2007, intensified considerably last fall. failures and near - failures of some major financial institutions greatly undermined confidence in financial institutions and severely disrupted financial markets, leading to a further sharp tightening of credit conditions. risk spreads, which were already elevated, escalated further and equity prices fell. in addition, the financial turmoil contributed to a sharp decline in consumer and business confidence. the result was a major pullback in spending as consumers responded to decreases in wealth and the deterioration in their future employment prospects and as businesses, worried about the demand for their products, cut back on capital spending and sharply reduced production to avoid an accumulation of unsold stocks. a gradual decline in economic activity through most of 2008 took a decided turn for the worse late in the year. the policy response because the threat to economic stability in the current episode has been so closely related to problems in the financial sector, most of the policy responses have been focused on financial institutions and markets and the flow of credit to households and businesses. many of these policies have been aimed at countering the tightening of financial conditions that occurred as lenders became more risk averse and took steps to conserve capital and liquidity. to that end, the federal reserve has lowered interest rates, made backup sources of liquidity available to private lenders, and used its own lending capacity to try to revive a variety of financial markets. in addition, the federal reserve, the treasury, and the federal deposit insurance corporation ( fdic ) have taken a number of steps to stabilize and repair financial institutions in order to limit the tendency of those institutions to pull back from lending and thereby intensify the decline in spending. other government policies operate at the intersection of the financial and real sectors. foreclosure mitigation, for example, not only serves to keep people in their homes, but also should reduce downward pressures on house prices and hold down loan losses at lenders. finally, fiscal stimulus works directly on demand, in effect bypassing the financial sector in its first - round effects ; by strengthening aggregate demand, it too should help alleviate strains on lenders and contribute to stemming the vicious cycle. although i'll be discussing each of these policy initiatives separately, it is important to keep their interactions in mind. they all attempt to break into that adverse feedback loop we've been talking about at different points in the chain of cause and effect and then cause again. the expectation of recovery rests importantly on the natural recuperative powers of the economy, but it also

have designed many of our facilities to discourage use when markets are functioning more normally, and securities that have been accumulated can be sold when such sales are judged to be appropriate. however, given very large purchases of long - term assets and substantial longterm lending for the talf and other purposes, the federal reserve would benefit from new tools that would allow it to drain reserves from the banking system. we are working with the treasury and the congress to obtain such tools. financial repair in addition to the federal reserve's monetary policy actions, which broadly support the financial sector and the economy, the government – including the treasury, the federal reserve, and the fdic – has been working to provide more direct support to financial firms. 4 in part, this effort has involved targeted actions to prevent the failure or substantial weakening of specific systemically important institutions, including bear stearns, fannie mae, freddie mac, aig ( american international group, inc. ), citigroup, and bank of america. these actions were not taken to protect the affected firms'managers or shareholders from the costs of past mistakes. indeed, managers have been replaced in some cases, and shareholders of the weakest firms have experienced massive losses. instead, our actions have been driven by concerns that the disorderly failure of a large, complex, interconnected firm would impose significant losses on creditors, including other financial firms, dislocate a range of financial markets, and impede the flow of credit to households and businesses. losses sustained by other financial firms could erode their financial strength, limiting their ability to play their intermediation role, or even cause them to fail, reinforcing financial pressures. moreover, the disorderly failure of a large, complex interconnected firm could undermine confidence in the u. s. financial sector more broadly, potentially triggering a widespread withdrawal of funding by investors and an additional tightening of credit conditions, which would, in turn, cause a further reduction in economic activity. besides this targeted support, the government has undertaken programs to inject capital more broadly into the banking system. since last fall, nearly $ 200 billion has been distributed under a treasury program that provides government capital investments to banks in good condition. more recently, the treasury, in conjunction with the bank supervisory agencies, announced a new program to ensure that u. s. banking institutions are appropriately capitalized. under this program, the capital needs of the major u. s. banking institutions are being evaluated relative to the losses that