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Financial Turmoil: Comparing the Troubled Asset Relief Program to the Federal Reserve's Response 1 (October 8, 2008)

handle is hein.tera/crser0301 and id is 1 raw text is: Order Code RS22966 October 8, 2008 WCRS Report for Congress Financial Turmoil: Comparing the Troubled Asset Relief Program to the Federal Reserve's Response Marc Labonte Specialist in Macroeconomics Government and Finance Division Summary As financial conditions have deteriorated over the past year, the Federal Reserve (Fed) has greatly increased its lending to financial firms. It has also expanded the scope of eligible borrowers to include non-bank financial firms. As of October 1, 2008, the Fed had loans of $559 billion outstanding, compared with less than $1 billion outstanding one year earlier. In addition, it has provided financial assistance to Bear Stearns and American International Group (AIG). Some have asked why these loans have not restored financial stability, and if the purchase of up to $700 billion of distressed assets through the recently enacted Troubled Asset Relief Program (TARP) might lead to a different result. H.R. 1424, signed into law on October 3 (P.L. 110-343), authorizes the creation of TARP. Financial firms have faced two broad problems over the past year - concerns about liquidity and capital adequacy. Liquidity problems refer to the inability of firms to liquidate assets fast enough to meet their short-term obligations; capital problems refer to an inadequate buffer between a firm's assets and its liabilities. The basic difference between the Fed's actions and those under TARP is that the Fed's normal activities can address only the liquidity issue, whereas TARP can address both. Some have suggested that a program similar to TARP could theoretically be carried out through the Fed. The Fed's normal authority would not allow this; however, it has much broader emergency authority. Although the Fed cannot purchase assets directly, the assistance it provided to Bear Steams is similar in form to the basic concept of TARP. Financial assistance to financial firms entails similar risks to taxpayers whether it is provided through the Treasury or the Fed. The Fed earns profits on its loans and other investments, and each year nearly all of those profits are remitted to the Treasury. If those loans were to yield losses, the losses would reduce the Fed's profits, and hence its remittances to the Treasury, causing the federal budget deficit to rise from what it would otherwise have been. Congressional Research Service a The Library of Congress Prepared for Members and Committees of Congress

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