The Role of Central Banks in Credit Markets

Jeffrey Lacker

Speech from Federal Reserve Bank of Richmond

Abstract: By now I'm sure the events of this past summer are very familiar to most financial market professionals.1 Since these events form the backdrop for my discussion of the central bank's role in credit markets, I will begin with a quick review. As the housing downturn that began early in 2006 deepened, delinquencies, defaults, and loss rates rose on high-risk mortgages, particularly more recent vintages. In response to unfolding events — including rating agency downgrades and losses and insolvencies at various intermediaries — participants in markets for instruments with mortgage debt exposure revised downward their assessments of the likely future returns on the underlying assets. At times investors had difficulty discerning the magnitude of their counterparty's vulnerability and thus distinguishing among various instruments. This became particularly acute in early August following a suspension of fund redemptions by a large European intermediary, and for several days thereafter many markets were roiled as investors appeared to pull back from a broad range of asset classes.

Date: 2007-11-07
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