Fed scopes options with key rate near zero

March 18, 2009 6:00:04 AM PDT
With a key interest rate already near zero, Federal Reserve policymakers are weighing what other tools they can use to jolt the country out of recession. Fed Chairman Ben Bernanke and his colleagues resume their two-day meeting Wednesday, and at its conclusion they are all but certain to leave a key bank lending rate at a record low to try to bolster the economy, which has been stuck in a recession since December 2007.

Economists predict the Fed will hold its lending rate between zero and 0.25 percent for the rest of this year and for most - if not all of - next year.

The hope is that rock-bottom borrowing costs will spur Americans to step up spending, which would aid the economy. So far, though, hard-to-get credit, rising unemployment and other negative forces have forced consumers and businesses to retrench.

Against that backdrop, Bernanke and his colleagues have pledged to use "all available tools" to battle the financial crisis and turn the economy around.

One option advanced at its last meeting in January is buying long-term Treasury securities. Doing so would help further drive down mortgage rates and help the crippled housing market, economists said.

Another option put forward in January is expanding a Fed program aimed at bolstering the mortgage market. The Fed could boost its purchases of debt issued or guaranteed by mortgage giants Fannie Mae and Freddie Mac. Since that program was announced late last year, mortgage rates have fallen.

"The main message the Fed will want to convey is that policymakers still have tools and options to support the economy," said Mike Feroli, economist at economist at JPMorgan Economics.

Fallout from housing, credit and financial debacles - the worst since the 1930s_ has thrown millions of Americans out of work, driven a growing number of banks out of business and forced the government to put up hundreds of billions of taxpayers' money to bail out troubled financial companies.

Much is riding on a new program, created by the Fed and the Treasury Department, to spur lending for auto, education, credit card and other consumer loans. The Fed later this month will start providing up to $200 billion in financing to investors to buy up such debt.

The program could generate up to $1 trillion of lending for businesses and households, the government says. It will be expanded to include commercial real estate, though that component won't be part of the initial rollout.

There are risks to pumping more money into the economy, bailing out financial institutions and leaving a key rate near zero for too long. Those steps could ignite inflation, put ever-more taxpayers' money in danger and encourage companies to make high-stake gambles, confident the government stands ready to rescue them.

Fed officials meet as public outrage over government bailouts of financial institutions has swelled.

What has really touched a public nerve: The fact that American International Group Inc. - bailed at four times by the U.S. government to the tune of more than $170 billion - paid millions in bonuses to employees who worked in a division that has been blamed for the insurance company's near collapse last year. The bonuses came even as the company reported a stunning $62 billion loss, the biggest in U.S. corporate history.

Fury expressed by the public as well as Democrats and Republicans on Capitol Hill over the AIG case could make it politically harder for the Obama administration and the Fed to sell new financial rescue efforts.

Stabilizing the nation's financial system is key to turning around the economy, Bernanke has repeatedly said. If that can be done, then the recession might end this year, setting the stage for a recovery next year, he said.

Even in this best-case scenario, though, the nation's unemployment rate now at quarter-century peak of 8.1 percent will keep climbing. Some economists think it will hit 10 percent by the end of this year.

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