Playing for time: the Fed’s attempt to mange the crisis as a liquidity problem

Purpose – The purpose of this paper is to examine the events leading up to the Great Recession, the US Federal Reserve’s response to what it perceived to be a short-term liquidity problem, and the programs it put in place to address liquidity needs from 2007 through the third quarter of 2008. Design/methodology/approach – These programs were designed to channel liquidity to some of the largest institutions, most of which were primary dealers. We describe these programs, examine available evidence regarding their effectiveness and detail which institutions received the largest amounts under each program. Findings – We argue that increasing financial fragility and potential insolvencies in several major institutions were evident prior to the crisis. While it is inherently difficult to disentangle issues of illiquidity from issues of insolvency, failure to recognize and address those insolvency problems delayed necessary adjustments, undermined confidence in the financial system and may have exacerbated the crisis. Research limitations/implications – Disentangling issues of illiquidity from issues of insolvency is inherently difficult and so it is not possible to specify a definitive counterfactual scenario. Nonetheless, failure to recognize and address the insolvency problems in several major institutions until more than a year after the crisis had begun delayed the necessary adjustment and undermined confidence in the financial system. Originality/value – This paper is among the first to analyze data showing the amounts of lending and the distribution of these loans across institutions under the Fed’s special liquidity facilities during the first 18 months of the financial crisis.