Counting the Costs

Meltdown 101: Why Fed can easily offer money help
By MARTIN CRUTSINGER – 17 hours ago

WASHINGTON (AP) — The Bush administration had to strive mightily to win congressional approval of a $700 billion rescue package for the financial system. Now, with no muss and no fuss, the Federal Reserve has announced an even bigger program totaling $800 billion.

What gives Ben Bernanke and his colleagues such power — and what are the consequences of the Fed's actions?

Here is a look at the Fed's powers and how they are being used to deal with the most serious financial crisis in more than seven decades.

Q: What did the Fed do this week?

A: In the latest in a series of bold moves, the central bank announced on Tuesday that it would purchase up to $600 billion in mortgages and mortgage-backed securities — investments, in other words — that are either owned or guaranteed by financial giants Fannie Mae, Freddie Mac and Ginnie Mae, and the Federal Home Loan Banks.

The Fed said it would also create a new program to make up to $200 billion in loans to institutions where the collateral is various types of consumer loans ranging from credit card debt to auto loans and student loans.

Both moves were made in an effort to lower mortgage rates and other consumer loan rates and make those loans more available, in an effort to deal with a prolonged credit crisis that is threatening to pull the country into a severe recession.

Q: What's unusual about the Fed's actions?

A: The Fed normally is not in the business of buying mortgage-backed securities or making loans to boost the market for securities backed by such assets credit card debt and auto loans. In the current crisis, the central bank is using powers it last used extensively during the Great Depression.

Q: How did the Fed suddenly come up with $800 billion to fund these two programs, when the Bush administration had to engage in extensive negotiations with Congress to get legislation for a $700 billion program to help the nation's banks?

A: The short answer is that the Fed used the power it has to print money. It doesn't actually crank up printing presses, but it can create all the money it needs through a few computer key strokes.

Q: That's pretty impressive. How did it get that kind of power?

A: Congress gave the Federal Reserve that power when it created the Fed in 1913 as the nation's central bank, responsible for controlling the nation's money supply. The Fed's goal is to create enough money to keep the economy growing at a steady rate while guarding against creating so much money that it triggers inflation.

Q: How much extra money has it created during the current crisis?

A: Right before the credit crisis first struck with force in August 2007, the Fed's balance sheet stood at $850 billion. As of last week, that figure totaled $2.2 trillion — nearly a threefold increase.

Q: What is the Fed doing with all of that money?

A: It is essentially pumping it into the financial system, mainly by making loans to banks, giving them added resources with the hope that they will turn around and make more loans to businesses and consumers.

Q: Isn't there a danger that creating all that extra money will fuel inflation?

A: Analysts say that the threat of inflation is not the biggest risk facing the country at the moment. They compare the current economy to a person who has just suffered a serious heart attack. The immediate need is to use a defibrillator to shock the person's heart back to life — or, in the case of the economy, to supply massive amounts of money to get the credit markets working properly again.

Once that is done, the Fed can worry down the road about withdrawing all the extra money it has supplied to make sure that inflation doesn't become a problem.

Q: How difficult is it for a central bank to withdraw the extra money it injected into the economy before inflation gets out of hand?

A: Throughout history, there are plenty of examples of countries that let inflation get out of control. The last bout of high inflation in this country occurred in the 1970s and early 1980s when a series of oil price shocks sent the country into a period of stagflation — stagnant growth together with persistently high inflation.

Analysts think that scenario is possible with the current downturn, but they note that the Fed has caught a break, in the form of a 60 percent drop in oil prices since crude hit a record at $147 per barrel in mid-July. The fall in oil prices, along with the severe economic slowdown, should dampen inflation pressures.