership, or corporation, as long as
certain requirements were met. This broadening of
the Fed’s lender-of-last-resort actions outside of its tra-
ditional lending to depository institutions was
described by Paul Volcker, a former chairman of the
Federal Reserve, as the Fed going to the “very edge
of its lawful and implied powers.”
The broadening of the Fed’s lender-of-last-resort
activities using section 13(3) grew as the crisis deep-
ened. On March 16, 2008, the Federal Reserve
announced a new temporary credit facility, the
Primary Dealer Credit Facility (PDCF), under which pri-
mary dealers, many of them investment banks, could
borrow on similar terms to depository institutions using
the traditional discount window facility. On
September 19, 2008, after money market mutual
funds were subject to large amounts of redemptions by
investors, the Fed announced another temporary
*Technically, the purchase of these assets was in effect done with a
nonrecourse loan of $30 billion to J.P. Morgan, with the Fed bear-
ing all the downside risk except for the first $1 billion, while get-
ting all the gains if the assets were eventually sold for more than
$30 billion. The effective purchase of commercial paper under the
Asset-Backed Commercial Paper Money Market Mutual Fund
Liquidity Facility, the Commercial Paper Funding Facility, and the
Government Sponsored Entities Purchase Program was also done
with no-recourse loans. Purchasing assets in this way conforms to
section 13(3), which allows the Fed to make loans, but not pur-
chase assets directly.
230
Part 4 Central Banking and the Conduct of Monetary Policy
Reserve requirements have rarely been used as a monetary policy tool because
raising them can cause immediate liquidity problems for banks with low excess
reserves. When the Fed increased these requirements in the past, it usually soft-
ened the blow by conducting open market purchases or by making the discount
loan window (borrowed reserves) more available, thereby providing reserves to banks
that needed them. Continually fluctuating reserve requirements would also create
more uncertainty for banks and make their liquidity management more difficult.
Monetary Policy Tools of the European Central Bank
Like the Federal Reserve, the European System of Central Banks (which is usually
referred to as the European Central Bank) signals the stance of its monetary policy
by setting a target financing rate, which in turn sets a target for the overnight
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