Fed ready to monetize debt, Bernanke says

Bernanke Says Fed May Buy Treasuries to Aid Economy

By Scott Lanman and Vivien Lou Chen
Bloomberg News
Monday, December 1, 2008

http://www.bloomberg.com/apps/news?pid=20601087&sid=ajcLVDMwN5To&refer=home

Federal Reserve Chairman Ben S. Bernanke said he has "obviously limited" room to lower interest rates further and may use less conventional policies, such as buying Treasury securities, to revive the economy.

The U.S. economy "will probably remain weak for a time," even if the credit crisis eases, Bernanke said today in a speech in Austin, Texas. While the Fed can't push interest rates below zero, "the second arrow in the Federal Reserve's quiver -- the provision of liquidity -- remains effective," he said.

Bernanke's comments pushed Treasury yields to record lows. Bernanke has created more than $2 trillion of emergency lending programs in the past year, using the Fed’s balance sheet and money-creation authority to cushion the economy from the worst financial crisis in seven decades. The central bank may lower its benchmark interest rate to zero, economists said.

"Although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest-rate policies to support the economy is obviously limited," Bernanke said in remarks to the Austin Chamber of Commerce.

One option is for the Fed to buy "longer-term Treasury or agency securities on the open market in substantial quantities," Bernanke said. "This approach might influence the yields on these securities, thus helping to spur aggregate demand."

Treasury prices rose on Bernanke's remarks, with yields on 10-year Treasuries tumbling 25 basis points to a record low of 2.67 percent at 2:31 p.m. in New York, according to BGCantor Market Data. The yield was the lowest since daily Fed records started in 1962 and the least since 1955 as measured on a monthly basis. One basis point is equal to 0.01 percentage point.

... New Credit Programs

Last week, the Fed announced two new programs aimed at unfreezing credit for homebuyers, consumers and small businesses. Those include a commitment to buy as much as $600 billion of debt issued or backed by government-chartered housing-finance companies and a $200 billion initiative to support consumer and small-business loans.

"It is encouraging that the announcement of that action was met by a fall in mortgage interest rates," Bernanke said of the Fed’s decision to buy housing debt.

The Federal Open Market Committee next meets Dec. 15-16 in Washington. Economists surveyed by Bloomberg News forecast a quarter-point reduction in the target overnight interbank lending rate to 0.75 percent, with some expecting a half-point cut.

"Bernanke is a policy activist, and you could see that today in the discussion of all the policy options that he thinks are still available," said Brian Sack, Washington-based senior economist at Macroeconomic Advisers LLC. He predicts the Fed will lower its main interest rate to zero next month.

... 'Pretty Aggressive'

While Bernanke was "pretty aggressive on the possibility of the Fed using its balance sheet aggressively through Treasury purchases," he wasn't specific about the policy path because he probably didn't want to preempt the discussion at the FOMC meeting in two weeks, said Sack, a former Fed economist.

The Fed will "continue to explore ways" to keep the market federal funds rate closer to policy makers' target, after paying 1 percent interest on banks’ reserves failed to stabilize the rate, Bernanke said. The average daily rate has been below the central bank’s target every day since Oct. 10.

That's because Fannie Mae and Freddie Mac, which are "large suppliers of funds," aren't eligible to get interest from the Fed and thus lend below the Fed's target, Bernanke said.

... Distressed Assets

The Fed also aided the rescue of Citigroup Inc. last week by agreeing to backstop a $306 billion pool of distressed assets after the company, the Treasury and the Federal Deposit Insurance Corp. shoulder the first losses.

Bernanke reiterated his defense of the government's decision to let Lehman Brothers Holdings Inc. fail, which intensified the financial crisis.

Lehman's bankruptcy was "unavoidable," he said. Since then, authorities have gained the tools to "address any similar situation that might arise in the future." Bernanke noted that the funds to aid Citigroup came from the $700 billion financial rescue passed by Congress in October.

The U.S. economy officially entered a recession in December 2007, the panel that dates American business cycles declared today. The National Bureau of Economic Research, a private, nonprofit group of economists based in Cambridge, Massachusetts, said the economy was last in a recession from March through November 2001.

"Our nation's economic policy must vigorously address the substantial risks to financial stability and economic growth that we face,' Bernanke said.

... 'Sustainable Level'

The Fed's balance sheet "will eventually have to be brought back to a more sustainable level,' Bernanke said. "However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy."

Signs are increasing that the recession may be the worst in a quarter-century. Even so, Bernanke, a scholar of the Great Depression, said in a response to an audience question that there is "no comparison" between today's situation and the 1930s. Back then, the Fed kept monetary policy too tight and failed to keep banks from collapsing, Bernanke said.

A private report earlier today showed manufacturing in the U.S. contracted in November at the fastest pace in 26 years, putting American factories at the forefront of the global industrial slump resulting from the lack of credit.

The Institute for Supply Management's factory index dropped to 36.2, the lowest level since 1982, the Tempe, Arizona-based group reported today. A reading of 50 is the dividing line between expansion and contraction. Similar measures from China, the U.K., euro area, and Russia all dropped to record lows.

On Dec. 5, the Labor Department will report U.S. employers eliminated 325,000 jobs in November, according to the median estimate in a Bloomberg News survey. That would be the worst month since October 2001, during the last recession. The jobless rate probably increased to 6.8 percent from 6.5 percent, according to the survey.

* * *

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at http://www.gata.org/.