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Billions later the same question: Will banks lend again?

Kevin G. Hall | McClatchy Newspapers • Published January 07, 2009

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In a statement, the rate-setting Federal Open Market Committee said that "The outlook for economic activity has weakened further . . . the Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability."

The vow to deploy "all available tools" sparked a rally on Wall Street. The Dow Jones Industrial Average shot up 359.61 points to close at 8924.14, while the S&P 500 finished up 44.61 points to 913.18 and the Nasdaq added 81.55 points to end the day at 1589.89.

A senior Fed official, briefing reporters late Thursday on the condition of anonymity in order to speak freely, said that a rate range was chosen because the real federal funds rate — what banks actually charge — has been well below the Fed's target in recent months.

The Fed's statement said that "weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time."

The Fed has little room left to maneuver on interest-rate policy now and will use other tools.

"They are saying that they have unlimited arrows. As the central bank of the United States, it is the only entity that can write checks on itself without limit, and that's a very powerful weapon the Fed has against the downturn," said Marvin Goodfriend, a former research director at the Federal Reserve Bank of Richmond who's now an economics professor at Carnegie Mellon University in Pittsburgh. "It won't work immediately, but if it is used aggressively, it will work."

Chief among those other tools is to keep lending aggressively; the Fed's balance sheet already has gone from about $800 billion to $2.2 trillion as it pulls out all the stops to confront the worst financial crisis since the Great Depression.

Fed Chairman Ben Bernanke next can scale up existing Fed lending facilities or create new ones, Goodfriend said. The Fed statement said that the central bank was weighing the possibility of purchasing long-term Treasury bonds, which would drive down their yield and make other investments such as corporate and municipal bonds more attractive.