Take-charge Fed acts to gird banks

Central bank expands its loan auctions.

A loss of 20,000 jobs is seen as a positive sign. [Print edition]
In a positive sign for the economy, April job losses shrink to 20,000. [online edition]

By Peter G. Gosselin, Los Angeles Times Staff Writer
May 3, 2008

WASHINGTON -- Moving to stop the economy from stumbling further, the Federal Reserve said Friday that it would pump more cash into U.S banks to keep the nation's financial system from seizing up.

The surprise action came as the Fed formally signed on to tough new rules for the credit card industry announced a day earlier by other regulators. The two initiatives were the latest examples of how the Fed, under the chairmanship of Ben S. Bernanke, is asserting its willingness to take charge in disparate parts of the economy.

"The Fed was already the big dog on the block, but it's getting much, much bigger," said Andrew Harding, chief investment officer with Allegiant Asset Management in Cleveland. "Within the next couple years, you'll see the kind of regulation of banks that we only dismantled a decade ago, and it will be extended to investment banks."

The Fed said it would increase the amount of cash made available to banks through its biweekly loan auctions from the current $50 billion to $75 billion. Banks can use the money to make loans, thereby providing more credit for consumers and businesses.

Fed officials "are increasing liquidity every way they can," said Christopher Rupkey, chief financial economist with Bank of Tokyo-Mitsubishi UFJ in New York. "But it's not being lent out by the banks, which means it's not reaching the right borrowers."

The Fed's move shifted its focus from where it was only six weeks ago -- the dangers posed by collapsing financial firms -- to problems with the nation's banks, many of which are so shell-shocked by the turmoil that they are not making the loans needed to keep the financial system and the economy lubricated.

The action came as the U.S. labor market offered the first tepid signal that the overall economy may be leveling off instead of plunging still deeper into trouble.

Employment sank for a fourth straight month in April, according to the Labor Department. But the loss of 20,000 jobs was not as bad as the losses of the previous two months, and the April unemployment rate dropped a tenth of a point to 5%.

The economy had shed 81,000 jobs in March and 83,000 in February.

The April employment report was taken as good news largely because the job losses were nowhere near the 75,000 to 85,000 that forecasters had predicted.

Most of the losses occurred in the goods-making side of the economy, especially in construction and manufacturing, where private-sector jobs fell by 110,000. That loss was partially made up in the service sector, which added 90,000.

The report provided little encouragement for most working Americans, however. Average hourly earnings increased by one penny to $17.88. But because working hours fell, average weekly earning slid $1.45 to $602.56. That was up 3.1% from a year earlier, less than most measures of inflation, which are running at 3.5% or higher.

"This is what a recession looks like to a working family -- jobs being lost . . . weekly hours down and hourly wages growing more slowly and far less than the prices of things you buy," said Lawrence Mishel, president of the Economic Policy Institute, a left-leaning Washington think tank.

Meanwhile, the Fed joined the Office of Thrift Supervision and the National Credit Union Administration in proposing new credit card rules that would label as "unfair and deceptive" such practices as raising interest rates on balances that were accrued under lower rates and charging late fees without giving consumers a reasonable amount of time to make payments. The new rules could take effect by year's end.

In recent months, the Fed has issued similarly tough regulations for home mortgages, created a host of new tools for influencing the economy and orchestrated the takeover of investment bank Bear Stearns Cos.

"If they're going to be rescuing investment banks, [Fed officials] are going to want to have some control over their business practices," said Harding of Allegiant.

Bernanke's predecessor, Alan Greenspan, who served as Fed chairman for 18 years, resisted virtually all calls for the Fed to use or expand its rule-making powers. Greenspan steadfastly asserted that the central bank could do little to prevent or limit financial bubbles such as the one in housing, the bursting of which caused many of the economy's current troubles.

The expansion of the Fed's cash auctions followed by only two days a modest cut by the central bank in its federal funds rate, the interest rate that the Fed would like banks to charge one another for short-term loans. The combination reflected Fed officials' increasing interest in using their newly devised tools for prodding the economy.

Until December, the Fed effectively had only the funds rate to speed up or slow down economic activity. If policymakers decided that the economy was stalling or financial gears were grinding, they would drive down the funds rate by pumping credit into the system.

The theory was that, as banks' borrowing costs fell, they would lend at lower rates. This, in turn, would spur growth by making it cheaper for home buyers to take out mortgages and companies to obtain loans to expand their businesses or deal with financial problems.

But when policymakers turned to cutting the funds rate last fall in the midst of the sub-prime mortgage debacle and housing market meltdown, they discovered that this tool had been rendered essentially powerless.

The banks and other key financial institutions with which the Fed deals had been so shaken that, instead of borrowing money and lending it out, they borrowed funds but hoarded them. The financial institutions feared they themselves might need the funds.

Policymakers reacted first by creating the cash auctions that they expanded Friday to lend directly to banks, instead of waiting for them to lend to one another. They acted next by setting up a similar system of direct loans for major nonbank investment firms.

The new tools allowed policymakers to inject credit directly into the financial system, rather than relying on the indirect route of lowering the funds rate.

But the nearly $250 billion the Fed has pumped in through these new means apparently has not been enough to solve the financial system's problems.

In a statement issued Thursday in conjunction with the European Central Bank and the Swiss National Bank, the Fed cited "the persistent liquidity pressures in some term funding markets" as its reason for expanding the auctions.

The Fed also increased the funds it provides to the European and Swiss central banks from $36 billion to $62 billion. And it expanded the collateral it will accept for its loans to investment firms to include not just mortgage-backed securities but also highly rated securities of other types.

In taking this last step, Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, said the central bank was agreeing to help bail out the government's troubled student loan system by accepting securities it issued. But observers said this was not the Fed's intention and the collateral change would do little to help the problem.

peter.gosselin@latimes.com