Fed to the rescue in subprime crisis.

• Position: Federal Reserve Board

The Federal Reserve has addressed the subprime mortgage crisis by again cutting the interest rate it charges banks, but the Fed needs to take a broader approach when attempting to fix financial problems that threaten to damage the economy seriously, suggests a law and business professor at Duke University, Durham, N.C.

"In the subprime crisis, the Federal Reserve reacted by cutting the discount rate and the interest rate it charges banks to borrow," explains Steven Schwarcz, founding director of the Duke Global Capital Markets Center. "The problem, however, is that these types of monetary policy approaches impact banks but do not directly impact financial markets--and it is markets, not banks, that are at risk in the current crisis."

The subprime mortgage crisis is an example of what can trigger systemic risk--the risk that an economic shock, such as market panic or institutional failure, may create a domino effect, causing the failure of a chain of markets or institutions, Schwarcz indicates. Systemic risk requires a governmental solution because individual market participants do not have sufficient incentives to limit risk-taking, he adds. One solution is to create a "lender of last resort," a private or public entity that would stabilize collapsing markets by purchasing securities in those markets.

"A lender of last resort need not burden taxpayers," Schwarcz notes. "If...