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Fed to shift $400B in holdings to boost economy

WASHINGTON — The Federal Reserve will use more than $400 billion to try to drive down long-term interest rates, make home and business loans cheaper and invigorate the economy.

Analysts said the moves would provide only a slight economic benefit.

The action the Fed announced Wednesday is modest compared with previous steps it’s taken. The Fed won’t expand its $2.9 trillion holdings; it’s just rebalancing them.

It will sell $400 billion of its shorter-term Treasurys to buy longer-term Treasurys by June 2012. And it will reinvest principal payments from its mortgage-backed securities, to help keep mortgage rates at super-low levels.

Fed policymakers announced the moves after a two-day meeting. Three members out of 10 dissented from the decision. The Fed acted despite criticism from Republicans who have warned that such steps could ignite inflation.

“The actions the Fed has taken are helpful,” says Josh Feinman, global chief economist at DB Advisors. “They will help hold down long-term rates, but they’re no panacea.”

The Fed left open the possibility of taking further action to try to strengthen the economy.

Stocks dropped immediately after the announcement around 2:20 p.m. and then continued falling. The Dow Jones industrial average closed down about 283 points.

But the yield on the 10-year Treasury note tumbled to 1.86 — the lowest since the Federal Reserve Bank of St. Louis started keeping daily records in 1962. The 10-year yield is used to peg rates on a variety of loans, including long-term mortgages.

The plan the Fed unveiled Wednesday, dubbed “Operation Twist,” resembles a program the Fed used in the early 1960s to “twist” long-term rates lower relative to short-term rates.

In its statement, the Fed noted that the economy is growing slowly, unemployment is high and housing remains in a prolonged slump.

Under its plan, the Fed will extend the average maturity of its holdings from six years to eight years. The Fed has directed the New York Fed to buy Treasurys with remaining maturities of six to 30 years, and to sell an equal amount of securities with maturities of three years or less.

Analysts say the shift in the Fed’s portfolio could reduce borrowing costs and perhaps raise stock prices.

“This is a measured response to weak economic conditions,” said David Jones, head of DMJ Advisors and the author of four books on the Fed. “The Fed is still trying but it can only do so much.”

In June, the Fed completed a $600 billion bond-buying program that many economists have credited with keeping rates low.

He said that just the market anticipation of the Fed’s Operation Twist had sent long-term rates down by around 25 basis points for the 10-year bond. He said that without the Fed’s move Wednesday, those rates would have risen. With the move, he predicted the 10-year bond would probably fall by another 5 basis points.

Once the Fed announced last month that it would expand its September policy meeting from one to two days, economists anticipated some new action. Chairman Ben Bernanke had said the Fed was considering a range of options.

The Fed’s move Wednesday came despite a rift within the central bank. The three members who dissented also did so at the Fed’s August meeting — the most negative votes in nearly two decades.

The three dissenters — Richard Fisher, Narayana Kocherlakota and Charles Plosser, all regional Fed bank presidents — have said the Fed’s policies may be raising the risk of high inflation. They favor giving the economy more time to heal without further Fed action.

Still, the central bank is under pressure to revive an economy that has limped along for more than two years since the recession officially ended.

In the first six months of this year, the economy grew at an annual rate of just 0.7 percent. The housing market remains depressed. The unemployment rate is 9.1 percent. In August, the economy didn’t add any jobs, and consumers didn’t increase their spending on retail goods.

Most economists foresee growth of less than 2 percent for the entire year. They say the odds of another recession are about one in three.

The Fed has offered its own bleak outlook. At its August policy meeting, it said the economy would likely struggle for at least two more years. As a result, it said it planned to keep short-term rates near record lows until mid-2013, as long as the economy remained weak.

Historically low mortgage rates, now averaging 4.09 percent on a 30-year fixed loan, have done little to boost either home purchases or refinancings.

Mark Zandi, chief economist at Moody’s Analytics, said 30-year rates, should fall further after the Fed’s action. Yet many would-be home buyers don’t have the required down payments or are reluctant to buy at a time when prices are still falling in many areas. And many homeowners have no equity and can’t refinance.

Bernanke’s policymaking has incited criticism from congressional Republicans and GOP presidential candidates. Some have argued that the Fed’s $600 billion bond-buying program raised inflation pressures, weakened the dollar’s value against other currencies and contributed to a spike in oil prices.

On Monday, the four highest-ranking Republicans in Congress sent Bernanke a letter cautioning the Fed against taking further steps to lower interest rates. Their letter suggested that lower rates could escalate the risk of high inflation.

Texas Gov. Rick Perry, who is seeking the GOP nomination for president, has gone so far as to say Bernanke would be “almost treasonous” to launch more bond buying.

The Fed’s efforts to stimulate the economy through low rates are occurring at a time when Congress is focused more on shrinking spending.

President Barack Obama has proposed a $447 billion job-creation program made up mainly of tax cuts and public works spending. Obama also wants the richest Americans to pay higher taxes to help cut federal budget deficits.

Obama’s proposals face an uncertain fate in Congress. Republicans have dismissed his deficit-reduction plan and have focused on efforts to reduce spending and keep taxes low for everyone.

One comment

  1. This is not the solution to the problem. U can put as much as money u want, all it will do is boom and bust. That’s what happens in the housing crisis in the first place. They make borrowing easier and what happened? It went bust. It might help to create a job in short term, but at the same time creating long term inflation. I hear a lot of ppl complaining about gas and food price. The problem is not the supply is low; it is mostly the weaker dollar. The dollar lost more than 90% of it value since the 1950’s. That means if the dollar was as strong as it was back then, gas price would have be less than 50 cent a gallon. Stop printing money and come up with a real solution for the problem. Come up with a solution for the trade deficit with china. Cut the cooperate tax and get rid of all loopholes. US cooperate tax is one of the highest in the world and they ask why US ranked 143 in new investment. Come up with a balanced personal income tax.US ranked one of the nations in the world with low personal income tax and they wonder why the US raned 186 in revenue from taxes and 191 in budget surplus. Make education and HC affordable. US spend more than 17% of it GDP for HC system that is less effective than Cuba. How u expect to compete in the new global market, era of technology, with the same man power before the era of internet. Let the unemployed go to school and let them take some skills that will make them fit for the new era. There are a lot of things that can be done but all the politician care is getting reelected.