Fed seen mulling further market soothing steps

By Mark Felsenthal

WASHINGTON (Reuters) - The Federal Reserve is mulling further steps to address liquidity problems in financial markets in case measures taken to date fail to gain traction, a Fed official confirmed on Wednesday.

Steps under review include the Treasury Department borrowing in excess of its requirements and depositing the surplus at the Fed. This would allow the central to make funds available to banks and Wall Street firms without pushing down interest rates.

Other possible actions include issuing debt under the Fed's name and seeking authority to immediately pay interest on commercial bank reserves, the official said.

The options under consideration by the Fed were first reported by the Wall Street Journal on Wednesday.

Such moves are not imminent because the Fed's balance sheet can currently accommodate further lending aimed at restoring normal flows of credit in a market paralyzed by the subprime mortgage debacle. In recent months, the central bank has announced several new facilities to extend credit to banks and Wall Street firms.

"Evidently it's another attempt at seeking out non-policy based solutions to the credit crunch, which sits well with the (Fed) minutes yesterday which noted that monetary policy alone was insufficient to stem the credit crisis," said Richard McGuire, fixed income strategist at RBC Capital Markets in London.

EFFECT ON RATES

The Fed uses its assets to set interest rate targets and control the money supply. The central bank can expand its balance sheet practically without limit, but that would boost reserves and push down the federal funds rate, which banks charge each other for loans.

While the central bank is not immediately constrained by the size of its balance sheet in addressing the crisis, it is preparing for the possibility that it might need to further expand the balance sheet without lowering the fed funds rate, the official confirmed.

As of April 2, the most recent point for which data is available, the Fed held $581 billion in Treasury securities on its balance sheet, down approximately $192 billion from a year ago. It listed roughly $221 billion in credits, loans, and repurchase agreements outstanding.

If the Treasury deposits funds at the Fed, and the Fed uses the funds to buy Treasuries, there would be no impact on interest rates.

One possible obstacle to this approach may be the Treasury's statutory debt ceiling of $9.8 trillion, which Congress has been reluctant to increase without a debate.

Even so, this is the likeliest option and one that the Fed and Treasury officials have discussed, the official confirmed.

A Treasury official acknowledged the discussions but did not provide details.

"Of course we're thinking through contingency plans, it would be negligent for us not to," the official said.