Federal Reserve edges away from crisis measures

By Neil Irwin
Washington Post Staff Writer
Thursday, December 17, 2009; A01

The Federal Reserve said Wednesday that it will shut down some of the emergency triage measures it put in place at the height of the financial crisis but will leave interest rates near zero out of continuing concern about the weak U.S. economy.

The decision reflects steady improvement in the functioning of financial markets. In recent months, the Fed's emergency programs to support money-market mutual funds, short-term corporate lending, investment banks and overseas banks had gotten little use, and major banks have begun to repay their government bailout money.

Even the troubled auto giant General Motors recently said it plans to return some federal assistance next year.

Still, the central bank's plans to terminate its unconventional lending programs on Feb. 1 will present a new test for the financial industry. There have been waves of worry in global markets in recent weeks, particularly in Europe and the Middle East, and losses on commercial real estate could endanger many smaller U.S. banks in the coming year.

The programs being wound down were major parts of the Fed's efforts to aid the broken-down financial system by directing cash into dysfunctional private markets, using its own ability to create money and an obscure provision in the Federal Reserve Act allowing loans to almost any entity under "unusual and exigent circumstances."

With private markets improving and the central bank's programs increasingly having fallen into disuse, the Fed is looking to pull away its supports.

"They're saying that these extraordinary life-support programs are becoming increasingly unnecessary and could be counterproductive," said Stuart Hoffman, chief economist at PNC Financial Services Group. "Like any good doctor, they're laying out a treatment plan, saying they'll unhook the financial system from these machines over the next few months."

The decision came on the same day that Fed Chairman Ben S. Bernanke was named Time magazine's Person of the Year for efforts -- including the creation of the soon-to-be-shelved programs -- that helped prevent a collapse of the financial system. A Senate committee will vote Thursday on whether to forward his name to the full Senate to be confirmed for a second four-year term.

The Fed is gradually returning its policymaking apparatus to normal, using a meat-and-potatoes response to the recession: When the unemployment rate is high, low interest rates help create jobs by boosting growth, and the Fed is likely to raise rates only once the economy is on more solid footing or inflation threatens to get out of hand.

That's why the Fed, after a two-day policymaking meeting, left its target interest rate near zero and said it will probably keep it very low for an "extended period," reflecting the deep economic hole the nation has yet to climb out of.

At the same time, the central bank said it would unwind its more unconventional programs. The Fed had already said it will complete $1.25 trillion in purchases of mortgage-backed securities by the end of March, and it completed purchases of $300 billion in Treasury bonds in October.

Next in line: An alphabet soup of programs designed to pump cash into the financial system, known by acronyms like PDCF (Primary Dealer Credit Facility) and TSLF (Term Securities Lending Facility). Both will be allowed to expire Feb. 1, as will the money-market support, the program for short-term corporate lending and swap lines designed to pump dollars into foreign banks.

The Fed's signature program to support consumer and business lending, the Term Asset Backed Securities Loan Facility, has a bit longer to live: The program mostly winds down March 31, but it can support commercial real estate lending until June 30.

Fed policymakers appear to be encouraged, but hardly buoyant, over the recent spurt of good news about the economy. In the statement after their meeting, they noted that "deterioration in the labor market is abating," reflecting a recent report that the unemployment rate ticked down in November and job losses came to a near halt.

But the overall tone suggested that they are far from confident about the recovery. That, combined with subdued inflation worries, indicates that increases in the Fed's target interest rate remain far off. It repeated language from recent Federal Open Market Committee statements that "economic activity is likely to remain weak for a time."

Just Wednesday, the Labor Department said that consumer prices rose 0.4 percent in November, though excluding volatile food and energy prices, the consumer price index was unchanged. Over the past year, prices are up 1.8 percent. Housing starts rose 8.9 percent in November, according to a separate report from the Commerce Department.

"They did give a real indication they are focused on the labor market and remain committed to the idea that inflation will remain subdued," said Dan Cook, senior analyst at IG Markets.

The final meeting of the Fed policymakers for 2009 came at a sensitive time for the institution. Congress is weighing legislation that could strip the central bank of its powers to supervise banks and reduce its independence in setting monetary policy.

And Bernanke's future is still being determined. Assuming that the Senate Banking Committee votes Thursday to bring his nomination to the floor of the Senate, Bernanke will need 60 votes to be confirmed for a second term. His current one ends Jan. 31.

Banking Committee Chairman Christopher J. Dodd (D-Conn.) said Wednesday that he expects the full Senate to confirm Bernanke in January.

Although he has received a mixed reception on Capitol Hill, Bernanke's Fed colleagues have been more supportive. When he entered the policymaking meeting Wednesday morning, he was greeted with a standing ovation over his recognition by Time. According to a witness, Bernanke took his seat with an embarrassed grin on his face.

"Those of us in the market are just hoping he'll be Time Person of the Year in 2010, too, by getting the economy going but not letting inflation take root," said economist John Canally of LPL Financial.

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