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Wednesday, March 12, 2008

[Posible SPAM] Fed Hopes to Ease Strain on Economic Activity

 

Fed Hopes to Ease Strain on Economic Activity

Published: March 12, 2008

WASHINGTON — Impelled to take extraordinary measures for the second time in less than a week, the Federal Reserve moved on Tuesday to subdue the deepening crisis in credit markets by stepping up as lender of last resort.

In an action that sent stock prices soaring, the central bank offered to let the biggest investment banks on Wall Street borrow up to $200 billion in Treasury securities in exchange for hard-to-sell mortgage-backed securities as collateral. And the Fed made clear that it was prepared to do more as needed.

The move, which was coordinated with central banks in Europe and Canada, came on the heels of two similar actions on Friday, in which the Fed offered up to $200 billion in 28-day cash loans to banks and big financial institutions.

But where investors were unimpressed by last week's efforts, which took place as the government announced that the number of jobs was falling, they were jubilant on Tuesday. The Dow Jones industrial average soared 416 points, or 3.6 percent, in its biggest increase in points in more than five years. The dollar enjoyed at least a momentary reprieve from its protracted plunge against other major currencies.

The Federal Reserve, in effect, is trying to ease an acute credit squeeze by agreeing to hold large volumes of mortgage-backed bonds that Wall Street firms are struggling to sell and providing them with either cash or Treasury securities that they can immediately convert to cash.

Fed officials are increasingly convinced that the United States is sliding into a recession, and they worry that the deepening credit squeeze will aggravate the problem by making it even harder for consumers and businesses to borrow money for houses, new equipment or new factories.

The Fed's hope is to relieve some of the pressure on institutions to sell at fire-sale prices, easing the strains on economic activity and making the credit markets feel more comfortable in buying mortgage bonds again.

Despite the staggering sums being offered by the Fed over the past week, some analysts warned that the new infusion of money might not be enough to fill the hole caused by the losses on ill-conceived mortgages during the housing bubble.

"They are essentially creating a $300 billion bank out of nothing," said Lou Crandall, chief economist at Wrightson ICAP, a financial research firm.

But while the Fed's moves may relieve short-term cash problems, Mr. Crandall said, "it doesn't solve the fundamental issue, which is the decline of capital in the banking system."

Indeed, some analysts warned that the central bank might make things worse in the long run by postponing the repricing of mortgage assets that financial institutions are holding, or by further weakening the value of the dollar and aggravating inflation.

"The Fed is saying if you don't want those mortgages, then give them to us," said Peter D. Schiff, president of Euro Pacific Capital, an investment firm in Darien, Conn. "The Fed thinks that inflation is the way to solve our problems, but all this does is create bigger problems."

Senior Fed officials said on Tuesday that the other concerns pale compared with the need to stabilize credit markets — particularly markets for mortgages — that have become increasingly trapped in a self-perpetuating downward spiral.

That spiral, which began last summer when defaults on subprime mortgages began to soar, has led to falling prices for almost all kinds of debt securities. The falling prices have forced selling by major institutional investors and lenders, partly to make up for other losses, and has spread to a much broader array of seemingly safe securities.

In its move on Tuesday, the central bank said that it would lend up to $200 billion in Treasury securities to a select list of top investment banks, known as primary dealers, that regularly trade with the Federal Reserve in its open-market operations.

The new twist is that the investment banks will be allowed to pledge as collateral a wide variety of securities that include hard-to-sell, privately issued mortgage-backed securities.

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