Tuesday, November 25, 2008

Fed bets $800 billion on consumers

The Federal Reserve and Treasury Department on Tuesday unveiled hundreds of billions more in money they are pumping into the struggling U.S. economy, trying to jumpstart lending by the nation's banks for mortgages and consumer debt.

Together, the programs from the Federal Reserve and the New York Fed aim to dump $800 billion in additional funds into the struggling U.S. economy, more than Congress approved in October for a bailout of the nation's banks and Wall Street firms.

By putting that money in the hands of holders of consumer and mortgage loan securities, the government hopes more money will flow to consumers than has occured so far in previous bailout plans.

But the program to make $200 billion available for a range of consumer loans - including credit cards and car loans - likely won't be up and running until February. Government officials briefing reporters couldn't say how much additional credit the program might make available to consumers in time to feed purchases for the holiday shopping season.

That $200 billion aimed at spurring consumer borrowing will come from the Federal Reserve Bank of New York, which will lend that money to holders of securities backed by consumer debt, such as credit card debt.

The statement from Treasury said that while roughly $240 billion of those kinds of securities were issued by the nation's financial institutions in 2007, the issuance of those securities essentially came to a halt in October.

"This lack of affordable consumer credit undermines consumer spending and, as a result, weakens our economy," said Treasury Secretary Henry Paulson at a press conference.

Treasury will allocate $20 billion to back that lending by the New York Fed, an attempt to cover any losses that the New York Fed might suffer as a part of the program.

But the $200 billion under this program, and an additional $600 billion being made available to increase mortgage lending, will come from an increase in reserves by the Fed. Essentially, the central bank is creating more money to cover that lending.

The Treasury, which oversees the $700 billion approved by Congress last month to help financial institutions, has been reluctant to make a major commitment of those funds to this new effort. Thus it allocated only $20 billion, or the same amount it invested in troubled banking giant Citigroup (C, Fortune 500) in a move announced Sunday.

So it was left to the Federal Reserve of New York, which is headed by Timothy Geithner, the man nominated by President-elect Obama to take Paulson's place, to come up with the funds to try to restart consumer lending.

The moves came as the Commerce Department announced that gross domestic product, the broad measure of the nation's economy, fell at an annual rate of 0.5% in the third quarter, the biggest drop in economic activity in seven years. Economists believe that the economy is likely to continue to contract in the current quarter and into early next year.

In addition, the Federal Reserve, the nation's central bank, announced it will purchase up to $500 billion in mortgage backed securities that have been backed by Fannie Mae (FNM, Fortune 500), Freddie Mac (FRE, Fortune 500) and closely held Ginnie Mae, the three government-sponsored mortgage finance firms set up to promote home ownership. It will also buy another $100 billion in direct debt issued by those firms.

"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," said the statement from the Fed.

The financial crisis has frozen lending markets, making it nearly impossible for consumers and businesses to borrow money.

Treasury originally had planned to use the $700 billion bailout to buy troubled mortgage assets. But it has shifted gears and focused mostly on injecting capital into banks.

The last capital injection into Citigroup was part of a broader rescue package under which Treasury and another U.S. agency, the Federal Deposit Insurance Corp., announced it would guarantee losses on more than $300 billion of Citi's troubled assets.

But once again, Treasury is not using the $700 billion in bailout funds for that guarantee, as it tries to keep those funds available for future capital needs by the nation's financial institutions.

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