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Fed Meeting Likely to Signal Fate of Intervention Programs

By Neil Irwin
Washington Post Staff Writer
Wednesday, August 12, 2009

When the Federal Reserve announces results of its policymaking meeting Wednesday, it should offer insights into whether the central bank will start unwinding some of its expansive interventions to prop up the economy.

The Federal Open Market Committee is all but certain to leave its target for short-term interest rates near zero, and likely will indicate that it intends to keep rates there for some time. The question is what the Fed will do with its less conventional programs rolled out over the past year.

Its decisions could signal how much longer the Fed will engage in extraordinary actions to support lending, and the call is a tough one. On one hand, the economy is starting to look better. On the other, financial crises can come in unpredictable waves, and Fed leaders still see considerable risks facing the economy and financial system.

"This has been such a severe economic decline that we could easily tip into a double-dip recession or have a slow recovery," said Bruce McCain, chief investment strategist of Key Private Bank in Cleveland. "But the longer you leave the programs in place, the more inflation risk there is. That makes it a very tough time to figure out what to do to negotiate between those two rocky shores."

The stock market fell Tuesday, off 1.3 percent as measured by the Standard & Poor's 500, as investors showed caution in advance of the Fed announcement. The steepest declines were in shares of financial companies.

The committee is meeting Tuesday and Wednesday, and will release a statement announcing its decision about 2:15 p.m. Wednesday. The most immediate concern is what to do with a program to buy $300 billion in long-term U.S. Treasury bonds. The purchases, designed to lower long-term interest rates and improve functioning of credit markets more broadly, are scheduled to end in the middle of September, unless the Fed expands the program.

Analysts are expecting the Fed to allow the program to expire, which would be the first of its extraordinary interventions to support the economy to be curtailed. (Several special lending facilities still exist but have fallen into disuse as financial markets have improved.)

The Fed has reasons for letting the bond purchase program expire: The economy has shown further signs of stabilizing since the central bank's last meeting. Moreover, it isn't entirely clear how much purchases made so far have achieved their goals. And the program has spurred fears in some quarters that the Fed will print money to fund U.S. government deficits.

Another possibility is that the Fed will use its meeting to send signals on the future of its marquee program to support consumer and business lending. The Term Asset-Backed Securities Loan Facility, or TALF, is scheduled to expire at the end of the year, and is designed to deploy up to $1 trillion (it has involved far less than that so far) to support credit cards, auto loans, student loans, small business loans and commercial real estate loans.

Top Fed leaders are generally pleased with the program, believing it has helped restart private lending more broadly. And the commercial real estate portion could help support a market that is due to encounter severe distress in the coming year.

However, the program was created under an emergency lending authority, so the central bank can continue it only as long as it judges lending conditions to be "unusual and exigent." That could make it difficult to extend the program in August beyond its current December expiration.

Michael Feroli, an economist at J.P. Morgan Chase, notes another reason the Fed might not extend TALF. A letter from 41 members of Congress urged the Fed to keep its lending to commercial real estate in operation, and paradoxically, the central bank might wish to show its independence from political influence.

"This is one reason to think the Fed may not extend TALF, at least at this meeting: doing so would appear to be a blatant case of the Fed bending to Congress' will," Feroli said in a research note.

Another wrinkle is that the decision on whether to extend TALF is made by the Board of Governors, a panel that includes five Washington-based presidential appointees. The Federal Open Market Committee, which sets interest rates, also includes presidents of regional Fed banks, who tend to be more wary of the Fed's unconventional interventions into markets.

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