Although the situation has recently improved somewhat, financial markets remain under considerable stress. Pressures in short-term bank funding markets, which had abated somewhat beginning late last year, have increased once again.

Many lenders have been reluctant to provide credit to counter parties, especially leveraged investors, and increased the amount of collateral they required to back short-term security financing agreements.

To meet those demands, investors have reduced their leverage and liquidated holdings of securities, putting further downward pressure on security prices. Credit availability has also been restricted because some large financial institutions, including some commercial and investment banks and the government-sponsored enterprises (GSEs), have reported substantial losses and writedowns, reducing their capital available to support increased lending.

Some key securitization markets, including those for nonconforming mortgages, continue to function poorly if at all.

Housing market woes:

These developments in financial markets–which themselves reflect, in part, greater concerns about housing and the economic outlook more generally–have weighed on real economic activity. Notably, in the housing market, sales of both new and existing homes have generally continued weak, partly as a result of the reduced availability of mortgage credit, and home prices have continued to fall.

Unemployment:

Private payroll employment fell substantially in February, after two months of smaller job losses, with job cuts in construction and closely related industries accounting for a significant share of the decline. But the demand for labor has also moderated recently in other industries.

Inflation:

Overall, the near-term economic outlook has weakened relative to the projections released by the Federal Open Market Committee (FOMC) at the end of January.Inflation has also been a source of concern. We expect inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Corrective measures by Fed:

Federal Reserve has taken a number of steps in recent weeks to improve market liquidity and market functioning.

These actions include reducing the cost and increasing the allowable term of discount window credit to commercial banks;

increasing the size of our Term Auction Facility, through which credit is auctioned to depository institutions;

initiating a Term securities Lending Facility, which allows primary dealers to swap less-liquid mortgage backed securities for more-liquid Treasury securities;

and creating the Primary Dealer Credit Facility, which is similar to the discount window but accessible to primary dealers.

Although these facilities operate through depository institutions and primary dealers, they are designed to support the broader financial markets and the economy by facilitating the provision of liquidity by those institutions to their customers and counterparties. With respect to monetary policy, at its March meeting the FOMC reduced its target for the federal funds rate by 75 basis points to 2-1/4 percent.

Bear Sterns Issue:

Normally, the market sorts out which companies survive and which fail, and that is as it should be. Our financial system is extremely complex and interconnected, and Bear Stearns participated extensively in a range of critical markets.

The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence. The company’