U.S. Treasury Secretary and Fed Chairman Declare War on the Financial Crisis

This represents a massive infusion of critical new capital into the U.S. banking system. Gross write-offs connected with the housing recession and overall recession accumulated to about $350 billion at the end of the third quarter, close to 35% of banking system capital, with further write-downs of $200 billion to $300 billion projected, depending on the severity of the housing cycle and the recession, and the effectiveness of the TARP program.

Banks faced increasingly difficult conditions for re-capitalization in the third quarter, leading to downward pressure on their risk capital ratios, a severe tightening of credit conditions, a sharp deceleration of credit growth to below critical thresholds, and associated negative feedback loops to the economy and the level of overall equity prices. The new capital infusion represents an effective short-term tool for dealing with the crisis in the financial system, and was taken in conjunction with a broad array of emergency action recently announced by European Union governments to stabilize European financial institutions on Monday, October 13.

While this program is an effective short-term deployment of TARP resources, and should help break the logjam on credit flows, the depletion of the total $700 billion available for asset re-repurchases will likely result in another appeal to Congress for more fiscal resources to deal with the crisis in the financial system and the recession in the economy.

With European governments stepping up to the plate and making close to $2.5 trillion available to combat severe pressure on European financial institutions, requests for additional fiscal resources in the United States to combat the crisis would appear to be inevitable, either when Congress reconvenes after the elections, or early in 2009.

In addition to the capital infusion, Treasury secretary Henry Paulson signed the systemic risk exception to the FDIC act, enabling the Federal Deposit Insurance Corporation to temporarily guarantee the senior debt of FDIC-insured institutions, as well as deposits in non-interest-bearing deposit transaction accounts.

The Federal Reserve also announced further details of its new commercial paper funding facility. This facility will fund direct purchases of highly rated commercial paper of three-month maturity, commencing on October 27, with no current limit established on total purchase volumes. The Fed is using "super leverage" of its balance sheet to ramp up its response to the crisis in the financial markets.

The three major announcements to stabilize the U.S. financial system today represent a significant heightening of the U.S. policy response, and Fed chairman Ben Bernanke stated emphatically that the Treasury and the Federal Reserve will not "stand down" until the financial crisis is brought under control. Those are highly charged fighting words from the chairman, and represent the kind of leadership that the markets and the American public are looking for in the depth of a financial crisis that has been worsening for over a year.