Thursday, December 13, 2007

Fed Acts to Boost Economy and Prevent Additional Subprime Fallout

The Federal Reserve made major moves this week to thwart a recession and improve economic growth.

On Tuesday, the Fed cut the interest rate again, the third cut in the last few months. The group cut the federal funds rate, an overnight bank lending rate that affects interest on credit cards, auto loans and home equity loans. The rate now stands at 4.25 percent.

The Fed also cut the discount rate, governing the interest banks pay to borrow directly from the central bank, to 4.75 percent.

On Wednesday, the Fed acted again, announcing a plan to pump billions into the financial system to ease the burgeoning credit crunch.

The plan involves auctioning off the rights to borrow money directly from the Fed. This means banks would be able to access funds without the usual interest, based on the discount rate. From December 17 until January 28, four auctions will be held, with the first two auctions offering rights at up to $20 billion each.

Around the world, other central banks will offer similar auctions. Additionally, the Fed has established foreign exchange swaps, enabling the European Central Bank and Swiss National Bank to make loans in dollars. The goal of this step is to hopefully alleviate interest rates abroad.

Analysts and economist say the auction plan could potentially help banks hurt deeply by the subprime mortgage meltdown. According to estimates, banks across the industry have already reported about $100 billion in losses associated with subprime mortgages.

The Fed has made its interest rate cuts in efforts to stem the bleeding from the housing market turmoil, and prevent major economic fallout. With their announcement this week they acknowledged that "economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending." The Fed added that "some inflation risks remain" and the Fed "will continue to monitor inflation developments carefully."

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