In announcing plans to pump more than US$1 trillion into markets, the US Federal Reserve seems alone in responding quickly to the shuddering economy now that the Treasury is engulfed by the AIG scandal.
To widespread surprise, the Fed unveiled a series of staggering measures on Wednesday that could double its balance sheet, throwing an additional US$1.15 trillion at an intensifying financial crisis.
The central bank this week will begin to buy long-term Treasury bonds with a budget of up to US$300 billion over the next six months.
It will also spend up to US$850 billion in acquiring securities issued by mortgage finance giants Fannie Mae, Freddie Mac and Ginnie Mae.
“Instead of waiting for markets to clear, the Fed has moved decisively to get the US economy moving,” said Joseph Brusuelas, an analyst at Moody’s Economy.com.
“Wednesday’s surprise announcement is the surest sign that at least one arm of the federal government has the will to act in the face of the systemic crisis,” he said.
Brusuelas was referring to a plan to buy up toxic assets on banks’ balance sheets announced by the Treasury last month, but whose anxiously awaited details have yet to be revealed.
US Treasury Secretary Timothy Geithner has faced a storm of criticism after AIG, which has received more than US$170 billion in public rescue funds, paid massive bonuses to top executives, including some in the division blamed for putting the once-mighty insurer on the brink of collapse.
“The Fed is likely to be concerned that politics and confusion are preventing the Treasury from doing its part in the bailout effort,” said Ethan Harris of Barclays Capital.
His Barclays colleague, Julia Coronado, said that Fed policymakers “have concluded they cannot wait around for the Treasury and Congress to solve the problems and need to be more aggressive in getting financial markets moving.”
The Treasury’s work as the economy sinks into a second year of recession has been further complicated by the extreme isolation of Geithner, whose team remains largely unconfirmed by the Senate.
The Fed’s intervention on the bond market should lower the yield on long-term Treasury bonds, driving investors to purchase other financial instruments, such as company bonds, that would inject much-needed capital into companies squeezed by the credit crisis.
For Brusuelas, the Fed’s purchases of long-term Treasury bonds would lower rates on a host of financial instruments.
The stepped-up buying of mortgage-backed securities was expected to lower mortgage rates, which in turn would “stimulate refinancing activity” that could put extra money into households’ strained budgets, he said.
Deutsche Bank economist Joseph LaVorgna said that recent signs of stabilization in depressed consumer spending were no harbingers of a rebound in the main driver of the US economy “for three primary reasons: wealth destruction, tight credit and rising unemployment.”
“The good news is that the Fed is firing all its weapons at the recession,” said Nigel Gault, chief economist at IHS Global Insight.
“The bad news is that the recession is severe enough that all weapons are needed,” he said.