Fed to Make $200 Billion Available To Lenders
Bank Seeks to Loosen Credit

By Neil Irwin and David Cho
Washington Post Staff Writers
Saturday, March 8, 2008; D01

The Federal Reserve took strong action yesterday to restore order to frazzled lending markets while a new report showing unexpected job losses underscored the toll that credit markets are taking on the economy.

The world's financial plumbing is so clogged that the central bank sees a need for new steps to clean it out to prevent severe damage. Mounting panic in the credit markets is making it harder for Americans to get mortgages and is increasing the rates they must pay on credit cards and auto loans. Even solid businesses are finding it difficult to raise money to expand.

The nation shed 63,000 jobs in February, the Labor Department reported, the second straight month of losses and the worst monthly decline since March 2003. The construction and manufacturing industries continued to shed positions, as they have for months, but the decline broadened to include big job cuts by retailers and temporary help services.

Forecasters had expected a modest employment gain, and the weak numbers prompted many top economists to conclude that the U.S. economy is now in recession.

"You've now strung together three months in a row of private-sector job losses," said Stuart G. Hoffman, chief economist of PNC Financial Services Group. "That doesn't happen unless you're in a recession."

The Fed said it will make $200 billion available to financial institutions in an effort to ease a crisis of confidence that is making it harder for families and businesses to borrow money.

"They're recognizing that financial markets aren't functioning well, and that that creates risks to the real economy," said Vincent Reinhart, a resident scholar at the American Enterprise Institute and a former senior Fed official.

In the past two weeks, interest rates have spiked even for safe forms of debt, including bonds issued by state and local governments and those from some of the healthier companies, such as General Electric. Rates also have soared on bonds issued by the government-sponsored mortgage companies Fannie Mae and Freddie Mac.

The stresses in financial markets drove the average rate on a 30-year, fixed-rate mortgage to people with sound credit to 6.875 percent Thursday, up from 6 percent on Feb. 29, according to Palm Beach Financial Network. It edged down again to 6.5 percent yesterday.

The problems in the credit markets are counteracting much of the effect of interest rate cuts by the Fed over the past six months meant to stimulate the economy.

"A lot of what we've done has been mostly just to offset the tightening of credit that has arisen because of the financial situation," Fed Chairman Ben S. Bernanke said in congressional testimony last week.

Instead of simply cutting interest rates further, the Fed responded to this latest crisis yesterday with carefully targeted measures. The central bank said it will auction $100 billion to financial institutions, injecting money into the banking system by trading cash for troubled securities. The Fed will also make another $100 billion in cash available in exchange for securities issued by Fannie Mae and Freddie Mac, trying to restore confidence to the market for home mortgages.

The problems are the latest wave of a crisis in debt markets that began in August and reappeared again in November and late February. This crisis is one major factor in a pullback by consumers and businesses that has driven the economy to the brink of recession, or possibly over it.

The jobs report yesterday marked the third straight month of disappointing results. The losses were heaviest in the construction sector, which shed 39,000 positions, and manufacturing, which fell by 52,000 jobs. But even sectors that have been sources of job growth are cutting back. Retailers cut 34,100 jobs, probably reflecting soft consumer spending. Financial companies cut 12,000 positions.

And in a particularly worrisome sign, temporary help services cut 27,600 jobs. Often, companies cut temporary workers before shedding permanent jobs, making that category a leading indicator for what is to come.

The latest problems in the credit markets are the result of the vast amount of debt that investors have assumed in recent years to finance their activities. Now, investors are being forced to unwind that debt as lenders get anxious and demand that hedge funds and other institutions come up with cash.

These are margin calls, no different from what happens to an individual investor when he buys stocks with borrowed money and the value of the stocks declines. For example, Carlyle Capital, a fund managed by the District-based Carlyle Group, faced margin calls this week from its lenders. Unable to come up with enough cash, the fund defaulted.

These margin calls are prompting investment funds to unload various kinds of debt to raise money, and often the only debt they can find a buyer for is the safest, such as bonds issued by municipalities. The result is higher mortgage rates, higher borrowing costs for state and local governments, and higher rates for companies.

"Margin calls make it difficult for banks to borrow money, for corporations to borrow money and for homeowners to borrow money," said Robert Nelson, a managing analyst at Thomson Financial. "That's going to be the theme through the rest of the year: tight lending."

Mortgage lenders rely on Fannie Mae and Freddie Mac for the money they lend to home buyers. Financial markets are now signaling that investors believe even the historically safe securities issued by Fannie and Freddie are increasingly at risk of default.

Leaders of the Federal Reserve view this to be a market anomaly rather than a reflection of a true increase in the risk of the loans. The Fed is trying to restore stability to that market by offering major financial institutions a 28-day "repurchase agreement," under which the Fed would temporarily hold their securities in exchange for cash.

The same crisis has caused rates on municipal bonds, those issued by state and local governments, to rise above those issued by the federal government. That is highly unusual. Municipal bonds are tax free, and their issuers can typically offer lower interest rates and still attract buyers.

Borrowing costs have also increased for large corporations and more so than in previous periods of markets stress. In recent months, the interest rate premium paid by low-risk, AA-rated firms has increased 1.2 percentage points, according to analysis by Macroeconomic Advisers, a forecasting firm. By contrast, during a world debt crisis in 1998, this rate only rose by 0.3 percentage points. After the Sept. 11, 2001, terrorist attacks and subsequent corporate scandals, it was up 0.2 percentage points.

Besides the repurchase agreements, the Fed has expanded a program of "term auction facilities" that allows financial institutions to put up collateral in exchange for cash, aiming to return liquidity to these markets.

"The Fed has been running around putting fingers in dikes," said Diane Swonk, chief economist of Mesirow Financial. "Without that, the dike would have imploded, and water would have been spilling in."

Staff writer Tomoeh Murakami Tse in New York contributed to this report.