Treasury to Sell Bills to Bolster Fed Balance Sheet

By Rebecca Christie and John Brinsley

Sept. 17 (Bloomberg) -- The Treasury will sell more debt to enable the Federal Reserve to expand its balance sheet, a sign of the strains created by the biggest extension of central-bank credit to financial companies since the Great Depression.

The program starts today with a $40 billion auction of 35- day bills, a day after the government agreed to take over American International Group Inc., the Treasury said in a statement in Washington.

The proceeds will ``provide cash for use'' by the Fed as it seeks to boost liquidity in credit markets struggling from $515 billion in writedowns and losses since the start of last year. The announcement illustrates the potential drain on the government's finances in taking over AIG, Fannie Mae and Freddie Mac, and taking on $29 billion in Bear Stearns Cos. assets.

``It is becoming imperative for the Fed to take actions to enlarge its balance sheet,'' said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York.

Yesterday the Fed announced an $85 billion loan to AIG, in exchange for a 79.9 percent government stake in the largest U.S. insurer. The Fed also has set up several other emergency lending programs to provide Wall Street firms with ready access to funding.

``The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program'' and ``will provide cash for use in the Fed initiatives,'' the department's statement said.

Paulson's Role

Treasury Secretary Henry Paulson has worked with the Fed to manage the financial sector's cash crunch. The new bill auctions will help to ensure financial institutions have ready access to Treasury securities, which have been in short supply recently as firms try to maintain liquidity.

Arguing before Congress in July for unlimited authority to help mortgage companies Fannie Mae and Freddie Mac, Paulson said ``if you have a bazooka in your pocket and people know it, you probably won't have to use it.''

``This is Hank Paulson making sure that there are extra bazooka shells sitting at the Fed,'' said Adam Posen, deputy director of the Peterson Institute for International Economics in Washington. Treasury is ``hoping this convinces people that'' the Fed won't have to use them, Posen said.

The Fed will offset the impact of the new bill sales on its balance sheet so as not to affect the stance of monetary policy. The federal funds rate target will remain at 2 percent.

The Treasury said it will sell the new bills using its existing auction procedures, giving ``as much advance notification as possible.'' The bills will not have a uniform fixed term, giving the Treasury the same duration flexibility that it has with cash-management bills.

Fed holdings of Treasury securities have fallen to $478 billion as of Sept. 10, from $741 billion at the beginning of the year, as the central bank has made room on its balance sheet for the new lending facilities.

To contact the reporter on this story: Rebecca Christie in Washington at rchristie4@bloomberg.netJohn Brinsley in Washington at jbrinsley@bloomberg.net