Fed pushes deeper into brave new policy world

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.


Yellen and several other top Fed officials, including Vice Chairman Donald Kohn, have conceded in the past month that quantitative easing has been added to the Fed’s policy tools.

But exactly which of the Fed’s array of possible policy measures can be specifically tagged as quantitative easing, and whether it even matters, remains an open question.

Ashraf Laidi, chief FX strategist at CMC Markets US in New York, said the Fed’s latest “liquidity drive” was “a new landmark” in quantitative easing.

“The Fed’s balance sheet ... is well on its way of following the Bank of Japan’s policy of quantitative easing -- targeting the quantity of money rather than its price,” he said.

But U.S. officials on Tuesday said that the new measures were not the same as the formal quantitative easing program practiced in the 1990s by the Japan’s central bank.

The Fed is not, in this case, increasing reserves in the banking system specifically to shift banks’ behavior toward lending more, the officials told reporters.

Still, some Fed watchers declined to split hairs and questioned whether the Japanese example represents the sole definition of what a quantitative easing program can or should entail.

Thus, almost any step by the Fed targeted at stabilizing financial markets and boosting the economy while the federal funds rate is anchored near zero could conceivably be seen as being under the quantitative umbrella -- and Tuesday’s moves will probably not be the last.

“Essentially the Fed can buy up to 10 percent of the GSE market ... speculation is that it could lead the Fed to buy Treasuries as well and maybe corporates down the road,” said 4CAST’s Narvas.

Additional reporting by Mark Felsenthal in Washington