Fed pushes deeper into brave new policy world

By Ros Krasny

CHICAGO (Reuters) - The Federal Reserve's latest programs to battle the credit crisis, announced on Tuesday, will further expand the central bank's balance sheet, in a move analysts said marks another step into the unconventional world of quantitative easing.

The Fed announced it will buy up to $100 billion in debt issued by agencies like mortgage giants Fannie Mae and Freddie Mac and up to $500 billion in mortgage-backed securities. The Fed also teamed with the Treasury Department to set up a $200 billion facility to support consumer and small business loans.

The moves came on a day when new data showed the U.S. economy contracted at the fastest rate in seven years, dragged down by the worst financial crisis in decades.

"The government is getting serious about shoring up the near-defunct capital markets," said Brian Fabbri, an economist at BNP Paribas in New York.

The central bank said its goal was to increase the availability of credit and drive down mortgage costs. Rates on U.S. 30-year home loans tumbled almost instantly on Tuesday.

"These programs are a way for the Fed to further expand the total amount of reserves outstanding while directing the new money toward areas where it is needed," said economists at Goldman Sachs.

Further, the two new programs allow the Fed to essentially side-step banks that have been reluctant to lend, and instead push money almost straight into Main Street.

"This is about as close as the Federal Reserve can come to lending directly to consumers," the Goldman Sachs economists said of the efforts to shore-up consumer finance.

Debate raged on whether the plans meant the Fed was wading further into the murky waters of quantitative easing -- an unconventional monetary strategy that seeks to bolster the economy by flooding the banking system with reserves when benchmark interest rates are at or close to zero.

Dealers jumped on the news as another sign that the Fed's benchmark interest rate, currently at 1.0 percent, will be cut closer to zero at the Fed's next two interest-rate meetings on Dec 15-16 and January 27-28.

"Our take ... is that it is the latest step toward a more aggressive quantitative easing regime, and with that, the Fed must lower rates even further," said Rudy Narvas, an analyst at 4CAST Ltd in New York.

In short-term interest rate futures markets, bets on a 0.25 percent federal funds rate, versus the current 1.0 percent, by year-end hit 44 percent from 18 percent late on Monday.

The new programs mean the Fed's balance sheet could conceivably swell close to the $3 trillion level mooted by San Francisco Fed President Janet Yellen on Oct 30.

"This could represent a further expansion of the Fed's balance sheet of $800 billion, a significant amount relative to its current size of about $2 trillion," the Goldman economists said.

QUANTITATIVE EASING REDEFINED?