Fed May Buy Lower-Rated Assets to Ease Credit Crunch

By Craig Torres

http://www.bloomberg.com/apps/news?pid=20601068&sid=aTmjdz7_Zvno&refer=economy

Dec. 16 (Bloomberg) -- The Federal Reserve is open to the idea of buying lower-rated securities to ease the credit crunch, and plans to discuss possible strategies with President-elect Barack Obama’s Treasury.
Because the Fed must lend only against good collateral, the Treasury would need to take the credit risk of assets that are rated below AAA, a senior Fed official said today in a conference call with reporters in Washington.
Fed officials today shifted to using the size and composition of the central bank’s assets as the main tool of monetary policy after cutting the benchmark interest rate as low as zero. The senior official said that policy makers will make decisions on new lending programs or expanding existing ones based on how housing markets and the overall economy evolve.
The central bank can make a difference in credit markets where yields are higher than they would otherwise be because of a lack of liquidity due to the financial crisis, the official said on condition of anonymity.
The official said that the central bank will collaborate through the Federal Open Market Committee, which includes five presidents of Fed district banks, on policy decisions that grow the central bank’s balance sheet. The Fed’s Board of Governors in Washington has been the key decision-making body for emergency lending programs up to now.
Assets Soar
The central bank has expanded its balance sheet to $2.26 trillion from $868 billion in July 2007 through several facilities designed to ease liquidity in money markets and interbank lending markets.
The U.S. central bank has taken care to limit credit risk by financing only the highest-rated securities, having the Treasury post an equity stake that would take the first loss, or loaning less than the value of collateral when it is of less quality than U.S. Treasuries.
Fed lending programs could become larger, and even more targeted with the aid of the Treasury in the future, the official indicated. The approach will depend on discussions with the new Treasury team after Obama takes office, the person said.
Today’s press briefing by telephone set a new precedent for transparency, after decades of reluctance by Fed officials to explain their moves beyond the FOMC statement.
The official said the FOMC didn’t see deflation as an immediate risk, and added that the current policies of the U.S. central bank are distinct from Japanese-style quantitative easing in that the U.S. central bank is instead focusing on assets.
Asked why the Fed shouldn’t set a target for market rates such as mortgages, the official said that such a step could be dangerous because it might lead to the central bank owning a large part of the market. It’s better to set quantitative indicators and adjust the size of intended purchases as officials take in the markets’ responses, the official said said.
No determination has been made about what maturities of Treasury securities the Fed might buy, the official said when asked to define the FOMC’s reference today to possible purchases of “longer-term” Treasuries.
To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net;