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(Updates with comments from Q&A, adds byline; dateline previously NEW YORK)
By Svea Herbst-Bayliss
CAMBRIDGE, Mass, Feb 23 (Reuters) - The Federal Reserve stands ready to do everything in its power to combat the financial crisis and recession and buying long-term Treasury bonds could be helpful, a top Fed official said on Monday.
"Few of us imagined in our wildest dreams that our global economy could have turned so rotten so quickly," Richard Fisher, president of the Federal Reserve Bank of Dallas, told Harvard's John F. Kennedy School of Government in Cambridge, Massachusetts.
"We are duty-bound to apply every tool we can to clean up the mess that has soiled the face of our financial system and get back on the track of sustainable economic growth with price stability," he said.
The Fed has lowered interest rates almost to zero and pumped hundreds of billions of dollars into financial markets as it tries to prevent a severe recession from turning into a prolonged slump. With companies slashing jobs aggressively, Fisher said that "unemployment appears to me to be headed in the direction of, and possibly past, 9 percent."
Fisher, who is not a voting member on the Fed's policy-setting committee this year, said options to battle the crisis include buying longer-term Treasuries, expanding holdings of mortgage-backed paper and buying larger amounts and different forms of asset-backed paper.
The Fed has already launched a stunning array of emergency lending programs, which have contributed to the Fed's balance sheet more than doubling in size.
While the Fed is prepared to grow its balance sheet further if needed, "we have to be very careful in deploying our arsenal," Fisher said.
He said the Fed must avoid appearing to monetize the "exploding" fiscal deficits, as this could undermine confidence in the central bank's independence and commitment to price stability.
"These concerns do not preclude some Treasury purchases, however, as we seek to strengthen the economy in this time of crisis," he said. "With short-term Treasury rates near zero an argument can be made that buying longer-term Treasuries would be especially effective in this regard."
He said Treasury purchases are not unusual, noting the Fed already buys Treasury bonds with a wide range of maturities as it balances its portfolio. "So we are talking only about a possible change in emphasis here," he said.
That said, the Fed shouldn't try to peg long-term rates. "We must be very careful not to provide for an unsustainable and potentially disruptive distortion in the benchmark market for Treasuries through any extraordinary efforts beyond our normal balancing operations," Fisher said.
In the asset-backed securities market, the Fed should make sure that it does no more than the absolute minimum needed, he said.
Fisher, who as a voting member of the Fed's policy-setting meeting last year supported the lowering of the fed funds rate to between zero and 0.25 percent, said he remained concerned about the effects of low rates on aging baby-boomers and the elderly who played by the rules and are now earning meager returns on their savings.
Answering audience questions about bank nationalizations after his speech, Fisher said he personally believes the government should not get involved in private business.
Any interventions should be short-term, he said, stressing that authorities should always have an exit strategy that can be "realizable very quickly." (Writing by Kristina Cooke; Editing by Leslie Adler)