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Fed Looking at How to Beef Up Lending Power: WSJ

The Federal Reserve is considering contingency plans to bolster its lending power, in case measures it has taken to rescue the troubled credit markets fail, the Wall Street Journal reported on Wednesday.

One option being considered is to have the Treasury borrow more money than it needs to fund the government and keep the proceeds on deposit at the Federal Reserve, the report said.

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

Other options include issuing debt under the Federal Reserve's name instead of the Treasury's, and asking Congress for immediate authority for the Fed to pay interest on commercial bank reserves rather than waiting until a law enacted earlier allows it to in 2011, according to the newspaper.

"Evidently it's another attempt at seeking out non-policy based solutions to the credit crunch, which sits well with the FOMC minutes yesterday which noted that monetary policy alone was insufficient to stem the credit crisis," said Richard McGuire, fixed income strategist at RBC Capital Markets in London.

But the steps are not imminent as the Fed still has room on its balance sheet for additional lending, the report said, adding that the internal talks were part of a continuing effort to identify the Fed's options in case the credit crunch gets worse.

The Federal Reserve was not available immediately for comment.

Firepower

"The Fed still has some firepower left, so it is not like they would have to use other means now, although it is encouraging that they are already thinking about other methods rather than sitting on their hands," said Marc Ostwald, bond analyst at Insinger de Beaufort in London.

"Their continued scope of using current methods is finite. The Federal Reserve holds about $600 billion in U.S.Treasuries and could use some of that." The Fed held $655.8 billion in Treasury securities as of March 19.

Ostwald said that if the Fed were to issue debt, it would be following the Bank of England and this could involve issuing short-dated paper in the two-to-five-year Treasuries area.

"To issue longer-dated paper would not be smart when you have a steep yield curve and can benefit from cheaper costs of servicing short-dated paper.

Secondly, the market would not like the Fed to issue long paper which would hang for many years." Should the Treasury decide with Congressional approval to issue more bonds to fund the Fed, there should be good demand for extra paper due to the backdrop of weakening global economic growth, although this would depend on the ultimate size of the issuance, analysts said.

"In general there is still good appetite for flight-to-quality flows, especially at the front-end of the U.S. curve," said Wilson Chin, rate strategist at ING.

"Given the credit market turmoil is still there, demand would be there up to a point. If there's really a huge excess of supply, it would restrain demand," he said.

British and Swiss central banks are also pondering such contingency plans, the Journal reported.

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