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Fed makes boldest move yet

The central bank plans to buy debt directly from companies for the first time in decades.

By Ron SchererStaff writer of The Christian Science Monitor / October 8, 2008

Bernanke: The Fed steps in again.

Susan Walsh/AP


New York

The Federal Reserve is now stepping in where financiers fear to tread.

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In its latest move to unlock the credit markets, the nation's central banker said Tuesday it will take the extremely unusual step of buying short-term debt directly from America's largest corporations, such as GE, ExxonMobil, and Bank of America.

The Fed effort is one of the most dramatic – and potentially riskiest – steps Ben Bernanke, the chairman of the Fed, has taken in the past month in his effort to get credit flowing again through the economy. He is effectively pushing the Fed into the middle of the private market for short-term corporate loans, known as commercial paper. If it works, companies will have the loans they need to make payrolls and pay bills. If it doesn't, taxpayers could be on the hook for loans that aren't backed by any tangible assets.

The bold measure illustrates the seriousness with which the Fed chairman views the current credit crisis.

"This move shows the Fed is pulling out all the stops to restore confidence in this market," says Phil Flynn, director of research at Alaron Trading in Chicago.

In recent days the $100-billion-a-day market has been frozen as the nation's money-market funds, which usually buy the short-term funding, have stayed on the sidelines with huge quantities of cash.

Economists say the Fed is scrambling to keep the economic downturn from deepening.

"If other economic indicators were looking more positive, they would not be taking such dramatic steps," says Ann Owen, a professor of economics at Hamilton College in Clinton, N.Y., and a former economist at the Fed.

The new program caught the financial markets by surprise. On Monday, the markets had been expecting some sort of coordinated interest rate cut from the world's central banks. So far the only bank to do so is the Australian Reserve Bank.

"I guess the Fed is trying to keep that powder dry for as long as it can," says Mr. Flynn.

The next Federal Reserve meeting is at the end of the month. The financial markets already expect the central bank to lower interest rates by half a percentage point. Many economists expect to see rates drop again in December by another quarter of a percentage point.
“The outlook for economic growth has worsened,” Mr. Bernanke said in a speech at the annual meeting here of the National Association for Business Economics. "In the light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate."

"The problem is if people are not lending, it does not matter what the target interest rate is," says Ms. Owen.