Subprime Mortgage Crisis Solutions Debate - Liquidity


All major corporations, even highly profitable ones, borrow money to finance their operations. In theory, the lower interest rate paid to the lender is offset by the higher return obtained from the investments made using the borrowed funds. Corporations regularly borrow for a period of time and periodically "rollover" or pay back the borrowed amounts and obtain new loans in the credit markets, a generic term for places where investors can provide funds through financial institutions to these corporations. The term liquidity refers to this ability to borrow funds in the credit markets or pay immediate obligations with available cash. Prior to the crisis, many companies borrowed short-term in liquid markets to purchase long-term, illiquid assets like mortgage-backed securities (MBSs), profiting on the difference between lower short-term rates and higher long-term rates. Some have been unable to "rollover" this short-term debt due to disruptions in the credit markets, forcing them to sell long-term, illiquid assets at fire-sale prices and suffering huge losses.

The central bank of the USA, the Federal Reserve or Fed, in partnership with central banks around the world, has taken several steps to increase liquidity, essentially stepping in to provide short-term funding to various institutional borrowers through various programs such as the Term Asset-Backed Securities Loan Facility (TALF). Fed Chairman Ben Bernanke stated in early 2008: "Broadly, the Federal Reserve's response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy." The Fed, a quasi-public institution, has a mandate to support liquidity as the "lender of last resort" but not solvency, which resides with government regulators and bankruptcy courts.

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