U.S. providing huge stimulus for borrowers
WASHINGTON: The Federal Reserve and the Treasury announced $800 billion in new lending programs on Tuesday, sending a message that they would print as much money as needed to revive the nation's crippled banking system.
The gargantuan efforts - one to finance loans for consumers, and a bigger one to push down home mortgage rates - were the latest but probably not the last of the U.S. government's initiatives to absorb the shocks that began with losses on subprime mortgages and have spread to every corner of the economy.
In the last year, the government has assumed about $7.8 trillion in direct and indirect financial obligations. That is equal to about half the size of the nation's entire economy and far eclipses the $700 billion that Congress authorized for the Treasury's financial rescue plan.
Those obligations include about $1.4 trillion that has already been committed to loans, capital infusions to banks and the rescues of firms like Bear Stearns and the American International Group, the troubled insurance conglomerate. But they also include additional trillions in government guarantees on mortgages, bank deposits, commercial loans and money market funds.
The mortgage markets were electrified by the Fed's announcement that it would swoop in and buy up to $600 billion in debt tied to mortgages guaranteed by Fannie Mae and Freddie Mac. Interest rates on 30-year fixed-rate mortgages fell almost a full percentage point, to 5.5 percent, from 6.3 percent.
But analysts said the program would do little to reduce the tidal wave of foreclosures. That is because most of the foreclosures are on subprime mortgages and other high-risk loans that were not bought or guaranteed by government-sponsored finance companies like Fannie Mae.
Stock investors reacted coolly to the announcements. The major stock indexes initially fell. The Standard & Poor's 500-stock index later edged up, closing at 857.39, up 0.66 percent. The Nasdaq closed down 0.5 percent, at 1,464.73.
The long-term risks are enormous but difficult to estimate. They begin with the danger of a new surge of inflation, at least after the economy comes out of its current downturn. Beyond that, taxpayers will have to pick up the losses from loans that default or guarantees that have to be made good.
But the most troublesome unknowns are how the maze of protections for investors and consumers will change economic and political behavior in the future.
"The Federal Reserve has a lot of levers of influence with consequences for individual industries," said Vincent Reinhart, a former Fed official and now a senior fellow at the American Enterprise Institute. "Now that it has used those levers, don't you think Congress will want it to start using them again? The Fed could become the go-to place for bailouts."
Administration and central bank officials contend that the risk of doing nothing is a full-blown depression in which unemployment climbs above 10 percent and the country needs years to recover. Many private economists agree.
"They are doing whatever it takes," said Laurence Meyer, a former Fed governor who is now vice chairman of Macroeconomic Advisers, an economic forecasting firm. "The problem is, the more you go in this direction, the harder it is to turn around and the harder your exit strategy is."
Most economists agree that the United States is in the worst financial crisis since the Great Depression, and that it has already fallen into a severe recession that is likely to be one of the deepest in decades.
"What they are doing is trying to limit the damage to something consistent with a severe postwar recession, but not something worse than that," Meyer said.
Indeed, the government reported on Tuesday that the economy contracted by 0.5 percent in the third quarter, slightly worse than previously estimated. But private forecasters predict that economic activity will fall by 4 to 5 percent in the fourth quarter and continue to contract for much of next year.
In the first of two new actions announced on Tuesday, the Treasury and the Fed said they would create a $200 billion program to lend money against securities backed by car loans, student loans, credit card debt and even small-business loans.
The Treasury would contribute $20 billion to the so-called Term Asset-Backed Securities Loan Facility and assume responsibility for any losses up to $20 billion. The Federal Reserve would lend the new entity as much as $180 billion.
The new facility would then lend money at low rates to companies that post collateral based on securities backed by consumer debt or business loans. The new program would be allowed to accept only securities with Triple-A ratings, the highest possible, from at least two rating agencies.
The Treasury secretary, Henry Paulson Jr., made it clear that the new lending facility was just a "starting point" and could be expanded to many other kinds of debt, like commercial mortgage-backed securities. "It's going to take awhile to get this program up and going, and then it could be expanded and increased over time," he said at a news conference.
Separately, the central bank announced that it would try to force down home mortgage rates by buying up $600 billion in debt tied to home loans guaranteed by Fannie Mae, Freddie Mac and other government-controlled financing companies.
The actions on Tuesday represented two milestones in the government's expansion into private markets.
It was the first time that the Fed and the Treasury have stepped in to finance consumer debt. The $200 billion program comes close to being a government bank.
But the new programs also represented a new level of commitment by the Federal Reserve. Instead of trying to strengthen the economy by reducing short-term rates, which is the usual policy tool, the Fed is now pumping vast amounts of money directly into specific markets for mortgages - and anything else it believes needs help.
Over the last year, the Fed and the Treasury have bailed out major Wall Street firms, rescued the world's biggest insurer, taken over Fannie Mae and Freddie Mac, and guaranteed hundreds of billions of dollars in bank transactions.
As big as the two new lending programs are, Meyer cautioned that they were only going to reduce the pain that lies ahead, not eliminate it. Unemployment, at 6.5 percent in October, is still likely to climb to 7.5 or even 8 percent next year, he predicted. But it may not shoot up to 9 or 10 percent, a level that economists often consider the unofficial dividing line between a recession and a depression.
The new actions are unlikely to be the last. Until the economy begins to turn around, Fed officials have made it clear they are prepared to print as much money as needed to jump-start lending, consumer spending, home buying and investment.
"They are using every tool at their disposal, and they will move from credit market to credit market to reduce disruptions," said Richard Berner, chief economist at Morgan Stanley.
The Federal Reserve has now moved to a radical new phase of its effort to shore up the economy. Until now, it has carefully distinguished between two goals - reducing the panic and turmoil in financial markets, and propping up the economy itself, which has been battered as the supply of credit has dried up.
To tackle the first goal, the Fed expanded its lending programs to banks and Wall Street firms, and organized the rescue of failing firms like Bear Stearns.
To bolster the general economy, it relied on its traditional tool: reducing the overnight federal funds rate, the interest rate that banks charge for lending their reserves to one another. Normally, a lower Federal funds rates leads to lower long-term rates, like those for mortgages.
But the central bank has already lowered the rate to 1 percent, and it cannot reduce it below zero. Instead, policy makers are buying up other kinds of debt securities, which has the effect of driving down the rates in those parts of the market.
The move amounts to what economists refer to as "quantitative easing," which means having the Fed pump staggering amounts of money into the economy by buying up a wide range of debt instruments.
In a conference call with reporters, Fed officials insisted their goal was not to pursue a policy of quantitative easing, but simply to unfreeze the mortgage market.
But for practical purposes, the actions lead to similar results.