WASHINGTON — The Federal Reserve escalated its war on the nation’s credit crisis Wednesday, announcing that it would more than double the amount of money it will spend in the coming year in an aggressive effort to force down interest rates on mortgages — perhaps by as much as 1 percentage point — as well as other business and consumer loans.
The move, which cheered the markets, is designed to keep money flowing through the economy’s clogged credit arteries to foster economic recovery.
“They are trying to fire absolutely every weapon they can,” said Nigel Gault, chief U.S. economist at IHS-Global Insight, a Lexington, Mass.-based forecasting firm. “It improves the odds that we’ll bottom out in the second half of the year.”
David M. Jones, a former Fed economist and president of DMJ Advisors, a Denver-based consulting firm, said he expects the Fed actions to help lower conventional mortgage rates from their current level of just below 5 percent, perhaps to near 4 percent.
“I’ve never known when the Fed has taken a move this powerful in easing monetary policy,” Jones said. “If you bring the interest rate down that much, we’ll have a huge amount of refinancings, and that will create money for banks” and help shore up the financial sector.
The news had an immediate impact on Wall Street, where the stock market reversed course and posted a modest rally, and yields on 10-year Treasuries dropped by 0.5 percentage points, to 2.5 percent.
Many interest rates, including mortgages, are pegged to the 10-year note.
But Guy Cecala, editor of Inside Mortgage Finance, a trade publication, said that many consumers may find that the rates their banks actually offer are higher than they might expect. And that may not change quickly, especially because lenders are already swamped with applications for loan refinancings and modifications.
“If they have all the business they can handle, what’s their incentive to lower their rates?” Cecala asked. “That has been the challenge the government has faced from Day One. You can’t force lenders to offer the cheapest possible rates.”
Although the Fed has kept the rates it charges banks near zero since December, interest rates for consumers and businesses have remained significantly higher because banks continue to be cautious about issuing new loans as the economy declines and unemployment rises.
Gault said that before the credit crisis, the difference between the 10-year Treasury note and rates offered to consumers for conventional loans was about 1.5 percentage points. It’s now around 2 percentage points and, he said, “I don’t expect the spread to go back down to 1.5.”
With its interest rates already hovering just above zero, the Fed has turned to other programs to generate money, or liquidity, in the credit system, which is the lifeblood of the economy.
Wednesday’s announcement significantly expands those programs and adds a new one: the direct purchase of $300 billion in long-term U.S. Treasury bonds.
In addition, the Fed will increase to $1.25 trillion the amount it intends to spend to buy mortgage-backed securities issued by government agencies including Fannie Mae and Freddie Mac, and will double its purchases of agency-backed bonds from $100 billion to $200 billion.
