The Feds to the Rescue

 

If the Federal Reserve had not partially offset this deleveraging by adding liquidity to the system, the economy would have fallen into an even deeper recession, almost certainly producing significant deflation.

Facing the prospect of a financial market collapse, the Federal Reserve and the Treasury Department worked feverishly to provide liquidity to the financial markets, to prop up those entities that needed rescuing and to reassure the public.

The Federal Reserve has been purchasing mortgages and mortgage-backed securities since January 2009. To date, Fed purchases have totaled $836 billion, and it may end up purchasing as much as $1.25 trillion in mortgages and securities. Although that volume of purchases may have replaced other purchasers, it has kept prime mortgage rates below 5.5% since November 2008.

While the Federal Reserve originally indicated that purchases would last through the end of 2009, that decision is open to change and you can expect the Fed to stretch its purchases beyond the first of the year.

One concern that has been raised frequently is the large amount of liquidity that the Federal Reserve has pumped into the financial system — and is still in the system. This greatly increases the risk of future inflation. However, this line of reasoning ignores the significant reduction in lending that occurred in the financial system during the past two years.

Courtesy of NAHB