Fed, Treasury to Scale Back Emergency Programs as Crisis Eases

Sept. 24 (Bloomberg) -- By Scott Lanman and Robert Schmidt

The Federal Reserve and U.S. Treasury said they’re scaling back emergency programs aimed at combating the financial crisis, reducing support for firms that now have an easier time getting funding.

The central bank today said it will further shrink auctions of cash loans to banks and Treasury securities to bond dealers, reducing the combined initiatives to $100 billion by January from $450 billion. The Treasury has “begun the process of exiting from some emergency programs,” the chief of the government’s $700 billion financial-rescue fund said separately.

Fed Chairman Ben S. Bernanke and other policy makers are trying to balance two goals: securing an economic recovery after the deepest contraction and financial crisis since the Great Depression while withdrawing fiscal and monetary stimulus in time to avoid driving inflation and borrowing costs higher.

“The stress in the system has been reduced significantly,” said Conrad DeQuadros, senior economist at RDQ Economics LLC, a New York research firm he founded with John Ryding, a fellow former Bear Stearns Cos. economist. At the same time, “they don’t want to completely wind down” the programs yet, he said.

The Libor-OIS spread, a gauge of banks’ willingness to lend, has narrowed to 0.11 percentage point, from a record 3.64 points in October 2008.

Rate Decision

The Fed yesterday said it will complete its planned $1.25 trillion in purchases of mortgage securities and extended the end-date of the program to March from December. In a unanimous decision, policy makers kept the benchmark interest rate in a range of zero to 0.25 percent and repeated that rates will stay low for an “extended period.”

Herb Allison, assistant Treasury secretary for financial stability, today told the Senate Banking Committee that the recovery is too fragile to halt all assistance. At the same time, he said aid programs for financial firms, auto companies and the credit markets are winding down.

The Treasury has $180 billion invested in the banking system through capital injections where the government receives preferred shares and warrants, said Allison, the chief of the $700 billion Troubled Asset Relief Program. That’s down from $239 billion when President Barack Obama took office in January, Allison said.

European policy makers are also moving to withdraw stimulus. The European Central Bank said it will discontinue its 84-day U.S. dollar liquidity-providing operations with the Fed “given the limited demand and the improved conditions in funding markets.” The ECB will keep conducting seven-day dollar operations.

German Debt Sales

Germany cut its planned sales of debt as the end of the recession helps boost the finances of Chancellor Angela Merkel’s government before national elections. The nation reduced proposed issuance of bonds and bills in the fourth quarter by 22 percent to 59 billion euros ($87 billion), citing in part “improved funding conditions.”

The Fed cited “continued improvements” in financial markets in reducing the size of the Term Auction Facility, created in December 2007, and the Term Securities Lending Facility, begun in March 2008.

The TAF will sell $50 billion in 70-day funds next month, down from $75 billion in 84-day funds in September, with the auctions’ size and maturity decreasing more in November and December, the Fed said in a statement today. The Term Securities Lending Facility will shrink to $50 billion, and then $25 billion, from $75 billion.

TAF’s Future

The Fed said it will evaluate whether to “maintain a TAF on a permanent basis” and put out for public comment a “range of possible structures for a permanent TAF.”

Under the TAF, a separate monthly sale of $75 billion in 28-day funds will be unchanged through January, the Fed said. The longer-term auctions will be reduced to $25 billion in November and December, eventually converting the auction schedule to a single cycle of 28-day funds from biweekly sales for different maturities, the Fed said.

“The schedules also take account of the possibility that market pressures could be heightened over year-end,” the Fed said. “The Federal Reserve remains prepared to expand its liquidity operations more generally should financial-market conditions deteriorate materially.”

Outstanding credit under the Term Auction Facility has declined to $196 billion as of Sept. 16 from a record $493.1 billion in March. The TSLF’s balance has stood at zero since Aug. 19, declining from a record $235.5 billion in October 2008.

TARP Repayments

The Treasury’s Allison said banks seeking to leave the Troubled Asset Relief Program have repaid the government $70 billion, Allison said. The Treasury estimates that lenders will repay another $50 billion over the next 12 to 18 months, he said.

In addition, the government has received about $3 billion from warrant repurchases and more than $6.5 billion in dividends, interest and fees, Allison said.

Because the economic recovery is just beginning, Allison said that the government’s withdrawal from TARP will be slow.

“Significant parts of the financial system remain impaired,” he said, citing potential problems with commercial real estate and downward pressure on housing prices. “In this context, it is prudent to maintain capacity to address new developments.”