Economy: The Fed Steps In

Alice Rivlin
Alice Rivlin (Brookings Institution)
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Alice Rivlin
Economist and Former Director, Office of Management and Budget
Monday, March 17, 2008; 12:00 PM

The The Federal Reserve took dramatic action on multiple fronts last night to avert a crisis of the global financial system, backing the acquisition of wounded investment firm Bear Stearns and increasing the flow of money to other banks squeezed for credit.

After a weekend of marathon negotiations in New York and Washington, the central bank undertook a broad effort to prevent key financial players from going under, including the unprecedented offer of short-term loans to investment banks and an unexpected cut in a special bank interest rate.

"The Fed had a busy weekend. It engineered the rescue of Bear Stearns. It set up a new discount window to lend to big investment banks taking mortgage-backed securities as collateral. And it cut the discount rate. That is a lot of emergency action," said Alice Rivlin, economist, former director of the Office of Management and Budget and founding director of the Congressional Budget Office, in an interview with

She was online Monday, March 17, at Noon ET to discuss the action of the Federal Reserve and how it will affect the economy.

Alice Rivlin, economist, former director of the Office of Management and Budget and founding director of the Congressional Budget Office, was online Monday, March 17, at Noon ET to discuss the action of the Federal Reserve and how it will affect the economy.

A transcript follows.


Richmond, Va.: Thank you for taking our questions.

Please help me out with the fundamentals. Why is "bailing out" preferred over just letting things adjust on their own?

Alice Rivlin: If a major firm like Bear went down, it would have ripple effects across the financial sector and maybe across the economy. A lot of innocent by-standers might get caught in the tide.


New York, N.Y.: How and when will this economic climate catch up with smaller private companies and start-up companies?

Alice Rivlin: No one knows. Plenty of smaller companies are already feeling the effects of the slowing economy. Things may be slow for a while and then get better OR we may be in for a longer, deeper recession than we have had in some years.


Franklin, Tennessee: What happens when we get to the point that there is no reasonable way to make further cuts to the discount rate -- are we left with no options?

Alice Rivlin: The Fed has already been using a lot of other tools besides lowering interest rates. They have been lending money directly to commercial banks and now to investment banks and taking securities such as mortgage-backed bonds as collateral. All this activity is designed to encourage banks to start lending more and get some of the questionable securities off the market, at least temporarily so markets will stabilize. And the Congress has acted, too, with the stimulus package.


Flemington, N.J.: Everybody says things might get worse but will get better.

My advisor says sit tight, it will get better. What happens if things don't get better?

Alice Rivlin: Eventually things will get better! If you own a good diversified portfolio of stocks, sitting tight is probably the right advice. But you may have to sit quite a while.


Montpelier, Vt.: How can a firm the size of Bear Stearns have these kinds of problems come 'out of the blue' if federal regulators were doing their job?

Has federal regulation of this industry gone lax in the last decade?

Alice Rivlin: There is a lot of blame to go around. The regulators did not foresee the risk that large holders of mortgage-backed securities would be in trouble if housing prices went down. But neither did investors. They didn't ask the right questions about the quality of the assets backing the securities they bought. There was a lot of greed and wishful thinking involved. Also the sub-prime market was quite new and should have been better regulated.


Boston, Mass: What kind of impact does the fall of the U.S. dollar have on the average American consumer?

Alice Rivlin: Consumers will find imported goods more expensive. Traveling abroad will be very expensive--even to Canada. Oil prices will probably continue to rise. But if this consumer makes exports or sells things to foreigners, she will benefit.


Bethesda, Md.: How is it that Bear Sterns got away with saying everything was fine last week and today it is sold for $2.00 a share. Someone is lying and the Fed is letting these companies deceive investors. I am dubious that letting Bear Sterns collapse would hurt anyone but traders on Wall Street. How do we know that one bank collapse would be ruin the economy? Maybe it would send a message to other Wall Street Firms to police itself better. And does anyone know if insiders were selling off the stock while assuring markets it was okay?

Alice Rivlin: Bear didn't get away with much. The share-holders lost almost everything. Let's hope the message has already gotten across.


Austin, Tex.: How much, if at all, does the war in Iraq contribute to current economic problems? (Whether because of federal budget deficits, oil prices, or consumer confidence and general state of mind.)

Alice Rivlin: Very hard to say. Most of the upward pressure on the oil price comes from high demand for oil, especially from rapidly growing countries like China and India. But the war keeps everything more unsettled and probably undercuts consumer and investor confidence. It also adds to the budget deficit. But looking ahead, the big drivers of government spending will be Social Security and Medicare--much bigger than military spending.


Vienna, Va.: Has the Fed considered any action like the Home Owner's Loan Corporation (HOLC) that was put in place during the 1930s? I understand the HOLC acquired defaulted residential mortgages from lenders and investors, gave its bonds in exchange, and then refinanced the mortgages on more favorable and more sustainable terms. Wouldn't this serve the dual purpose of helping struggling homeowners and shoring up the debt-backed securities comprised of their sub-prime mortgages?

Alice Rivlin: This idea is certainly being talked about in Washington. The Fed probably wouldn't be the right agency. Congress could give this responsibility to the Treasury or some other agency or create a new one. This administration (so far)has not favored such direct government intervention.


Capitol Hill, D.C.: Ms. Rivlin: My sense from reading articles on the Bear Stearns buy-out and the rest of the sub-prime mess is that the U.S. economy is quite fragile. I also gather that "trust" seems to be at the heart of economics -- people trust in the "value" of gold, banks, dollars, whatever. And that the fate of the dollar (now lower even than the Canadian dollar) reflects the world's lack of trust that the U.S. can exercise enough self-control to turn a crisis around.

Is my non-economist's understanding correct?

Alice Rivlin: Yes--but don't over do it. The financial system is fragile, although so far almost all big financial institutions are weathering the storm. The Fed is trying to help the banks to regain their trust in each other and potential credit-worthy borrowers, so the distrust doesn't spread to the rest of the economy. It may work!


Ashburn, Va.: What effect might this economic maelstrom have on interest rates for ordinary consumers? Will we see mortgage rates go down further?

Alice Rivlin: Mortgage rates will probably go down further for people with good credit. Lenders are going to be much more cautious about lending to people with less good credit.


USA: Why was the price paid for Bear so very low? I'm not expert, but I would have imagined that Bear's physical assets (everything from real estate to office supplies) would be worth more than $2/share.

Alice Rivlin: You are probably right, but it was a fire sale. Bear had to find a buyer or face total collapse, so they took the $2.


Arlington, Va.: I see this as a credit crisis -- not a traditional crash-provoked lack of money. With foreclosed properties accumulating on banks and outfits like Countrywide, I think the Fed should try to accelerate the writing off of these bad debts, instead of letting them sit there and fester. The bad debts are just accumulating, which is what brought Bear Stearns down. So what do we do with all these bad mortgages, foreclosed (and empty) houses? I am old enough to recall a similar crisis involving S and L's which resulted in the government bulldozing down a Texas development. Do we need to come up with a method to get these foreclosed homes off the market faster?

Alice Rivlin: You are certainly right about waiting too long to fix the S and L crisis. Also the Japanese waited too long after their crisis. But I think this lesson has been learned. We have already seen big writedowns and will doubtless see more.


Woonsocket, R.I.:"It may work."

And if it doesn't? If the US economy follows a more pessimistic model, what can ordinary working-class Americans do to cope with the recession or depression to come?

Alice Rivlin: Most ordinary Americans have not been greatly affected yet. Most people have jobs and are going about their business as usual. The irony is that the best advice for individual Americans is: spend a little less, save your money in case you need it, pay down your credit card debts. The problem is that if everyone does that the economy will slow more!


Ellicott City, Md.: It's often said that if we bail out foolish investors, then we'll just encourage unsupported risk-taking in the future and another crisis will follow down the road. I read that Bear Stern stock that was $30/share recently is going to cost just $2 as a condition of the bail out. Are the right people suffering at this 90 percent drop in stock value?

Alice Rivlin: The shareholders of Bear lost a bundle. Remember that the shares were $30 on Friday when everyone already knew the firm was in trouble. They had been way over $100 last year. The executives lost a lot--both money and status. Some people who contributed to the downfall doubtless made a lot of money and got out with it already. Its hard to punish them.


Oviedo, Fla.: Ms. Rivlin -- you were my childhood hero. Thanks for your decades of exemplary public service.

How much control does the Fed have over the current market crisis given that the global markets are also in turmoil? How much stability can the Fed bring to bear here?

Alice Rivlin: Thanks! The Fed is pretty central to the world economy and is cooperating with the other big central banks, such as the European Central Bank and the Bank of Japan. They all want the markets to stabilize, but we will see how much collective power they have. I'm hopeful.


Alice Rivlin: I am sorry I didn't get to more questions. I'm a slow typist! Thanks for the interest and the excellent questions! Alice Rivlin


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