WASHINGTON (AP) – Jan. 29, 2009 – The Federal Reserve signaled that it stands ready to use new unconventional tools, or expand existing ones, to spur lending and consumer spending that could help lift the economy out of a painful recession.
The Fed also agreed Wednesday to keep the targeted range for the federal funds rate between zero and 0.25 percent for “some time” to help brace the economy. Economists predict the Fed will keep the funds rate, the interest banks charge each other on overnight loans, at that record low level through the rest of this year.
With its key lending rate to banks already near zero, the Fed pledged anew to use “all available tools” to revive the economy.
Specifically, the Fed said it is “prepared” to buy longer-term Treasury securities if the circumstances warrant such action. At its previous meeting in December, the Fed said it was merely evaluating that option.
Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, was the sole dissenter on this point. He wanted the Fed to move forward on buying the securities.
Doing so would help drive down mortgage rates and provide help to the stricken housing market, economists said.
For example, many 30-year fixed-rate mortgages and other home loans are pegged to the 10-year Treasury note. If the Fed were to buy that security, it would push down rates on mortgages connected to it. The same logic would apply to other Treasury securities.
“So many consumer rates are pegged to Treasury rates – homes, cars,” said Joel Naroff, president of Naroff Economic Advisors. “If the economy is to recover, consumers need to borrow and need to borrow at reasonable rates. The Fed made clear that it is prepared to make that happen.”
The Fed also said it “stands ready” to expand another program aimed at providing relief to the crippled mortgage market.
Under that program, the Fed is buying up to $500 billion in mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. It also has agreed to buy up to $100 billion of Fannie and Freddie debt.
Mortgage rates have fallen since the program’s announcement late last year. The Fed said it could buy more of these securities or extend the length of the program.
The Fed on Tuesday took steps to curb home foreclosures as required by a 2008 law. The relief would apply to mortgage assets the Fed is holding because of last year’s bailouts of Bear Stearns and insurer American International Group. Distressed borrowers could see the amount they owe on their home loan lowered or their interest rate reduced, among the options for help.
But borrowers have no way of knowing whether their mortgages are held by the Fed, because their loan payments are collected by other companies, known as loan servicers
The central bank also will be launching a program aimed at bolstering the availability of consumer loans. Under the program, which is expected to start in February, up to $200 billion will be made available to spur auto, student and credit card loans as well as loans to small businesses. To do that, the Fed will buy securities backed by those different types of consumer debt. The Fed also hopes that action will lower rates on those loans.
The Fed said Wednesday that it will assess whether the program should be expanded in size or scope. Fed officials previously have mentioned the possibility of expanding the program to provide financing for other types of securities, such as those backed by commercial mortgages.
Stuart Hoffman, chief economist at PNC Financial Services Group, took away this message from the Fed’s overall statement: “We’re going to throw all we have – including the kitchen sink – into supporting financial markets.”
Wall Street rose Wednesday on news that the government may take additional steps to assist the nation’s ailing banks. The Dow Jones Industrial average rose nearly 201 points, or about 2.5 percent, to 8,375.45.
Even as the Fed wants to use all tools available to battle the crisis, it is mindful that there are dangers: the potential to put ever-more taxpayers’ dollars at risk; sow the seeds of inflation in the future; and encourage “moral hazard,” where companies feel more comfortable making high-stakes gambles because the government will rescue them.
Fed Chairman Ben Bernanke and his colleagues are battling a three-headed economic monster: crises in housing, credit and financial markets that — taken together— haven’t been seen since the 1930s.
Despite the Fed’s aggressive rate-cutting campaign, a string of radical Fed programs and a $700 billion financial bailout program run by the Treasury Department, credit and financial markets are still stressed and far from normal.
“Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight,” the Fed said.
On the economy, the Fed struck a somber note, saying it had “weakened further” since its Dec. 16 meeting.
“Industrial production, housing starts and employment have continued to decline steeply as consumers and businesses have cut back spending,” the Fed said. “Furthermore, global demands appears to be slowing significantly.”
Looking ahead, the Fed anticipates “a gradual recovery in economic activity will begin later this year,” but cautioned that “the downside risks to that outlook are significant.”
The recession, now in its second year, could turn out to be the longest since World War II.
The U.S. unemployment rate bolted to a 16-year high of 7.2 percent in December and could hit 10 percent or higher at the end of this year or early next year. A staggering 2.6 million jobs were lost last year, the most since 1945, though the labor force has grown significantly since then. Another 2 million or more jobs will vanish this year, economists predict.
This week alone, tens of thousands of new layoffs were announced by companies including Boeing Co., Pfizer Inc., Caterpillar Inc., Home Depot Inc., Target Corp., Corning Inc. and Ashland Inc.
Meanwhile, consumer prices have been falling. At first that seems like a blessing for shoppers, but it if spreads to wages and already stricken prices for homes, stocks and other things for a long time, it could wreak more havoc on the economy. The country’s last serious bout of “deflation” was in the 1930s. Holding rates at record lows would help fend off any deflation risks.
Against that backdrop, the Fed raised the specter of deflation – but didn’t use the word. The Fed saw a risk that “inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”
With jobs disappearing, home values tanking, foreclosures soaring and nest eggs shriveling, consumers have sharply cut spending. That, along with the housing collapse, has played a big role in causing the economy’s backslide.
Many economists predict data will show the economy contracted at a pace of 5.4 percent in the final three months of last year when the government releases the gross domestic product report Friday. If they are correct, that would mark the worst performance since a drop of 6.4 percent in the first quarter of 1982, when the country was suffering through a severe recession. The economy is still contracting now – at a pace of around 4 percent, according to some projections.