In an online chat at washingtonpost.com, Brookings Expert Alice Rivlin discusses the Federal Reserve’s decision to create a new discount window for the financial institution Bear Stearns, rescuing it from the brink of bankruptcy.
Richmond, Va.: Thank you for taking our questions.
Please help me out with the fundamentals. Why is “bailing out” preferred over just letting things adjust on their own?
Alice Rivlin: If a major firm like Bear went down, it would have ripple effects across the financial sector and maybe across the economy. A lot of innocent by-standers might get caught in the tide.
New York, N.Y.: How and when will this economic climate catch up with smaller private companies and start-up companies?
Alice Rivlin: No one knows. Plenty of smaller companies are already feeling the effects of the slowing economy. Things may be slow for a while and then get better OR we may be in for a longer, deeper recession than we have had in some years.
Franklin, Tennessee: What happens when we get to the point that there is no reasonable way to make further cuts to the discount rate — are we left with no options?
Alice Rivlin: The Fed has already been using a lot of other tools besides lowering interest rates. They have been lending money directly to commercial banks and now to investment banks and taking securities such as mortgage-backed bonds as collateral. All this activity is designed to encourage banks to start lending more and get some of the questionable securities off the market, at least temporarily so markets will stabilize. And the Congress has acted, too, with the stimulus package.