Fed warns of big economic risks

Updated: 2011-09-22 06:09

(Agencies)

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WASHINGTON - The US Federal Reserve on Wednesday moved to counter what it said were significant risks to the US economy with an effort to lower long-term borrowing costs and bolster housing.

The US central bank said it would launch a $400 billion program to weight its $2.85 trillion balance sheet more heavily toward longer-term securities by selling short-term government debt to purchase longer-dated Treasuries.

It also said it would reinvest proceeds from maturing mortgage and housing agency bonds it holds back into the mortgage market, an acknowledgment of just how weak housing remains.

The Fed's action met with a mixed reception in financial markets. Apparently spooked by the central bank's dismal outlook, US stocks sold off. The Standard & Poor's 500 index closed down nearly 3 percent.

Prices for long-term government debt rose, pushing yields lower -- a sign the measures were more aggressive than some investors had expected. The yield on the benchmark 10-year note dropped as low as 1.856 percent, the lowest in more than 60 years.

"Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated," the Fed said in a statement after a two-day meeting. "There are significant downside risks to the economic outlook, including strains in global financial markets."

The US economy grew at less than a 1 percent annual rate over the first half of the year and economists have warned of a heightened risk of recession.

Analysts, however, said the Fed's move might not have a great impact, even if it does lower long-term interest rates.

"The cost of borrowing simply isn't the problem," said Paul Ashworth, an economist at Capital Economics in Toronto. "Businesses don't have the confidence to invest and half of all mortgage borrowers don't have the home equity needed to refinance at lower rates."

Still, faced with a lofty 9.1 percent jobless rate and an escalating sovereign debt crisis in Europe, Fed officials felt they needed to do what they could to try to breathe more life into the sluggish US recovery.

With Fed Chairman Ben Bernanke reluctant to stay on the sidelines, his activism has become a punching bag for politicians as an election year nears. Top Republican lawmakers wrote to Bernanke this week urging the central bank to resist further economic interventions, echoing criticism voiced by Republican presidential candidates.

By shifting their bond holdings into longer maturities, the Fed seeks to "twist" long-term interest rates lower relative to its target for overnight lending, hopefully spurring mortgage refinancing and more borrowing by businesses and consumers.

Not all policymakers were on board with the Fed's latest action. The same three officials that had dissented against a decision in August to bolster a low interest rate pledge also opposed Wednesday's move.

Mohamed El-Erian, co-chief investment officer at PIMCO, the world's biggest bond fund, said the combination of dissents and and a gloomier outlook pointed to a growing policy divide.

Doing the twist

In its statement, the central bank said it will buy $400 billion in securities with maturities of six to 30 years by the end of June 2012, selling an equal amount of debt maturing in three years or less.

The Fed is not alone in its concerns. The Bank of England on Wednesday signaled it was ready to pump more money into the weakening British economy, while Norway's central bank signaled it might refrain from rate increases for longer than previously expected.

The Fed had already embarked far down one of the most aggressive monetary easing paths on record. It cut overnight interest rates to near zero in December 2008 and then moved to more than triple its balance sheet through a series of bond purchases.

After its last meeting on August 9, the Fed said it expected to hold rates at rock-bottom levels at least until the middle of 2013, drawing the trio of dissents.

Critics claim the monetary easing campaign has failed to produce results and warn it could actually cause damage by fueling inflation and debasing the dollar.

"We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the US economy," Republican congressional leaders said in their letter to Bernanke, which they released on Tuesday.

The central bank's policies have also become a topic on the presidential campaign trail. Texas Governor Rick Perry, a leading Republican candidate, said any further Fed money printing would be almost "treasonous."