Fed gives shot in arm, but recession looms

A pedestrian passes in front of the Federal Reserve Building in Washington January 22, 2008.

WASHINGTON (Reuters) - The Federal Reserve has offered credit markets a quick shot in the arm with a new $200 billion lending facility, and while this will ease some the liquidity problems, it isn't likely to be enough to keep the U.S. economy out of recession.

Wall Street economists were quick to call the new lending facility a step in the right direction, but what's most needed is time for the de-leveraging of billions of dollars in loans globally.

"This is another tool and, with additional upcoming reductions in the Fed funds rate, this should help what is a painful process," said Chris Wiegand, financial economist at Citigroup. "But it's not the be-all and end-all solution."

The Fed, which has cut benchmark interest rates by 2.25 percentage points since mid-September last year, is widely expected to reduce them further when it meets on March 18.

But more is needed as mortgage backed bond prices have plunged, imperiling the value of bank assets, impeding bank lending, while corporate credit costs have soared.

The U.S. dollar has also fallen sharply in the past six weeks, oil prices have risen to new record highs, and benchmark U.S. stock prices have fallen back to near the 18-month lows seen in January.

The Fed's action on Tuesday to allow banks to off-load even private label mortgage backed securities onto the Fed's balance sheet was another attempt to ease the growing credit crisis that policy-makers less than a year ago vowed would be contained to the housing sector.

Some analysts question if the Fed has responded too late.

"They are moving in the right direction. I just think they are being seen as reactive," said John Canally, an investment strategist at LPL Financial.

The Fed's latest actions follow a plan announced last Friday to increase the amount of liquidity offered in the special term auction facilities introduced last year, and the 2.25 percentage point reduction in the target Fed funds overnight lending rate since last September.

"We've got a global margin call in effect" said Marc Chandler, market strategist at Brown Brothers Harriman in New York.

Chandler and others say the Fed's efforts are still going to be looked upon as rather modest given the magnitude of the de-leveraging of financial institutions' balance sheets that is going on. Some Wall Street estimates say these amounts could exceed $1 trillion, eclipsing the $200 billion program unveiled.

"I'd say the problem has metastasized and basically has punished the innocent and guilty alike," Chandler said.

WORST TO COME

The worst in the credit crisis is likely still yet to come and that will complicate efforts to re-start U.S. economic growth after what some economists see as the worst housing slump since the Great Depression.

"It would be a bit naive however to assume that the worst is now over. The fact that ingenious liquidity measures have had to be designed in the first place is, after all, almost by definition a clear sign that policy makers believe that the global banking sector is in a state of crisis," said UBS economist Andrew Cates.

With their balance sheets under pressure, banks have been reducing lending to private equity groups, hedge funds, corporations and even municipal borrowers, contributing to a slowdown in consumer spending caused by falling home prices and rising food and energy costs.

"What we've seen is really a seizing of the money markets and it will help to alleviate this by injecting much needed cash," said Kathleen Stephansen, director of global economics at Credit Suisse in New York. "It doesn't take away the credit crunch because deleveraging will still have to take place. But this will make it a more orderly process."

Analysts maintain that more is needed from the Fed to help cushion the credit crisis, particularly if lending remains tight as market participants wait on the sidelines to avoid exposure.

"Throwing dollars out there is almost polluting the world with dollars and is similar to lowering interest rates, but that doesn't mean that banks or lenders are going to loan yet," said Daniel North chief economist at Euler Hermes, the world's largest accounts receivable insurer.

"They (banks) are not going to ease credit if they think that there are still potential losses out there," North said.

(Reporting By Joanne Morrison; Editing by Clive McKeef)