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 in debt issued or backed by government-chartered housing-finance companies. It will also set up a programme of $200 billion 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 are aiming to prevent a financial collapse and stamp out the threat of deflation.
“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. “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 the Federal Home Loan Banks and up to $500 billion of mortgage-backed securities backed by Fannie, Freddie and Ginnie Mae, the statement said. Treasury Secretary Henry Paulson said at a press conference that $200 billion is just the “starting point” for the asset-backed securities programme.
“The economy is turning down pretty dramatically,” he said. “It’s very important that lending continues to be available.”
“This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which, in turn, should support housing markets and foster improved conditions in financial markets more generally,” the Fed said.
Fannie and Freddie bonds rallied. The yield premium on Fannie Mae’s five-year debt over similar-maturity Treasuries tumbled 21.5 basis points to 114.7 basis points as of 8:35 am in New York. A basis point is 0.01 percentage point.
“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.
The US officials, speaking on condition of anonymity, said they don’t see the Fed purchases of mortgage bonds as a way of “quantitative easing,” or using central bank policy to add reserves to the banking system when interest rates are very low, even though the purchases will have that effect.
WHAT’S THIS NEW DEAL?
* The Fed will buy $600 billion in debt issued or backed by government-chartered housing-finance companies like Freddie Mac and Fannie Mae
* To set up $200 billion programme to support consumer and small-business loans. Called Term Asset-Backed Securities Loan Facility or TALF, it is expected to be up and running by February
Treasury will provide $20 billion of ‘credit protection’ to the Fed in the lending programme, using funds from the $700 billion financial-rescue package
Separately, under the new Term Asset-Backed Securities Loan Facility, the Fed will lend up to $200 billion on a non-recourse basis to holders of AAA rated asset-backed securities backed by “newly and recently originated” loans, such as for education, automobiles, credit cards and loans guaranteed by the Small Business Administration, the Fed said.
The Fed hopes to have the TALF running by February. Traditional investors in the asset-backed securities include securities lenders and bank-affiliated conduits, the government officials said.
HOW THE MARKETS REACTED
US % Chg*
Dow Jones -1.6
Nasdaq 100 -2.29
* at midnight (IST)
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,” said Derrick Wulf, who helps manage $70 billion in mostly fixed-income assets at Dwight Asset Management Co in Burlington, Vermont. “One of the things that has worked is the commercial paper facility.”
Wulf added that “it can certainly improve credit conditions for consumers.”
The Treasury will provide $20 billion of “credit protection” to the Fed in the lending program, 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.
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.
With the asset-backed securities program, the Fed is trying to avoid having “continued disruption of these markets” that would limit lending and “thereby contribute to further weakening of US economic activity,” the central bank said.
Under the new lending program, known as 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 to be created by the Fed. The programme will stop making new loans on December 31, 2009, unless the Fed Board of Governors extends it.
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.
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.