What's another $1 trillion? Fed moves to boost lending

McClatchy NewspapersMarch 18, 2009 

WASHINGTON — The Federal Reserve's surprise announcement Wednesday that it would purchase more than $1 trillion in Treasury securities and mortgage bonds in hopes of sparking greater economic activity shows that Chairman Ben Bernanke is working hard to keep his pledge to do whatever it takes to reverse the nation's deep recession.

The Fed's rate-setting Federal Open Market Committee ended a two-day meeting with the announcement that it would leave its benchmark federal funds rate near zero. That was expected. Unexpected was word that the Fed would now aggressively purchase assets to get money flowing across the broader economy.

"It's a decision by the committee to go all out," said Laurence Meyer, a former Fed governor from 1996 to 2002, joking that "every move these days is historic and unprecedented."

Throwing caution to the wind, the Fed committee said it would purchase another $750 billion of top-rated mortgage-backed securities issued by Fannie Mae and Freddie Mac. Those two mortgage finance titans were seized by the government in September.

The new purchases will bring the Fed's total purchases of Fannie and Freddie mortgage bonds this year to $1.25 trillion. The Fed said it would also double its purchase of Fannie and Freddie debt, to $200 billion.

Those two moves are designed to boost the flow of mortgage finance and revive the moribund housing market nationwide. In a second and related move, the Fed said it would purchase, over the next six months, up to $300 billion in medium and long term Treasuries. This action seeks to lower borrowing costs of all sorts for consumers and businesses, and to boost housing affordability by knocking fixed mortgage rates below 5 percent.

"The Fed is essentially underwriting half of the gross issuance in the (mortgage-backed securities) market and 30 percent of the gross issuance in the Treasury market," wrote Ethan Harris, the co-head of U.S. markets research for Barclay's Capital in New York, in a research note. "With the rest of Washington moving in slow motion (and in some cases hindering the revival in capital markets), the Fed continues to move ahead aggressively."

The aggressive Fed actions were expected later in the year, and the Fed may have been trying to gain some shock value with an element of surprise. It wrested attention away from bailout and bonus controversies — for the afternoon at least — and drove up stocks. The Dow Jones Industrial Average closed up 90.88 points to 7486.58. The S&P 500 finished up 16.23 to 794.35 and the Nasdaq rose 29.11 points to 1491.22.

The Fed's actions aren't without potential consequences.

"In the short run, Fed easing is a plus. Over the longer run, however, a long period of easy monetary policy may generate more problems down the road with a combination of higher inflation premiums and a weaker dollar to boot," said John Silvia, the chief economist at Wachovia, in a note to investors. "Higher long-term (interest) rates are the likely outcome."

But that's tomorrow's problem.

The bold Fed action followed an unprecedented television interview with Bernanke. Appearing Sunday on CBS's "60 Minutes," Bernanke said that "the Federal Reserve is here and is going to do everything possible to support this recovery."

Meyer interpreted for McClatchy: "Recently they've shown some reluctance to buy Treasuries . . . (But) today they've said lets do everything, let's do it all, and let's be very aggressive about it. Let's leave no doubt we mean what we say in our statement that we'll use all available tools."

The Fed's benchmark federal-funds rate remains in a range that floats between zero and a quarter of a percent. The Fed statement said that rate — which influences the prime rate charged by banks to their best customers — is expected to stay at these historic lows "for an extended period."

The Fed is turning to the only alternative left: printing more money to circulate in the economy.

"We see this as equivalent to a (three-quarters of a percentage point) cut in the funds rate," wrote Harris of Barclay's Capital. "This underscores our belief that a combination of monetary, credit and fiscal easing will slow the recession in (the second quarter) and spark a modest recovery by year-end."

The Fed wasn't as date-certain. In its statement, the Fed noted only that "policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth."

The big announcement of heightened Fed intervention to drive loan rates down was preceded by a rundown of grim economic data.

"Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession," the Fed said, darkly.

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