Bernanke Bets on Targeted Loans Over Rate Cut to Aid Wall St.

By Scott Lanman
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Sept. 17 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke is betting he can use targeted emergency loans rather than another interest-rate cut to pull Wall Street through the credit crisis.

The Fed kept the benchmark rate at 2 percent yesterday, citing risks to growth and inflation. Two days earlier, officials allowed securities firms use equities as loan collateral to ease the impact of Lehman Brothers Holdings Inc.'s bankruptcy. Hours after the meeting, the Fed agreed to an $85 billion loan as part of a government takeover of American International Group Inc.

By rebuffing calls by some investors for a rate cut, the central bank aims to meet its mandate to ensure stable prices while counting on auctions of cash and Treasuries and direct loans to address the credit crunch.

Policy makers believe ``lowering the funds rate is a blunt instrument and not aimed at financial markets,'' said Stuart Hoffman, chief U.S. economist at PNC Financial Services Group in Pittsburgh and a former Fed economist. Instead, officials are relying on ``creative and innovative ways to get funds into the financial system.''

At the same time, the Fed edged closer yesterday to a rate reduction by saying in a statement after their meeting that financial-market strains have ``increased significantly.''

Employment is weakening, export growth is slowing and risks to growth and inflation are ``both of significant concern,'' the central bank said in its statement. After their Aug. 5 meeting, policy makers said such concerns applied only to inflation. The central bank yesterday dropped a reference last month to rising expectations that prices will increase.

`Push the Committee'

``The outcome is going to be driven by the incoming data,'' former St. Louis Fed President William Poole said in an interview with Bloomberg Television. If retail sales, industrial production and employment are weak, ``that is going to push the committee probably to cut rates.''

Tumbling commodity prices, including a 37 percent decline in crude oil from a July 11 peak, ease pressure on the Fed to fight against inflation. The consumer price index fell 0.1 percent in August, the Labor Department said yesterday. So-called core prices, which exclude food and energy, rose 0.2 percent after a 0.3 percent gain in July.

The rout sparked by the collapse of the U.S. subprime mortgage market has cost financial institutions worldwide $516 billion in writedowns and losses since the start of 2007. Firms have raised $362 billion of capital in response.

Since the credit crisis began in August 2007, the Fed has lowered the rate on direct loans to commercial banks and created one loan program for banks and two for securities firms. It also secured the sale of Bear Stearns Cos. to JPMorgan Chase & Co. by taking on $29 billion of mortgage-backed debt and other assets.

AIG Takeover

Late yesterday, the Fed agreed to an $85 billion loan for AIG, the insurer hit by billions of dollars of writedowns on investments in securities tied to mortgages. The government will get a 79.9 percent equity interest in the company as a result.

Fed staff officials told reporters on a conference call that AIG's extensive operations across financial markets, including substantial business outside of insurance regulators' jurisdiction, meant the company needed rescuing.

``The Fed is reasonably confident that the fundamental and liquidity problems in the financial markets can be adequately addressed with the various tools they have at their disposal,'' said David Resler, chief economist at Nomura Securities International Inc., in New York. ``It doesn't require a shotgun approach to macroeconomic policy.''

Rate Cuts

New lending mechanisms and rate cuts totaling 3.25 percentage points in the past year have so far failed to revive lending among banks.

Central banks around the world pumped more than $210 billion into the financial system this week as they sought to alleviate the credit-market seizure.

The New York Fed injected $70 billion of temporary reserves into the banking system yesterday and $70 billion Sept. 15, the most since the September 2001 terrorist attacks. The central bank has also provided billions of dollars through direct loans of cash and Treasuries.

Still, banks are hoarding cash, driving up short-term lending rates.

The cost of borrowing in dollars overnight more than doubled to the highest since 2001. The overnight dollar rate soared 3.33 percentage points to 6.44 percent yesterday, its biggest jump in at least seven years, according to the British Bankers' Association. The rate was as low as 2.07 percent in June.

Economists anticipate the economy will slow to a 1.2 percent annual growth rate, or less than half the prior quarter's pace, as consumer spending, the biggest part of the economy, stalls this quarter, according to a Bloomberg survey this month.

``The financial-market turmoil we have seen has tightened financial conditions,'' Brian Sack, who used to serve as head of monetary and financial market analysis at the Fed and is now a vice president at Macroeconomic Advisers in Washington, said in a Bloomberg Radio interview. ``That is really going to impart some restraint on the economy.''

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net