Fed Tries to Revive Economy by Buying Debt

In Washington on Wednesday the Federal Reserve announced they will buy up to $300 billion in long-term US government bonds and an additional $750 billion in mortgage-backed securities that have been guaranteed by Freddie Mac and Fannie Mae. After a 2 day meeting, Fed Chairman Ben Bernanke announced a record low short term banking rate would be left between zero and a quarter percent. Economists believe the Fed will keep this rate in place for both 2009 and most of 2010.

The real surprise of this Fed strategy is the plan to buy up such a large quantity of government bonds to the order of a trillion dollars or more. This has the immediate effect of liquefying the credit markets, lowering the rate on consumer debt, and has the long term effect of spurring consumer spending and ultimately reviving the struggling economy. After the announcements by Bernanke, Wall Street rebounded, and the Dow rose over one percent by close.

Government bond prices took off, while both the dollar and the 10 year Treasury note took a loss. The T-note had the largest one day drop in over 25 years. Bernanke has said the key to ending the recession; is stabilizing the credit and financial markets, and has pledged to do everything at his disposal to accomplish just that. At the announcement issued Wednesday by Fed policymakers that the economy continues to contract since January, implying causes such as job losses, equity loss in the housing sector, and constricting credit conditions.

Leading economists have the belief that everyone should benefit from the new Fed spending, as well as the belief that these steps are enough to halt the declining economy. The additional $750 billion on top of the $500 billion the Fed already buys in mortgage backed securities creates a whopping $1.25 trillion in debt purchasing. This is supposed to spur lending, the Feds main goal for this economy. The mortgage rates are low and have even fallen as a result of the announcement. Experts feel that this huge influx of credit may increase lending, and it may keep the rates down for a long time. Lending is related to spending, and the Fed hinted at program it may be unveiling next week that will expand consumer lending for autos and education another $1 trillion.

This has the net effect on the Fed of increasing its balance sheet to almost $2 trillion, doubled in five months from $900 billion. The Fed has to be careful and has said as much with regard to the so called “moral hazard” by creating an environment where companies play high-stakes games full well cognizant that the government will jump in and bail them out.

The Bank of England has taken similar measures buying government bonds to help revive the ailing British economy. Ministers of Finance from a number of countries have discussed coordinating their actions to maximize the effectiveness for the global financial situation.

The Fed warns that although the short-term economic outlook is not great the long-term outlook is for a gradual resumption of sustainable economic growth. For example some experts predict a peak unemployment rate of ten percent before the end of the year. Over four million jobs have been lost since the end of 2007, and a total of twelve and a half million out of work.

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