All the Right Moves? Bold U.S. Policy Action

The credit crisis isn't over, but the U.S. policy response in the last week, in addition to earlier measures that helped re-open the commercial paper and asset-backed commercial paper markets, will gradually revive important parts of the capital markets. It also will leave the Federal Reserve with several challenges, including an expansion of the Fed's balance sheet that is roughly three-quarters of the Fed's balance sheet prior to the onset of the crisis.

Last Friday, the Federal Deposit Insurance Corporation tweaked its plan to guarantee new bank bonds. This will re-open, even if by fiat, a channel in the capital markets that has been closed for a few months.

The bailout of CitiGroup (C - commentary - Cramer's Take) underscored official resolve not to let another large financial firm go under while sheltering its current shareholders. The dividend to common shares will be eliminated, but that is no more onerous than what the U.K. insisted for its banks that took government money.

On Tuesday, the Federal Reserve stepped into the breach created by Treasury Secretary Paulson's refusal to use TARP money for asset relief, in effect creating the monetary equivalent of TARP. Next week, the Fed will buy $100 billion of agency debt from a pool of primary dealers. Over the next several quarters, with the help of asset managers yet to be named, the Fed will buy $500 billion of the agencies' mortgage backed securities.

This is huge -- Paulson may not want to buy mortgage-backed securities, but the Fed will and for all practical purposes it has an unlimited balance sheet to do so (with less scrutiny and/or greater discretion). There was a huge sigh of relief triggered by this announcement: the 30-year fixed-rate mortgage rate collapsed to about 5.5% from almost 6.4%, while the five-year interest rate premium Fannie Mae (FNM - commentary - Cramer's Take)and Freddie Mac (FRE - commentary - Cramer's Take)pay over Treasuries fell 34 and 36 bps respectively to 102 and 105 bps.

Finally, the Fed announced a new facility to support the consumer and small business asset-backed security market in a bid to re-open securitization and consumer lending. It will essentially guarantee the purchase of new or recently issued AAA-rated asset-back securities with $20 billion from TARP covering the first 10% of what will be a $200 billion program initially, and only a small Fed-determined haircut for the owner.

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Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.