Fed takes further steps to ease credit crunch

updated 4:44 p.m. ET March 11, 2008

WASHINGTON - Staring at spreading financial dangers, the Federal Reserve announced a rescue package that would pour as much as $200 billion into banks and investment houses and allow them to put up risky home-loan packages as collateral.

Wall Street rebounded on the news Tuesday with its biggest rally of the year — and hoped the Fed had even more cards to play.

The Federal Reserve’s maneuver, coordinated with central banks overseas, was its latest effort to stem the global credit crisis and severe housing woes that threaten to bury the United States in its first recession since 2001. Fed Chairman Ben Bernanke and his colleagues have been stretching for new and imaginative ways to confront the situation.

They are hoping to bring relief where it is sorely needed: in the market for mortgage securities. Home loan financing has become much harder to get as nervous lenders have hunkered down.

“It is a highly significant move. The Fed is innovating in a way that is going to push liquidity directly into the mortgage markets, where it is most needed,” said David Jones, president of DJM Advisors.

On Wall Street, the Fed’s action propelled stocks upward. The Dow Jones industrials jumped by some 416 points.

Traders will be looking for still more action. Recent stock rallies have been followed by renewed selloffs by investors who believe the economy is still headed for recession, if it isn’t there already.

Assuming Tuesday’s action helps to stabilize turbulent financial markets, that could reduce the chances that the Fed will order a deep, three-quarters of a percentage point cut in its key interest rate next week to further encourage lending and other economic activity. An increasing number of economists now believe the Fed is more likely to cut rates by a half-point, though that could newly roil Wall Street.

The Federal Reserve announced it would allow squeezed financial institutions — including big investment houses and banks — to borrow up to $200 billion in super-safe Treasury securities by using some of their more risky investments as collateral.

The Fed announced the creation of a new Term Securities Lending Facility (TSLF) to provide financial institutions with 28-day loans of Treasury securities, rather than overnight loans. The institutions would pledge other securities — including federal agency residential-mortgage-backed securities, such as those of mortgage giants Fannie Mae and Freddie Mac — as collateral for the loans. Fed officials said it’s the first time they’ll be accepting mortgage-backed securities through this type of lending program.

“Firms that were having difficulty financing their mortgage positions have been thrown a lifeline,” said Stephen Stanley, chief economist at RBS Greenwich Capital.

By allowing financial institutions to put up mortgage-backed securities — for which there’s little market appetite — in return for safe securities that are in high demand, the Fed hopes to take pressure off financial companies and make them more inclined to lend to individuals and to businesses.

If the effort works, it should in time help to keep home loan rates down, especially on those backed by Fannie Mae and Freddie Mac, which are the few remaining sources of mortgage financing as credit has increasing dried up elsewhere, said Mark Zandi, chief economist at Moody’s Economy.com.

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