by Amy Lillard
March 19, 2009 - The financial system got another boost yesterday when the Federal Reserve announced they would pump an additional $1.2 trillion into the economy.
Adding to the existing cash infusion from the Fed, this additional amount is setting records, dwarfing all previous government bailouts thus far.
The decision is being hailed as a recognition by Fed leaders that the economy is worsening, much more so than they anticipated at their last policymaking meeting in January. Analysts also say the decision is an attempt to show market players that they still have tricks up their sleeve to boost the economy, even after cutting short-term interest rates all the way to zero.
The Fed will buy government bonds and mortgage-related securities in attempts to lower borrowing costs for home mortgages (30 year interest rates) and other loans. In effect, the Fed will print more money to pay for the purchases, but ultimately stimulate economic activity.
The move does have its risks. The Fed, which held nearly $900 billion in assets in the beginning of the economic crisis in September, will now balloon their assets to more than $3 trillion. Once the economy begins to recover, it could extremely difficult to draw their money back out of the system.
The plan includes a massive purchase of U.S. treasury bonds and additional purchases of mortgage-backed securities, along with the acquisition of debt in housing-finance firms like Fannie Mae and Freddie Mac. The central bank could end up funding 60 to 70 percent of mortgages issued this year.
Until this new plan, the Fed had been hesitant to buy up long-term U.S. treasury bonds. They were unsure if the purchase would help reduce borrowing costs, and were uncertain about the repercussions of such a move. In many countries, the central bank essentially printing money to finance government debt is a sure sign of poorly managed economies. But the extent of the economy's troubles have overshadowed the Fed's concerns, and the successful example from the Bank of England, who took similar steps earlier this month, is paving the way.
The move by the Fed is not anticipated to affect interest rates significantly. Rates could drop slightly for long-term loans, but adjustable-rate mortgages will be unaffected.
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