KEY POINTS:
The federal reserve is injecting US$800 billion ($1.4 trillion) more into the troubled credit markets in its latest high-stakes attempt to end the drought of mortgages, car finance deals and student loans that has pushed the United States into recession.
With three new plans announced yesterday, the Fed is massively increasing the scale of its intervention in the markets and inflating the size of its balance sheet.
"Millions of Americans cannot find affordable financing for their basic credit needs," said the Treasury Secretary, Hank Paulson. "And credit card rates are climbing, making it more expensive for families to finance everyday purchases. This lack of affordable consumer credit undermines consumer spending and as a result weakens our economy."
Lenders have turned off the taps to consumers because off the collapse of the secondary market, where they used to sell on the loans and raise the cash needed for yet more lending.
Loans are packaged together and sold as asset-backed securities (ABS) in a process called securitisation, but ABS buyers are demanding vastly inflated interest rates because of their concerns about the underlying economy, so issuance declined precipitously in September and came to a halt last month.
By offering US$200 billion in loans to ABS holders, the Fed believes it will stimulate demand and securitisation will restart, encouraging lenders to thaw their dealings with consumers.
"The ABS markets historically have funded a substantial share of consumer credit and small business loans. Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and contribute to further weakening of US economic activity." it explained.
To insulate the Fed from losses on its US$200 billion in ABS loans, the Treasury is handing the central bank US$20 billion from the US$700 billion Wall St bailout fund agreed by Congress last month. Traders hailed the scheme as an ingenious way of using the Fed to "leverage" the bailout money, magnifying the effect of taxpayers' investment by 10 times.
Having already spent US$270 billion taking direct stakes in US banks and loaning US$40 billion to the nationalised insurance group AIG, just US$20 billion is left in the first half of the bailout fund, and Paulson may ask Congress to release the second US$350 billion tranche before he leaves office.
The US$200 billion ABS plan was the most unusual of the three major Fed programmes.
It also said it would buy US$500 billion of mortgage-backed securities to support the mainstream mortgage market, and US$100 billion in debt issued by Fannie Mae and Freddie Mac, the government-controlled mortgage finance businesses.
Both plans are aimed at propping up the secondary mortgage market, making home loans more readily available and reducing mortgage rates.
The credit markets have been wrecked by collapse of US house prices. A glut of homes repossessed from sub-prime borrowers who could not afford the payments is still putting downward pressure on prices.
The latest Case-Shiller house price index showed values in 20 metropolitan areas down a record 16.6 per cent in the third quarter of the year and they are now back where they were in the early months of 2004.
Falling house prices have trashed the value of mortgage-backed securities and related assets on bank balance sheets, forcing banks to pull back on their lending activities.
The wider impact of the credit crisis was on display in other economic figures yesterday. The third-quarter GDP figure was revised down to minus 0.5 per cent; the government had first calculated only a 0.3 per cent decline.
Economists are bracing themselves for anything between minus 3 per cent and minus 5 per cent in the fourth quarter, representing the sharpest contraction in economic activity in at least 25 years.
The US$800 billion intervention will be run mainly out of the Federal Reserve in New York, whose president, Tim Geithner, was named on Monday as President-elect Barack Obama's Treasury Secretary. Peter Orszag is to be his budget director, with a brief to slim down government spending.
- INDEPENDENT
