Fed keeps rates at zero and prepares to monetize debt

By Craig Torres
Bloomberg News
Wednesday, January 28, 2009

http://www.bloomberg.com/apps/news?pid=20601087&sid=aXsP9Q.VvA.U&refer=home

WASHINGTON -- The Federal Reserve left the benchmark interest rate as low as zero and said it's prepared to purchase longer-term Treasury securities to resuscitate lending and the economy.

The Fed is "prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets," the Federal Open Market Committee said in a statement after meeting in Washington.

Chairman Ben S. Bernanke, by making emergency credit programs rather than rates the focus of policy, is quelling some of the panic in markets while failing to revive growth. Falling home prices, rising unemployment and more than $1 trillion in losses and writedowns at global financial institutions are deepening the longest recession since the 1980s.

"The focus of the committee's policy is to support the functioning of financial markets and stimulate the economy through open-market operations and other measures that are likely to keep the size of the Federal Reserve’s balance sheet at a high level," the Fed said in the statement.

Richmond Federal Reserve Bank President Jeffrey Lacker dissented from today's decision.

The Fed's assets have grown by $1 trillion over the past year under credit programs ranging from $416 billion in term loans to banks to purchases of $350 billion in commercial paper issued by U.S. corporations. The balance sheet will continue to grow under plans announced by the central bank.

"The Fed has pulled out all the stops," Paul McCulley, a managing director and fund manager at Pacific Investment Management Co. in Newport Beach, California, said in an interview before the announcement. "The Fed's mission has to be to bring down private-sector borrowing rates."

Bernanke, a scholar of the Great Depression, criticized the Fed in December for failing to stop bank failures that inflamed panic in financial markets during the 1930s. The former Princeton University economist views financial stability as a prerequisite for an economic recovery.

The Fed Board has supported bailouts of Bank of America Corp. and Citigroup Inc. by offering a layer of protection against losses on troubled assets. The Federal Deposit Insurance Corp. and U.S. Treasury also back the rescues.

"For now, the goal of policy must be to support financial markets and the economy," Bernanke said at the Dec. 1 speech in Austin, Texas.

The Fed announced Nov. 25 that it would buy $600 billion in housing agency bonds and mortgage-backed securities they guarantee. The bond purchases will expand money in the banking system. Excess bank reserves averaged $843 billion in the first two weeks of January, an increase from $1.64 billion for the same month a year earlier.

Next month, the Fed plans to launch the $200 billion Term Asset-Backed Securities Loan Facility, which will buy bonds backed by newly issued consumer and small-business loans. The program can be expanded to include other assets.

There are some signs that the Fed’s action has begun to thaw credit markets. Sales of commercial paper totaled $1.69 trillion last week, up from October’s low of $1.45 trillion, though down from $1.76 trillion in the first week of the year.

The cost of borrowing dollars in London for three months rose to a two-week high this week as confidence in the banking system weakened. The London interbank offered rate, or Libor, for three-month loans slipped 1 basis point to 1.17 percent today, according to British Bankers’ Association data. Libor had surged to 4.82 percent on Oct. 10 as credit froze following the bankruptcy of Lehman Brothers Holdings Inc. The TED spread, the difference between what the U.S. government and companies pay for loans for three months, was unchanged at 105 basis points. The spread was 464 basis points on Oct. 10.

U.S. employers slashed 2.6 million jobs last year, the most since 1945, pushing the unemployment rate up to 7.2 percent in December. Home prices in 20 U.S. cities declined by 18.2 percent in November from a year earlier, the fastest drop on record, according to the S&P/Case-Shiller index.

Gross domestic product probably contracted at a 5 percent annual rate from October through December, the biggest drop since 1982, according to the median estimate in a Bloomberg News survey ahead of Commerce Department figures due on Jan. 30.

"The first half of the year is going to look quite tough," Ethan Harris, co-head of economic research at Barclays Capital Inc., said before the announcement. "There is a lot of downward momentum."

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