This design worked incredibly well, as activity in most of the facilities gradually declined to near zero, allowing the Fed to simply turn them off with no market disruption. Overall, central banks were able to accommodate the most extreme shift in the demand for liquidity that has been seen in a generation, and to do so in ways that responded to the specific needs that arose in a market-based credit system. Structural changes in dollar asset markets Although U.S. authorities managed to provide the financial system with sufficient liquidity and support to stem the market panic, they must now find a way to foster more enduring changes that will result in a sounder financial system. The crisis revealed significant structural flaws, but reforms are being debated to address many of these issues. Some of the required changes are associated with the oversight of large and interconnected financial institutions. The reform efforts underway in Congress are intended to address several points of weaknesses, including gaps in the coverage of systemically important firms and the absence of a resolution process for an orderly wind-down of failing firms. In addition, regulatory standards are being reevaluated to strengthen capital and liquidity requirements and to improve the risk capture of those standards. The crisis also revealed weakness related to specific financial markets involving structured products, housing-related GSEs, over-the-counter (OTC) derivatives, triparty repo and money market mutual funds. Reforms are underway in each of these areas.
The broad intent of all of these facilities was the same – to keep an extreme increase in the demand for liquidity from significantly disrupting the functioning of financial markets and impairing the flow of credit to the economy. The facilities, along with other efforts from governments, helped to halt the downward spiral and to alleviate the pressure on global financial institutions and markets. In the absence of such effective actions, the implications of the crisis for real economic performance would have been much worse. The success of the programs has been apparent in a number of dimensions. Most clearly, the degree of counterparty concern and liquidity hoarding in the money markets has diminished, as reflected in the decline in term funding spreads. Moreover, issuance of both commercial paper and some types of asset-backed securities has rebounded, and it has done so increasingly without reliance on the Fed’s liquidity support. It is also worth noting that the exit from the Federal Reserve’s liquidity facilities has been quite smooth. At their peak, these facilities provided about $ trillion of short-term dollar credit. Today, the remaining balance across them is well under $ billion. This reduction was achieved without creating any significant problems for financial markets or institutions. That success largely reflects the effective design of those programs, as most were structured to provide credit under terms that would be less and less appealing as markets renormalized.