Staring at spreading financial dangers, the Federal Reserve announced a rescue package that would pour as much as $200 billion into banks and investment houses and allow them to put up risky home-loan packages as collateral.
Wall Street rebounded on the news Tuesday with its biggest rally of the year--and hoped the Fed had even more cards to play.
The Federal Reserve's maneuver, coordinated with central banks overseas, was its latest effort to stem the global credit crisis and severe housing woes that threaten to bury the United States in its first recession since 2001. Fed Chairman Ben Bernanke and his colleagues have been stretching for new and imaginative ways to confront the situation.
They are hoping to bring relief where it is sorely needed: in the market for mortgage securities. Home loan financing has become much harder to get as nervous lenders have hunkered down.
"It is a highly significant move. The Fed is innovating in a way that is going to push liquidity directly into the mortgage markets, where it is most needed," said David Jones, president of DJM Advisors.
On Wall Street, the Fed's action propelled stocks sharply higher.The Dow Jones industrials jumped by some 416 points.
Traders will be looking for still more action. Recent stock rallies have been followed by renewed selloffs by investors who believe the economy is still headed for recession, if it isn't there already.
Assuming Tuesday's action helps to stabilize turbulent financial markets, that could reduce the chances that the Fed will order a deep, three-quarters of a percentage point cut in its key interest rate next week to further encourage lending and other economic activity. An increasing number of economists now believe the Fed is more likely to cut rates by a half-point, though that could newly roil Wall Street.
The Federal Reserve announced it would allow squeezed financial institutions--including big investment houses and banks--to borrow up to $200 billion in super-safe Treasury securities by using some of their more risky investments as collateral.
The Fed announced the creation of a new Term Securities Lending Facility (TSLF) to provide financial institutions with 28-day loans of Treasury securities, rather than overnight loans. The institutions would pledge other securities--including federal agency residential-mortgage-backed securities, such as those of mortgage giants Fannie Mae and Freddie Mac--as collateral for the loans. Fed officials said it's the first time they'll be accepting mortgage-backed securities through this type of lending program.
"Firms that were having difficulty financing their mortgage positions have been thrown a lifeline," said Stephen Stanley, chief economist at RBS Greenwich Capital.
By allowing financial institutions to put up mortgage-backed securities--for which there's little market appetite _ in return for safe securities that are in high demand, the Fed hopes to take pressure off financial companies and make them more inclined to lend to individuals and to businesses.
If the effort works, it should in time help to keep home loan rates down, especially on those backed by Fannie Mae and Freddie Mac, which are the few remaining sources of mortgage financing as credit has increasing dried up elsewhere, said Mark Zandi, chief economist at Moody's Economy.com.
The housing meltdown--leading to sagging home prices and record-high foreclosures--has caused financial institutes to rack up huge losses in bad mortgage investments. Fannie Mae and Freddie Mac recently reported fourth-quarter losses totaling $6.1 billion and predicted multibillion-dollar losses throughout this year, amplifying concerns about their stability. Prices
also have plunged recently for the billions of dollars of mortgage securities that Fannie Mae and Freddie Mac guarantee, package and sell to investors as supply has outstripped demand.
The Fed's move comes as banks and other financial institutions face cash crunches.
"Pressures in some of these markets have recently increased again," the Fed said in a statement. "We all continue to work together and will take appropriate steps to address those liquidity pressures." The other banks involved are the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank.
The loans of Treasury securities would be made available through weekly auctions, beginning on March 27.
For now, up to $200 billion of Treasury securities is envisioned being made available. Fed officials, however, didn't rule out additional operations of this sort down the road.
Next steps? Some economists said the Fed might move to accept an even wider array of collateral for the auctions.
"This will not turn the economy around or fix all the problems in the markets but it should reduce the liquidity issue, at least for now," said Ian Shepherdson, chief economist at High Frequency Economics.
White House press secretary Dana Perino said President Bush welcomed the latest step and "has full confidence in Ben Bernanke at the Fed."
Since December, the Federal Reserve has been making short-term loans of cash available to banks through a new auction setup. With the latest bank auction results announced Tuesday, the Fed has now made $210 billion available to squeezed banks in hopes it will help them to continue lending to individuals and companies.
Separately, the Fed also on Tuesday said it has authorized increases in existing programs called "swap lines" with the European Central Bank and the Swiss National Bank
"These arrangements will now provide dollars in amounts of up to $30 billion and $6 billion to the ECB and the SNB respectively," the Fed said, extending the term of these swap lines through Sept. 30.
The European Central Bank, in conjunction with the Fed, said it would offer U.S. dollars to euro money markets of up to $15 billion. It took similar action in December and January. The Frankfurt-based central bank for the 15 countries that use the euro said it has been working closely with other central banks.
A meltdown in the housing and credit markets has made banks and other financial institutions reluctant to lend to each other, causing a cash crunch. Financial companies racked up multibillion-dollar losses as investments in mortgage-backed securities soured with the housing market's bust. Problems first started in the market for subprime mortgages_ those made to people with blemished credit histories. However, troubles have spread to other areas.