Fed's rescue plan gets praise for its imagination

WASHINGTON -- The Federal Reserve's dramatic decision to let securities dealers and banks swap up to $200 billion in mortgage-backed bonds and other products for ultrasafe Treasury securities illustrates its deep concern about deteriorating credit conditions and Chairman Ben Bernanke's willingness to innovate.

"This is the kind of thing they should be doing," said Mike Englund of Action Economics. He said the program, announced Tuesday, doesn't directly bail out banks but could shore up the huge market for mortgage-backed securities.

Expanding an existing program, the central bank will lend Treasuries for 28-day periods to investment firms and banks that trade directly with the Fed. Securities firms, for the first time under this particular program, can use mortgage-backed securities as collateral.

Reflecting the global nature of the credit crisis, which has spread from mortgage loans to a wide variety of financial products, the Fed also increased existing "swap lines" with the European Central Bank and the Swiss National Bank. The lines provide dollars that those institutions can lend to banks facing a U.S. dollar crunch.

Fed officials approved the plans during a Monday evening video conference that lasted about 90 minutes. It was the latest in a series of aggressive moves — including some of the steepest interest rate cuts in Fed history, discounted loans to banks and funding auctions — aimed at stabilizing markets and the economy.

"We give the Fed credit for imagination," says Todd Abraham, Federated Investors senior portfolio manager. But he added the Fed "didn't fix everything. It won't change overnight."

Other analysts doubted the ability of the Fed plan to spark a fundamental turnaround in multitrillion-dollar credit products.

The plan injects the Fed more deeply into markets and increases its own risks, though the central bank will accept only highly rated securities as collateral under the new initiative.

But if the move is successful, it could reduce the need for the Fed to make additional, deep interest rate cuts to stimulate the economy at a time when inflation is surging. The Fed plan could help financial firms raise cash by providing them easily convertible Treasuries. And it could help the mortgage market by making financial firms more willing to deal in mortgage-backed securities because of their potential use as collateral with the Fed. Better-functioning markets would enhance the effectiveness of previous Fed rate cuts.