What do central bankers do during a financial crisis?
On a typical day, the central bankers in the US spend their time monitoring the activities of the bank, and trying to understand the economic data, the adjustment of interest rates to help price stability and employment.
But every so often, the economy faces a financial panic that forces the Federal Reserve to take further action.
During the financial crisis of 2007-2009, which meant that the launch of lending programmes, brokering the acquisition of the weakening of society, and pumping trillions of dollars into the economy, in an attempt to ward off economic collapse.
The aggressive response marked an important change. Remember just a century before, the USA does not have a central bank at all.
Here is a look at how the Fed’s approach to the financial crisis has evolved.
The panic of 1907
Panic flares when there is suddenly a rush of demand for cash – the creation of a credit crunch of the banks and other financial institutions that have lent money.
In the 1800s, without a central bank to monitor the money supply, such episodes were frequent. Also the normal collection cycle, it may cause problems, since the farmers were in need of cash, all at once to pay their workers.
Until the panic of 1907, however, the UNITED states has been politically resistant to the idea of a central bank.
That year, when the cash was already tight – spread the word about the failure of a financial play by major bankers.
Investors rushed to pull money from businesses associated with bankers, concerned with – not necessarily rationally-their funds could be at risk.
Without a central bank, a group of entrepreneurs led by JP Morgan co-ordinated the response to the run, which included shoring up companies with the money from the Department of the Treasury.
The panic stopped, but the economy has taken a serious hit anyway.
In the following, the bankers and the legislators concluded the US need a federal government-backed institution that would have control of the coin and to serve as a lender of last resort to the banks, to prevent future panic.
Congress created the Federal Reserve in 1913.
The Great Depression
The Fed soon faced with an episode that has tested its ability to prevent problems.
At the end of the 1920’s, a credit fueled the rally in equity markets collapsed, the economy entered in a global recession, due in part by the return to the gold standard.
Thousands of banks collapsed, the unemployment rate was above 20%, and the US GDP contracted by more than a third.
The Fed has taken some measures to try to deal with the crisis, but many economists say that the institution should go beyond that.
As the Federal Reserve that sets interest rates
What is the Federal Reserve doing?
They argue that the officials were too worried that the more aggressive action of the fuel risky, speculative behaviour.
Some say not to intervene to stop the bank collapses has been particularly damaging, since it has led others to become wary about borrowing and spending, a further slowdown in economic activity.
In the end, Presidents Herbert Hoover and Franklin Delano Roosevelt came on the scene, the creation of new powers of the central bank, as the authority for the broader loan programs and the guarantee of most bank deposits.
In some cases, however, it took the industrial boom stimulated by the second World War to really get the revival of the economy.
A Meltdown Avoided
Occasionally, however, a light touch seems to be enough.
In 1998, officials at Long Term Capital Management contacted the Federal Reserve.
The hedge fund, which had Nobel prize winners among its protagonists, has had more than $100bn (Â£74.2 bn) in assets, and has enjoyed close ties with the most important financial companies.
But the losses on Asian markets had brought on the verge of bankruptcy.
Worried about the consequences of a collapse to other firms, the Fed has convened a group of companies to organize a rescue plan. At the end of the 14 companies injected $3.6 billion and took the shares.
The episode was resolved without major problems of the market and without the use of Fed funds.
But a decade later – as the US faced another crisis of some cite as an example of a lost opportunity when the regulatory authorities should have imposed stricter rules for the risk of the financial instruments.
The 2007-2009 financial crisis
In 2007, US housing prices started to falter – a sign of the cracks that form in the US economy, which would then be declared in recession.
The Fed chairman was Ben Bernanke, a professor who has studied the Fed’s response to the Great Depression and was determined to avoid her mistakes.
The Fed has put its traditional tools to use, by cutting interest rates and injecting money into the economy buying bonds.
Then the officials went over.
I am convinced Congress to launch loan programs, and engineered the acquisition of the failures of business, proving willing to take on non-performing assets to get deals done.
And for the first time in decades they have used the Fed’s lender of last resort powers to provide loans to financial companies that were not banks, including the insurer AIG.
The moves drew fierce game, and fueled a political movement, angry at a banker’s rescue. But the fans, has said that it has stopped financial problems to stimulate a great recession.
These days, with strong economic growth and a low unemployment rate, the Fed has stopped or is the reversal of these programmes.
Some analysts, however, joke that officials also want the space to manoeuvre, as they are already anticipating the next panic.