Buying Time

Meet your new mortgage banker: Fed Chairman Ben S. Bernanke.

DESPERATE times call for desperate measures -- or at least unorthodox ones. That is one way to interpret the Federal Reserve's announcement yesterday that it would go into the consumer lending business, to the tune of $200 billion in loans to holders of securities backed by auto, credit card, student and small business loans. Simultaneously, the Fed became a mortgage business, offering to purchase up to $100 billion in Fannie Mae, Freddie Mac and other government-sponsored enterprise (GSE) bonds, as well as $500 billion in mortgage-backed securities guaranteed by the GSEs. We've come a long way from old-style, open-market operations in which the Fed lends funds to banks, taking ultra-safe Treasury bonds or GSE securities as collateral. The consumer-loan piece of the new program does include a $20 billion loss-reserve supplied by the Treasury Department's Troubled Assets Relief Program. But there is no getting around the fact that the Federal Reserve has taken the kinds of credit risks normally associated with private-sector banking onto its very public balance sheet.

This is an admission both that the nation's credit markets are badly broken and that the steps the Federal Reserve has taken so far, chiefly cutting its discount rate to 1 percent, have not repaired them. Notwithstanding that Fannie Mae and Freddie Mac have been taken over by the government, the difference between their cost of funds and the Treasury's is roughly 1.5 percentage points bigger than it was a year ago. In part, this reflects a panicked market's extraordinary appetite for Treasurys. But it also shows that the market had grown so risk-averse that it was demanding an ironclad government guarantee for Fannie and Freddie debt, which would take an act of Congress. The bottom line, until yesterday, was that 30-year mortgage rates were stuck at around 6 percent, not much lower than they were at this time in 2007. Meanwhile, car loans and the like, even for people with strong credit ratings, had all but dried up.

Yesterday's Fed moves seek to reverse those frightening trends, essentially by having the central bank take the place (temporarily, one assumes) of the now-vanished secondary market for loans. To some economists, this looks like the policy known as "quantitative easing," last engaged in by the Bank of Japan during that country's deflationary spiral of the 1990s. Basically, quantitative easing consists of taking interest rates to near zero and then flooding the markets with liquidity via asset purchases -- until the private financial system recovers to the point where it can take on the job itself. In Japan, that took about five years.

In the short run, the Fed's actions may well reduce 30-year mortgage rates, which should help the housing market. The long-term risk is that investors come to think of quantitative easing in more old-fashioned terms -- as printing money. Then we'll get inflation. At the moment, however, the dollar is enjoying unexpected strength because, for all its woes, the U.S. economy is not quite as badly off as many others. And the Fed is worried about deflation, not inflation. Apparently, Federal Reserve Chairman Ben S. Bernanke feels that he can spend some of the United States' strong-dollar windfall on propping up the erstwhile pillars of our economy: residential real estate and consumer spending. The Fed's strategy might buy time for financial institutions, the Treasury Department and other government agencies to recapitalize the banking sector and purge its bad assets. They are already working on that, and they need to work even harder.