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The Fed Adopts Another Economic Stimulus

While we were watching Congress grill AIG’s caretaker CEO about $165 million in retention contracts (see Jane, and Marcy), the Federal Reserve Open Markets Committee announced a package of measures that, among other things, will also function as a new $200 billion per year stimulus package.

The always helpful econ blog, Calculated Risk, first carried the FOMC statement key measures:

. . . To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. . . .

Those actions will tend to lower interest rates on home mortgages, and the effect of that is to provide an economic stimulus to everyone who refinances. Again, from Calculated Risk, quoting David Greenlaw, Morgan Stanley:

"The Fed’s announcement signals a clear intent to continue to drive mortgage rates lower and we expect them to meet this objective. … In 2008, the average mortgage rate on the outstanding stock of loans was about 6.50%. So, if the Fed brings 30-yr fixed rate mortgages down to 4.50% and all homeowners are able refi, the aggregate permanent cash flow savings would be on the order of $200 billion per year."
David Greenlaw, Morgan Stanley, WSJ Real Time Economics March 18, 2009

Recall the Administration has already announced programs that will allow 4-5 million home owners lower monthly payments and another 5 million to refinance. If you add up every thing Treasury and the Fed are doing, its clear they’re not just trying to alleviate the mortgage foreclosure problem and the associated effects on mortgage-backed securities, they’re doing it in ways that also function as economic stimulus.

It’s important to keep watching this bigger picture. We’ve criticized individual Administration pieces as not big enough (stimulus) or properly designed/focused (TARP, etc), but we need to see all the pieces and how they might work together. And they’ve been coming out with a new piece every couple of weeks. One of the lessons I hoped the Administration would take from the New Deal was to try everything and keep trying until something works. That seems to be what they’re doing, with the "independent" Fed working in tandem.

Today’s immediate issue was AIG retention contracts, and it’s essential to resolve that in ways that lead to better compensation incentives and badly needed oversight. But in the long run, what the Fed did today, and related measures the Obama Administration is taking, may be even more important.

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John has been writing for Firedoglake since 2006 or so, on whatever interests him. He has a law degree, worked as legal counsel and energy policy adviser for a state energy agency for 20 years and then as a consultant on electricity systems and markets. He's now retired, living in Massachusetts.

You can follow John on twitter: @JohnChandley