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October 14, 2008

The lender of last resort

The Federal Reserve has been in the news a lot recently with its efforts to rescue banks and prop up the financial services system. Why is the Fed doing this? Is it part of its job?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"It really is. The Federal Reserve was created a little less than 100 years ago. Before that time, we really did have a free for all in the banking and financial system, and when we did periodically have a systematic failure among banks, the market just had to absorb that, and we had horrendous recessions that followed those and big spikes in unemployment. So in the early part of the 20th century, the view was that we needed some backstop. We needed an institution that stood behind the banks, stood behind the financial services sector, that could step in when there was a systematic problem across the entire spectrum of banks. And that, indeed, was the Federal Reserve. And among other things, it is the lender of last resort. So what we're seeing today really does follow from the purpose of the Federal Reserve. I think what is different today is number one, the scope - how much money the Federal Reserve has had to put out there - and also the fact that we've got a different financial services sector system today. We don't have just commercial banks. We have these investment banks. We have these conglomerates. And the Federal Reserve has expanded its scope to enclose those institutions. But really, this is following from the charter, the whole purpose of the Federal Reserve, established in the early part of the 19th century."

Posted by Dave at October 14, 2008 08:44 AM