Fed warns of deepening slump, may move on mortgage rates

McClatchy NewspapersJanuary 28, 2009 

WASHINGTON — The Federal Reserve on Wednesday kept its benchmark lending rate near zero and said that it's likely to stay that way for some time, as it also signaled new efforts to lower home-mortgage rates.

The Fed left unchanged its target for the fed funds rate, which banks charge each other for overnight loans, in a range of zero to a quarter point. This ensures that most consumer lending rates will remain unchanged, too.

The Fed promised new steps to boost lending to consumers. It also suggested that it would soon purchase Treasury bonds to decrease other lending rates — notably, home mortgage rates and long-term corporate loans.

In an unusually detailed statement, the rate-setting Federal Open Market Committee warned of a grim economic outlook.

"Information received since the committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending," the Fed statement said. "Furthermore, global demand appears to be slowing significantly."

That explanation dovetails with announcements this week by major U.S. corporations that they'll collectively shed more than 80,000 jobs.

The Fed statement is sure to give new urgency to efforts in the Congress to pass a proposed stimulus plan, whose costs now range from $825 billion to $1 trillion. Separately, the Treasury Department is preparing new steps to boost the sagging bank sector, where lending of virtually any sort remains frozen.

"Fed policies cannot be designed independently of other financial rescue plans," wrote economists John Ryding and Conrad DeQuadros of forecaster RDQ Economics in New York, in a note to investors.

Treasury Secretary Timothy Geithner said on Wednesday that he hopes not to nationalize U.S. banks, sending the message that he instead favors new efforts to get distressed assets off their balance sheets.

Stocks rallied on this news, with the Dow Jones Industrial Average closing up 200.72 points to 8375.45. The S&P 500 rallied 28.38 points to 874.09 and the Nasdaq finished up 53.44 points to 1558.34.

Promising that it would take steps soon to boost lending to consumers, who account for about two-thirds of U.S. economic activity, the Fed suggested that it may soon purchase long-term U.S. Treasury bonds. The goal would be to drive down interest rates on these bonds, which are benchmarks for private-sector lending.

"The committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets," the Fed said.

"This is effectively an attempt to bring down mortgage rates directly, as well as influence Treasury rates," said John Silvia, the chief economist for Wachovia, in a note to investors.

By lowering the cost of long-term Treasury bonds, the Fed also could lower the cost of long-term borrowing for U.S. corporations.

Another unconventional move, already announced by the Fed, involves buying as much as $200 billion in distressed assets from banks.

"The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses," the Fed said, referring to a program to purchase distressed assets to free banks to lend more.

By purchasing these assets, the Fed is taking over the private sector's role in the marketplace.

The asset-backed securities that the Fed will purchase are top-rated pooled car loans, student loans, mortgages and credit card debt. These pooled loans usually are sold to investors in a secondary market.

The Fed already has been purchasing mortgage-backed securities, but the global downturn has left investors with no appetite for other types of asset-backed securities.

In the FOMC statement, the Fed noted that these and other purchases of distressed assets are "likely to keep the size of the Federal Reserve's balance sheet at a high level." The statement said the size and composition of what the Fed purchases should be viewed "in light of evolving financial markets developments."

The lack of any sort of cap or target for how much liability the Fed is willing to put on its ledger sheet tells investors that there is virtually no limit and that the Fed will do whatever is feels necessary to reverse the deep recession gripping the economy.

ON THE WEB

FOMC statement

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