Stocks Surge as Fed Offers A Boost

NEW YORK, March 11 -- The Federal Reserve took bold action Tuesday to revive the economy's ossified credit markets by offering to take over the risk of spurned mortgage securities, igniting a rally on Wall Street that sent stocks to their best performance in five years.

Setting aside earlier reservations, the Fed essentially made itself the lender of last resort to investment banks squeezed for cash by offering them up to $200 billion in new credit against their holdings of highly rated mortgage securities that no one else is eager to buy. This move, coordinated with four other central banks, was the most aggressive step the Fed has taken to address the spreading credit crisis.

The Dow Jones industrial average of 30 blue-chip stocks responded to the morning announcement by jumping 250 points within the first moments of trading and ended the day up 416.66 points, or 3.5 percent, to 12,156.81. The Standard & Poor's 500-stock index, a broader market measure, rose 47.28, or 3.7 percent, to 1320.65. The tech-heavy Nasdaq composite index advanced 86.42, or 4 percent, to 2255.76.

But while the Dow's percentage gain was its steepest since 2003, the rebound in trading still left markets below where they'd been just a week ago. Nor did the move by the central bank address the underlying weakness of the economy triggered by widespread exposure to failing subprime mortgage loans, though the initiative did blunt the immediate threat: a run from even the safest high-grade bonds.

Until Tuesday, the central bank had been unable to reverse the downward slide of the U.S. economy despite a series of interest rate cuts and other steps to introduce liquidity into the system. The series of cuts to the federal funds rate had threatened to stoke inflation and, by driving down the value of the dollar, contributed to price rises in oil and other imported commodities. But these moves had done little to restore the confidence of banks, which have increasingly tightened the credit they offer to businesses and home buyers, even those with excellent credit.

All this was choking off already anemic economic activity. The government reported last week that the economy shed jobs for the second consecutive month. Consumer spending has softened, corporate profits have flagged, and both residential and commercial real estate have displayed new signs of stress.

In the past week, the vicious cycle accelerated. Bankers demanded that hedge funds and other investors holding troubled securities put up more cash to back them, prompting a sell-off of high-grade securities such as those issued by the mortgage giants Fannie Mae and Freddie Mac, to raise the money. Some investment funds, like one run by Carlyle Group of the District, could not meet these margin calls, and they defaulted. Rumors of trouble at one of the largest Wall Street banks, Bear Stearns, and speculation that other banks would soon disclose new, staggering losses, added to the mounting panic.

So the Fed moved Tuesday to auction up to $200 billion in Treasury securities, which will be available to large financial institutions if they put up collateral including highly rated mortgage-backed securities. The aim was to make Wall Street firms more confident about buying and holding these mortgage investments and provide an outlet for them. This could free up money for banks to lend.

After the announcement, the market for these highly rated mortgage securities showed signs of improvement.

Economists and analysts largely praised the move, saying it goes further in directly addressing current problems than simply cutting a short-term interest rate, which adds to inflationary fears.

"They may have hit the right spot in the marketplace where the help was needed," said Bill Tedford, fixed-income strategist at Stephens Capital Management.

The Fed action represented a change in a long-standing but little-known program called a term securities lending facility. The program will allow large investment banks to trade in securities issued by Fannie Mae and Freddie Mac and other AAA-rated mortgage-backed securities that are not on a watch list to be downgraded. It will allow financial institutions to borrow Treasurys for 28 days, not just overnight.