http://www.bloomberg.com/apps/news?pid=20601087&sid=ag3TJyGD73qk&refer=home Fed Risks âSpitting in the Windâ With New $800 Billion Pledge By Craig Torres and Scott Lanman Nov. 26 (Bloomberg) -- The Federal Reserveâs new $800 billion effort to combat the financial crisis is designed to make credit more accessible to shaken consumers who arenât sure they want more debt. Households and lenders may not respond much because of the wealth destruction from plunging property and stock values, and the deepening economic slump, economists say. That means banks may end up returning the Fedâs new liquidity through deposits at the central bank. âWe are sort of spitting in the wind,â said Michael Darda, chief economist at MKM Partners LP in Greenwich, Connecticut. âBanks wonât be throwing a lot of loans out there when they fear -- rationally -- those loans may not be paid back.â Policy makers aim to kick-start markets for loans to students, car buyers, credit-card borrowers and small businesses with a new $200 billion program. Backed in part by the Treasury, the Fed will become a new buyer in the market for consumer loans at a time when many traditional holders of the assets, such as off-balance sheet bank units, have collapsed or been dissolved. The announcement of the new efforts yesterday came amid rising criticism that officials were excessively focused on saving Wall Street firms, with the Citigroup Inc. rescue Nov. 23 the latest example. President-elect Barack Obama said repeatedly in the past two days heâll compose a plan to help âMain Streetâ as well as the financial industry. 1966 Powers Obama and congressional Democrats have also pushed for a stronger response to the housing crisis. The Fed responded yesterday, invoking authority first granted in 1966 to buy $500 billion of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae. Along with a $100 billion plan to buy the corporate debt of Fannie, Freddie and federal home loan banks, the step marks the central bankâs biggest foray into a type of quantitative easing. Thatâs an unorthodox monetary policy tool that goes beyond setting short-term interest rates. The central bank has already cut its benchmark rate to 1 percent. âRates are going to be kept down for a long time, the Fedâs balance sheet is going to be expanded for a long time,â said John Ryding, chief economist at RDQ Economics, New York. âIt does, as we have argued, represent a very significant quantitative easing.â Mortgage rates and yield premiums on Fannie and Freddie debt tumbled after the announcement. The average U.S. rate for a 30-year fixed mortgage ended at about 5.5 percent after starting the day at 6.38 percent, according to Bankrate Inc. Markets React The spreads on most of Fannieâs and Freddieâs $1.7 trillion of corporate debt and $4.1 trillion of mortgage-backed bonds over comparable Treasuries tumbled to the lowest levels since early October. The cost to protect against defaults on corporate bonds and on securities backed by commercial mortgages also declined. The question remains whether the lower rates will have much impact on the flow of credit and the economy. While the Fed has expanded its balance sheet by $1.3 trillion so far, banks have left much of the liquidity on deposit at the central bank itself, as so-called excess reserves. The surplus stood at $604 billion on Nov. 19. Bank regulators have tried to cajole lenders, saying they âexpectâ them to lend, in a guidance letter issued Nov. 12. The Fedâs most recent quarterly survey of bank loan officers showed that 70 percent of domestic firms had tightened lending standards for their best mortgage borrowers in the third quarter, and 60 percent had raised standards on credit-card loans. âNon-Functioningâ âThe root of the problem is our securitization markets are non-functioning,â said Josh Rosner, managing director at New York research firm Graham Fisher & Co. âWe have capital problems at the banks so they canât take over.â While officials yesterday contested claims that the Fed is undertaking quantitative easing, they acknowledged that the central bankâs new actions will result in another injection of funds into the system. Officials said their objective is to affect credit markets rather than to target money supply. The Bank of Japan is the only major central bank to deploy quantitative easing in modern times, from 2001 to 2006. Current Governor Masaaki Shirakawa said in May that the policy âwas very effective in stabilizing financial markets,â while at the same time it had âlimited impactâ in resolving Japanâs economic stagnation of the time because banks wouldnât lend and companies wouldnât borrow. Fed Meeting Fed officials next meet on Dec. 16-17, when economists anticipate they will cut their target rate for overnight loans between banks to 0.5 percent. The central bank expanded the meeting to two days, making it likely that the Federal Open Market Committee will explore the options for conducting policy with rates near zero percent. âWe canât look back to recent historyâ as a guide for what to do, Mark Gertler, a New York University economics professor who has collaborated with Fed Chairman Ben S. Bernanke on research, said in a Bloomberg Television interview. âWe really do have to make it up as we go along.â Yesterdayâs announcements continue the trend of the Fed and Treasury taking on more risk with public money, while private sector balance sheets contract. Earlier this week, the two agencies and the Federal Deposit Insurance Corp. offered a backstop for a $306 billion portfolio of Citigroup assets. Under the new Term Asset-Backed Securities Loan Facility, the Treasury will use taxpayer funds to protect the Fed against the first $20 billion of losses, or 10 percent, of $200 billion in exposure to AAA rated securitized consumer debt. Risk to Taxpayer âI am willing to believe that these things that are rated AAA might have a maximum 10 percent loss if the assets behind them never changed,â said Ann Rutledge, a principal at R&R Consulting in New York, which specializes in structured finance. âThe collateral in credit card asset-backed securities changes.â Ratings may be harder to judge when credit quality is deteriorating. Also, the government has less information than issuers, who could back the bonds with assets that pose the most risk of declining quality, Rutledge said. Officials yesterday said the risk of loss is minimal, and noted that the Fed will put haircuts on the value of the ABS that it takes on. Treasury Secretary Henry Paulson said the mortgage debt purchases are a âgreat investment for the taxpayerâ because the government already stands behind Fannie and Freddie.