WASHINGTON – The Federal Reserve signaled Wednesday 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 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 help options.
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.
Stuart Hoffman, chief economist at PNC Financial Services Group, took away this message from the Fed’s statement: “We’re going to throw all we have – including the kitchen sink – into supporting financial markets.”
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.
Despite the Fed’s aggressive rate-cutting, 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. 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.”