WASHINGTON - With the economy on the mend, the Federal Reserve on Wednesday said it is slowing the pace of a program to lower mortgage rates and prop up the housing market.
The Fed decided to stretch out its goal of buying $1.45 trillion in mortgage-backed securities and debt issued by Fannie Mae, Freddie Mac and Ginnie Mae until the end of the first quarter of 2010. Originally, the central bank intended to complete buying those securities by the end of this year.
It marked the second time since August that the Fed has opted to slow some of its extraordinary support to revive the economy and spur Americans to boost spending. It shows that the Fed chairman Ben Bernanke and his colleagues are increasingly confident the recovery will take hold.
In a more upbeat assessment, the Fed said: "Economic activity has picked up following its severe downturn." When the Fed last met in August, policymakers declared that economic activity was "leveling out."
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Even with the pickup in economic activity, Fed policymakers predict inflation will remain "subdued for some time."
Factories are operating well below capacity, one force that should keep a lid on inflation. Other factors keeping prices in check include the weak job market enabling employers to avoid wage increases, and cautious shoppers making companies wary of raising costs.
Even though the Fed will stretch out its purchases of mortgage securities, rates for home loans should remain low, "in the 5 percent range," as long as the purchases continue, said Guy Cecala, publisher of Inside Mortgage Finance.
If the Fed hadn't extended its deadline, it would have faced pressure to buy more than $600 billion in mortgage-backed securities by December, said Brian Bethune, an economist with IHS Global Insight. A sudden withdrawal from the market after such rapid purchasing could have caused major disruptions. Low inflation and bond yields also will keep mortgage rates low, he added.
"They want to stabilize the markets. They want to contain excess volatility, but they don't want to be a market-maker," Bethune said. "This is the best thing they could have done."
Policymakers on Wednesday noted other improvements - specifically that financial conditions are better and activity in the housing market increased.
To foster the recovery, the Fed also decided to hold the target range for its key bank lending rate at a record low of between zero and 0.25 percent. It again pledged to keep rates there "for an extended period." Economists predict that means through the rest of this year, and perhaps into part of next year.
Holding that bank lending rate steady means commercial banks' prime lending rate - used to peg rates on home equity loans, certain credit cards and other consumer loans - will stay at about 3.25 percent, the lowest in decades.
The goal behind leaving rates at super-low levels is to entice people and businesses to step up spending to aid economic growth.
The central bank announced the mortgage-buying program in November, shortly after financial turmoil reached a crisis point.
The Fed has bought about $775 billion worth of both mortgage-backed securities and debt from Fannie Mae, Freddie Mac and Ginnie Mae, which finance the vast majority of new mortgages for people to purchase homes.
By one estimate, the central bank is buying about 85 percent of the mortgages issued by those companies. It's basically bankrolling mortgage lending.
By doing so, the Fed is helping provide demand for these securities - which had dried up when the crisis deepened - and forcing down mortgage rates in the process. The Fed's purchases of mortgage securities and debt have averaged roughly $25 billion a week over the last six weeks.
The housing market has been propped up by the Fed's program. Rates on 30-year home loans dropped to 5.04 percent last week, compared with 5.78 percent a year earlier, Freddie Mac says. But the housing sector's health remains precarious as foreclosures continue to mount.
"There was sufficient concern that if the Fed quit buying mortgage-backed securities cold turkey, that we could see a sharp spike in mortgage rates that would endanger not only the housing market, but the broader economic recovery as well," said Greg McBride, senior financial analyst at Bankrate.com. "This puts those fears to rest, with the Fed instead aiming to wean the markets off their reliance on Ben Bernanke's checkbook."
As the recovery gains traction, the Fed will face more pressure to wind down some emergency programs.
It's a fine line Fed policymakers have to walk. They need to leave programs intact long enough to support the recovery but not long enough to unleash inflation later on.