The Federal Reserve’s monetary policymaking committee (the Federal Open Market Committee – FOMC) announced today that it has decided to cut its target overnight interest rate (the “federal funds rate”) to 2¼ percent, from 3 percent, a 75 basis-point cut (one basis point is one hundredth of a percent).
Highlights of today’s monetary policy statement:

• In today’s policy statement, the Fed noted that: “Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened.”

• The statement also noted that: “Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.” :

• The Fed, in addition, noted that inflation has been elevated and that there is some evidence that inflation expectations have risen. :

• The Fed also approved a 75-basis-point cut in the discount rate to 2½ percent, from 3¼.

• Today’s action follows a sequence of earlier cuts in the federal funds rate:
o a cut of 50 basis points on January 30;
o a cut of 75 basis points in the federal funds rate on January 22, that occurred between regularly scheduled FOMC meetings;:

o a cut of 25 basis points on December 11 of last year; :

o a cut of 25 basis points on October 31; :

o and a cut of 50 basis points on September 18.
• There have also been cuts in the Fed’s discount rate—a rate, called the “primary credit rate,” charged by regional Fed banks on loans to financial institutions with eligible collateral—from a recent high of 6¼ percent in effect until August 17 of last year down to the current 2½ percent.

• The next scheduled meeting for the FOMC is April 29 and 30.

• The Fed’s policy statement that was issued today can be viewed at http://www.federalreserve.gov/newsevents/press/monetary/20080318a.htm

Earlier Actions:


• In addition to the usual monetary operating procedures involving changes in the federal funds rate and the discount rate to influence the economy, the Fed has established more unusual practices in the face of persistent strains in financial markets:
o On December 6 of last year, in an unscheduled FOMC meeting, the Fed decided to establish a “Term Auction Facility (TAF)” designed to provide term funding to eligible depository institutions through an auction mechanism that began in mid-December (the Board of Governors of the Federal Reserve System approved the TAF via notation vote on December 10, 2007).
- The TAF provides more liquidity (i.e., borrowed cash) to more counterparties and against a broader range of collateral than used in the Fed’s typical open market operations (which involve Fed injections of currency into the banking system when the Fed buys or temporarily possesses Treasury securities from dealers).

- Under the TAF, the Fed auctions term funds to depository institutions against a wide variety of collateral used to secure the loans at the Fed’s discount window.

- According to the Fed “By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.”

- The Fed began in mid December with auctions of $20 billion. The auction sizes were increased to $30 billion each at the start of this year. On March 7, the Fed announced that the auctions on March 10 and March 24 would be increased to $50 billion each.
o The Fed also announced, on March 7, that it would initiate a series of term repurchase transactions expected to cumulate to $100 billion. Those transactions are conducted as 28-day term repurchase agreements in which primary dealers deliver collateral to the Fed in exchange for cash with a promise to repurchase and repossess the securities 28 days down the road. The Fed decided to allow dealers to elect to deliver as collateral any of the types of securities—Treasury, agency debt, or agency mortgage-backed securities—that are eligible as collateral in conventional open market operations.

o On March 11, in an unscheduled meeting of the FOMC, the Fed decided to expand its securities lending program under a new “Term Securities Lending Facility (TSLF).”
- Under the TSLF, the Fed will lend up to $200 billion of Treasury securities (the Fed is lending Treasury securities here, not cash) to primary dealers, secured for a term of 28 days (rather than overnight, as in the previously existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities, and non-agency AAA/Aaa-rated private-label residential and other collateral. As in the case with the Fed’s existing securities lending program, securities in the TSLF will be made available through an auction process. Auctions are to be held on a weekly basis, beginning on March 27, 2008.

- In effect, the Fed is engaging in a re-shuffling of the asset side of its balance sheet, trading off Treasury securities for the other securities listed above, potentially including non-agency private-label residential securities. Of course, the Fed will take such collateral with a “haircut” (meaning that the Fed will trade on less than a dollar-for-dollar value of Treasuries for these other securities as a safeguard against risk), but unless we know how big the haircut is, we don’t know how much risk the Fed is undertaking on behalf of taxpayers.
o On Sunday, March 16, the Fed announced two more unusual initiatives designed to bolster market liquidity and orderly market functioning.
- First, the Fed decided to create another lending facility designed “…to improve the ability of primary dealers to provide financing to participants in securitization markets.”
• The facility, available for business on Monday, March 17, will be in place for at least six months.

• Credit extended to primary dealers under this facility can be collateralized by a broad range of investment-grade debt securities, with the interest rate charged on the credit equaling the primary credit rate (the “discount rate”).

• By extending credit directly to dealers against a wider range of collateral, the Fed is taking on additional private sector risk.
- Second, the Fed approved financing arrangements announced by JPMorgan Chase & Co. and the Bear Stearns Companies Inc. As part of those arrangements, the Fed agreed to a non-recourse loan of $30 billion to JPMorgan Chase & Co., secured by difficult-to-value assets inherited from Bear Stearns. In the event that those assets decline significantly in value, the Fed and, consequently, U.S. taxpayers will incur the losses.



Jeffrey Wrase
Chief Economist, Senate Republicans
jeff_wrase@jec.senate.gov
202 224 2335