Fed Plans to Buy Long-Term US Government Debt

The U.S. Federal Reserve on Wednesday, in a surprise move, said it will buy up to $300 billion worth of longer-term U.S. government debt over the next six months and expand purchases of mortgage-related debt to help ease credit market conditions.

In a statement at the end of a two-day meeting, the central bank’s policy panel also said it had decided to hold its target for overnight interest rates in a zero to 0.25 percent range —the level reached in December.

It said rates would stay low for “an extended period,” a more explicit vow to stay on hold for a prolonged time.

“In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability,” the Fed said.

Prices for U.S. government bonds shot higher and U.S. stocks jumped on the move, with the blue chip Dow Jones industrial average moving into positive territory. The dollar fell sharply.

“This is a pretty dramatic move … They are trying to bring down all consumer rates,” said James Caron, head of global rates research at Morgan Stanley in New York.

In addition to the purchases of U.S. Treasury debt, the Fed said it would expand an already existing program to buy debt and securities issued by the government-backed mortgage finance agencies.

It said it would expand those purchases by a combined $850 billion to a total of $1.45 trillion this year.

The program has already been effective in lowering U.S. mortgage rates.

“Bottom line is the Fed is adding a trillion dollars to their balance sheet and that’s a lot of taxpayer money,” said Greg Salvaggio, vice president for trading at Tempus Consulting in Washington.

With benchmark rates virtually at zero, the Fed has turned its focus to pumping money into stressed credit markets in the hope of restarting lending and restoring growth — a policy Fed chief Ben Bernanke has dubbed “credit easing.”

Bernanke on Sunday said repairing the tattered financial system was necessary to secure a recovery for the U.S. economy, which has been stuck in recession for more than a year.

The Fed this week began taking bids for a program designed to spur student, auto, credit card and small business lending, and it said Wednesday it would consider expanding that program to cover a wider array of assets.

The consumer and small business credit program will initially aim to inject $200 billion into the market for securities backed by these loans, but the Fed has already said that program could be ramped up to $1 trillion.

While the Fed has gone to extraordinary lengths to try to get credit flowing, the economy is still in a nose dive.

U.S. gross domestic product shrank at a 6.2 percent annual rate in the fourth quarter, the deepest contraction since early 1982, and the unemployment rate has shot to a 25-year high of 8.1 percent.

However, there have been some signs recently that suggest consumer spending may be stabilizing and hints the battered housing sector is beginning to heal.

After a $700 billion bank bailout approved by Congress in October and a $787 billion tax-cut and spending bill passed this year to lift the economy, public resentment at the large tab taxpayers are picking up has grown more strident.

Fury over $165 million in bonuses paid to executives of insurer AIG [AIG  1.28    0.32  (+33.33%)   ] which has received up to $180 billion in government aid, has eroded support for extensive government efforts to heal the financial sector.

The Nasdaq and the S&P 500 shot up more than 1 percent Wednesday, while the Dow Industrials turned positive, after the Federal Reserve said after its policy meeting it will buy long-term U.S. Treasuries.

The Dow’s initial modest gains picked up speed, lifting the blue-chip average by more than 1 percent, while both the S&P and the Nasdaq extended their jumps to gains of more than 2 percent.

The Dow Jones industrial average shot up 120.98 points, or 1.64 percent, at 7,516.68.

The Standard & Poor’s 500 Index was up 17.42 points, or 2.24 percent, at 795.54, just off its session high at 795.68. The Nasdaq Composite Index was up 38.42 points, or 2.63 percent, at 1,500.53.

The last time the Fed set out to influence long-term interest rates was during the 1960s with Operation Twist, conceived by the Kennedy administration.

Across the Atlantic, the Bank of England last week began buying government bonds from financial institutions as it turned to other ways to help revive Britain’s moribund economy. The Bank of England, like the Fed, already had lowered its key interest rate to a record low of 0.5 percent.

Finance leaders from top economies have discussed coordinating actions from their governments and central banks to provide a more potent punch against the global financial crisis.

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