Markets not yet back to normal, says Fed’s Mishkin

NEW YORK – The Federal Reserve’s actions in lowering interest rates in August and September “have helped improve conditions in several short-term funding markets and instill confidence in investors that liquidity would be available if needed,” Frederic Mishkin, a member of the central bank’s board of governors, told a conference today. But, he added, “market functioning has certainly not yet returned to normal.”
The gathering at the Museum of American Finance commemorated the Panic of 1907, the market collapse that spurred the Fed’s creation. In the 15 months from September 1906 to November 1907, the total value of shares listed on U.S. markets plunged 37 percent, ushering in the collapse of at least 25 banks and 17 trust companies, according to a recent book on the event.
Mishkin made no other reference to recent Federal Reserve monetary policy. Instead, he discussed the Fed’s responsibilities and its reactions to past financial crises.
“A stable financial system is of vital importance for the Federal Reserve if it is to pursue its statutory goals of maximum sustainable employment and stable prices,” Mishkin said. The agency’s “role as a provider of liquidity … has been, and will continue to be, critical to its success,” he added, stressing that “the more quickly liquidity can be provided when financial instability occurs, the more effective it may be.”
Intervening too often or too early – especially to assist insolvent financial institutions – might encourage banks to take on too much risk, he warned, saying: “That additional moral hazard will worsen, rather than enhance, the stability of the financial system.” But, Mishkin added, “when financial institutions that are otherwise perfectly solid are at risk of failure because market infrastructures are disrupted – or, more generally, when financial instability originates outside the banking sector – an intervention by the Federal Reserve would certainly be beneficial and the creation of perverse incentives would probably be limited.”
The next regular meeting of the policymaking Federal Open Market Committee is slated to begin tomorrow and run through Wednesday.
Last month, the FOMC pared the benchmark federal funds rate by half a percentage point – twice as much as most economists had predicted. (READ MORE) At its meeting this week in Washington, D.C., the panel is expected to pare the funds rate by a quarter of a percentage point to 4.5 percent, according to a survey of economists by Bloomberg News.
Additional information, including the text of Frederic Mishkin’s speech today at the Museum of American Finance Commemoration of the Panic of 2007, can be found at www.federalreserve.gov.