PART III: Money Market Actions Fail to Stem the Tide

The Global Financial Crisis: How Did We Get Into This Mess?

PART I: The Back Story
PART II: Securitization, CDOs and Sub-Prime Mortgages
PART III: Money Market Actions Fail to Stem the Tide
PART IV: Corporate Casualties Pile Up

The U.S. Federal Reserve and other central banks including the Bank of England and the European Central Bank reacted to the developing credit crisis by pumping money into their respective financial systems to unfreeze liquidity, and allocating funds for lending to banks at reduced rates.

Interest rates were also cut repeatedly across the world. This made loans less expensive to amortize (pay off), and was done to encourage banks to lend, which in turn, it was hoped, would help the general economy halt its downward trend. In the U.S., for instance, the Fed Funds Rate, which is the interest rate at which banks lend to each other, was maintained at 5.25% from June 2006 to August 2007. Over the next year and a half it was then systematically reduced to the current all-time low target range of 0.00% to 0.25% in December 2008.

The Bank of England’s Official Bank Rate similarly underwent several cuts from its recent high of 5.75% in July 2007 to its current 0.5% level in March 2009. Meanwhile, the European Central Bank’s MRO rate now stands at 1%, down from a recent peak of 4.25% in July 2008.

However, the efforts of the world’s central banks had little real effect, and the credit squeeze continued as banks remained reluctant to lend to each other or to corporations and individuals. When lending activity dries up, we tend to see an increase in job losses, bankruptcies and foreclosures, which can lead to recession – and this is exactly what transpired in the United States and across the globe.  

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