Fed Commits $800 Billion More to Unfreeze Lending
By Scott Lanman and Dawn Kopecki
The Federal Reserve took two new steps to unfreeze credit for homebuyers, consumers and small businesses, committing up to $800 billion.
The central bank will purchase as much as $600 billion of debt issued or backed by government-chartered housing-finance companies. It will also set up a $200 billion program to support consumer and small-business loans, the Fed said in statements today in Washington.
With today’s announcement, the central bank is starting to use some of the unorthodox policy tools that Chairman Ben S. Bernanke outlined as a Fed governor six years ago. Policy makers hope the initiatives will bring down the interest rates on mortgages and consumer loans, offsetting the withdrawal of private-sector financing.
“They’re trying to put funds into the system, trying to unfreeze these markets,” said William Poole, the former St. Louis Fed president, in an interview with Bloomberg Television. “Clearly, the Fed and the Treasury are beginning to take a large amount of credit risk.”
The Fed will purchase up to $100 billion in direct debt of Fannie Mae, Freddie Mac and Federal Home Loan Banks after the yield premiums on those securities jumped. It will also buy up to $500 billion of mortgage-backed securities issued by Fannie, Freddie and Ginnie Mae, a government agency that insures bonds.
Fannie and Freddie have about $1.7 trillion of corporate debt outstanding and $4.1 trillion of mortgage-backed securities.
Rates on home loans haven’t fallen even after the Fed cut its key interest rate and yields on benchmark Treasuries tumbled. Average 30-year mortgage rates were 5.98 percent yesterday, little changed from the 2007 average of 5.95 percent, according to bankrate.com.
In that time, the Fed has cut its target rate for overnight loans between banks by 4.25 percentage points, to 1 percent. Bernanke said in a November 2002 speech that as the rate approached zero, the central bank could consider buying mortgage bonds or U.S. Treasuries to finance government spending.
Fannie and Freddie bonds rallied after the announcement. The yield premium on Fannie Mae’s five-year debt over similar- maturity Treasuries tumbled 0.34 percentage point, to 1.02 percentage point, by 2 p.m. in New York, according to data compiled by Bloomberg. Treasuries rallied, with yields on two- year notes tumbling 0.13 point to 1.15 percent, while the 10-year yield dropped 0.25 point to 3.08 percent.
“It’s very important that lending continue to be available” because “the economy is turning down pretty dramatically,” Treasury Secretary Henry Paulson said at a press conference in Washington. He also said $200 billion is just the “starting point” for the Fed’s program to buttress consumer and small-business loans.
The Fed won’t be removing cash from other parts of the financial system to make up for the purchases, government officials told reporters on a conference call. They rejected any comparison with Japan’s so-called quantitative easing effort to combat deflation, saying that the Fed’s objective is to buttress credit markets rather than ramp up money.
“The aim of credit policy is focused on narrowing credit spreads, as opposed to expanding the money supply,” said Mark Gertler, a New York University economics professor who has collaborated with Bernanke on research. “The hallmark of this crisis is unusually high credit spreads which are dampening borrowing and spending across the economy.”
Under the Term Asset-Backed Securities Loan Facility, the Fed will lend up to $200 billion to holders of AAA rated asset- backed securities backed by “newly and recently originated” loans. Those include education-, car- and credit-card loans, and borrowing guaranteed by the Small Business Administration. The Fed hopes to have the TALF running by February.
Private-sector ABS buyers have either disappeared or have shrunk their balance sheets, contributing to the market’s disruption, officials said. Traditional buyers included the structured investment vehicles, set up by Citigroup Inc. and other banks, that have been wound down in the crisis.
Even asset-backed securities that the government already stands behind have been hammered by the exodus of investors.
Bonds backed by payments on government-backed student loans made by the Federal Family Education Loan Program, or FFELP, are trading at 300 basis points more than the three-month London interbank offered rate, according to JPMorgan Chase & Co. data. The premium was 60 basis points in January.
“It can certainly improve credit conditions for consumers,” said Derrick Wulf, who helps manage $70 billion in mostly fixed-income assets at Dwight Asset Management Co. in Burlington, Vermont.
The asset-backed securities program is similar to the Fed’s effort to bring down the cost of financing for commercial paper, the short-term debt companies issue to finance payrolls and other expenses, because it goes beyond banks.
“What the Fed has been trying to do is get a sense of what works and what doesn’t work,” Wulf said. “One of the things that has worked is the commercial paper facility.”
“The cheaper that they could issue their debt, the more aggressively they should be able to buy mortgages in the secondary market,” said Alan Bosworth, director of agency trading at Vining Sparks in Memphis, Tennessee.
The Fed may hold the Fannie and Freddie debt and securities until they mature or sell them, with plans to be determined, government officials said on a conference call with reporters.
A separate Treasury program for buying debt linked with home loans has already quadrupled, from about $7 billion, a government official said on condition of anonymity.
The Treasury will provide $20 billion of “credit protection” to the Fed for the TALF, using funds from the $700 billion financial-rescue package. The Treasury said in a statement that the facility may expand over time and cover other assets, such as commercial and private residential mortgage- backed debt.
Under the TALF, the New York Fed will auction a fixed amount of loans each month for a one-year term. Assets will be held in a special-purpose vehicle. The program will stop making new loans at the end of next year unless the Fed Board of Governors extends the program.
Lenders providing credit under the TALF “must have agreed to comply with, or already be subject to,” executive- compensation restrictions in the October bailout law, the statement said.
Separately, in a sign of disagreement among Fed officials, seven of the 12 district banks opposed lowering the rate on direct loans to banks before the Oct. 28-29 policy meeting, the central bank said in meeting minutes released today.
Timing of Purchases
The Fed will start buying the direct debt of government- sponsored enterprises -- Fannie, Freddie and a dozen federal home loan banks -- through primary dealers in government debt from next week. The purchases of mortgage-backed securities will be done through asset managers, and officials aim to begin the effort by year-end.
Purchases of both types of debt “are expected to take place over several quarters,” the Fed said.
Treasury staffers are in regular communication with President-elect Barack Obama’s team, officials said. New York Fed President Timothy Geithner, Obama’s pick to be Treasury secretary, was involved in today’s plans, though not in a capacity with the new administration, officials said.