First published: Financial Times, 07/04/2008
If you want insight about the common features of financial crises, look no further than J.K. Galbraith’s A Short History of Financial Euphoria (1990). One observation was the headlong rush to regulate and reform after the crisis erupts. True to form, the demand for or prediction of regulatory backlash is on full view. But with financial markets faulty or failing, only large-scale, unorthodox intervention by the public authorities will help stabilise the more pressing problems in credit markets. Until this is accomplished, the chances of stabilising the US and western economies are slim.The US Federal Reserve has almost single-handedly acted as bulwark against systemic financial risk and an economic meltdown. Since December 2007 the Fed has introduced credit facilities for commercial banks and primary dealers that will soon reach in excess of $300bn (€191bn, £151bn) and, in effect, nationalised the securities repurchase system in the process. In spite of these initiatives and other liquidity arrangements provided by European central banks, the liquidity premium in interbank rates remains elevated.
The Fed still has options. It can boost the volume of its lending and, more radically, it could purchase securities, including mortgage-backed assets, outright. While it may be reluctant to do so for reasons of both principle and practicality, there are precedents. It was required to by Congress in …more