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Fed's bold $200 billion move

The central bank's unusual cash infusion aims to keep banks lending.

By Ron SchererStaff writer of The Christian Science Monitor / March 13, 2008

New York

The Federal Reserve is becoming increasingly creative in its efforts to keep the world's credit markets from shutting down.

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The central bank's latest effort is to show the world's lenders it has faith in the highest quality debt – whether it's issued by such institutions as Fannie Mae or a highly rated company.

Later this month, the Fed, in concert with other central banks in Europe, will offer to swap up to $200 billion in US Treasury securities for other debt including mortgage securities.

The move, which was met with wide approval on Wall Street, is essential to keep liquidity flowing at a time when some lenders are growing wary even of debt with the implicit guarantee of the US government. Without the Fed's actions, there could have been a further deterioration of the nation's housing market.

"This indicates the Fed is the true lender of last resort," says Doug Roberts, chief investment strategist for Channel Capital Research, based in Shrewsbury, N.J. "It's not bailing people out but it is providing a sandbag."

However, some economists worry that the Fed is going to potentially fund assets other than US Treasury obligations. "Every politician will soon have their pet set of loans they would like to see supported," cautions Bob Eisenbeis, chief monetary economist at Cumberland Advisors and a former director of research at the Federal Reserve Bank of Atlanta.

Fed watchers also warn that the Fed's latest actions will not do much to arrest falling housing prices. Last year for the first time since the Great Depression, home prices fell. They are widely expected to drop again this year since the inventories of unsold homes is quite high by historical standards.

"To a large degree the Fed's actions do not get at the solvency issues," says Paul Kasriel, chief economist at the Northern Trust Company in Chicago. "We're seeing the bursting of the credit bubble, and one of the main assets is homes and they are declining in value, which is putting pressure on mortgage-related debt."

Helping Bear Stearns

However, many Fed observers agree the central bank had to act. Interest rates had risen on loans guaranteed by Fannie Mae, Freddie Mac, and other agencies with debt implicitly guaranteed by the US government. Last week, this resulted in a $400 million margin call on Carlyle Capital, which had a $21.7 billion portfolio of residential mortgage-backed securities, many of them rated AAA, the highest quality.