Ben S. Bernanke, having survived a surprising challenge to his second term as Federal Reserve chairman, now faces the delicate task of beginning to pull the central bank out of its extraordinary effort to prop up the economy, Sewell Chan writes in The New York Times.

The main question is when and how the Fed should start raising short-term interest rates, which have been at a record low for more than a year. Related is the issue of how to manage, and eventually shrink, the record $2.2 trillion balance sheet that the Fed amassed as it pumped vast sums of money into the economy, starting in 2008. On Wednesday morning, the Fed will release a statement outlining Mr. Bernanke’s views on moving away from its exceptionally easy monetary policy.

As a policy tool, Mr. Bernanke is expected to consider a little-known mechanism — referred to as the interest rate on excess reserves — that gives the Fed leverage over $1.1 trillion in bank deposits.

Most of those deposits were created as the Fed gobbled up mortgage-backed securities and Treasury notes and bonds during the financial crisis. The banks in turn parked the funds at the Fed as reserves. In the months and years ahead, the Fed wants to make sure that banks do not reduce their reserves too quickly, because it could create inflationary pressures as banks step up their lending.

To achieve its goal, according to Fed officials and speeches, the central bank will raise the interest rate on excess reserves, now 0.25 percent. It also plans to lift its target for the fed funds rate — what banks charge one another for overnight loans and the centerpiece of its policy statements since 1994. But officials stress that rates will remain quite low for months to come.

“We’re in a different situation than ever before, and the tools we are using are entirely new,” said Lyle E. Gramley, a former Fed governor who now works at the Potomac Research Group, an investment advisory firm.

Mr. Gramley predicted that Mr. Bernanke would try to reassure the markets that the new tools would work. “There’s an awful lot of talk that we’re going to have inflation down the road,” he said. “But this Fed is determined to maintain price stability. They’ve said that over and over again, and they want to communicate that to the markets.”

Mr. Bernanke has used the term “exit strategy” to describe his task. Much like the American military’s withdrawal from Iraq, the Fed’s plan has few precedents and carries much uncertainty. At a minimum, officials have signaled, it will have to be carried out delicately, be flexible when circumstances change, and, most likely, be gradual.

With unemployment at 9.7 percent, the Fed may be months away from raising rates, but it is discussing the plan now to prepare the markets and tamp down inflation fears, said Vincent R. Reinhart, a former director of monetary affairs for the Fed.

“The reason they’re starting to talk about the exit now is to reassure investors, so that they aren’t pressed to head for the exit prematurely,” said Mr. Reinhart, now a scholar at the American Enterprise Institute. “Chairman Bernanke has to walk a very, very fine line.”

If the Fed raises interest rates too hastily, it could choke off the fragile recovery. If it dallies, it might set off market jitters about rising prices.

But that decision occurs in the context of an economy whose normal rules have been reshaped. As Mr. Bernanke put it in a speech last April, “we no longer live in a world in which central bank policies are confined to adjusting the short-term interest rate.”

The Fed’s balance sheet has nearly tripled since the summer of 2007. At the end of that year, the Fed found new ways to lend to banks, and in early 2008, it began to cut interest rates aggressively, pushing the target rate for fed funds to nearly zero in December 2008.

By that month, the Fed’s balance sheet had ballooned to $2.2 trillion as the central bank doled out loans to commercial banks, issuers of commercial paper and foreign central banks. The American International Group, the bailed-out insurance giant, and JPMorgan Chase, which bought Bear Stearns, also received aid.

Many of those programs are winding down. Two of the biggest — the Fed’s purchase of $1.25 trillion of mortgage-backed securities and of about $175 billion in debts guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae — are to be completed by March 31.

The Fed in essence created new money to buy those securities, and now holds $1.1 trillion in reserves that the banks can demand when they wish. “The Fed’s great worry is that instead of holding onto these reserves, the banks would decide they’d rather take the money they’re tying up and lend it out,” said Anil K. Kashyap, a professor of economics and finance at the University of Chicago’s business school. If they did that, “you’d see broad measures of money growing quickly, and presumably that would be the start to having some inflation.”

In the short term, that prospect seems remote, as banks have been wary and tightfisted in lending since the financial crisis erupted. But in the long run, a huge balance sheet carries risks.

The ability to charge an interest rate on excess reserves was created in 2006, after decades of discussion, when Congress granted the Fed such authority. (One reason it took so long is that the interest payments will reduce the amount the Fed turns over to the Treasury each year.) The tool — which is used by other central banks, like those in England and Canada — was to become available in 2011, but Congress moved up the date during the crisis. The Fed started paying the interest in October 2008.

Mr. Bernanke has argued that the new rate will eventually serve as an interest-rate floor, with the discount rate — the rate at which the Fed lends directly to banks — functioning as the ceiling, and the fed funds rate fluctuating in between them.

Looking longer term, Mr. Bernanke has four other tools that could be used gingerly to tighten monetary policy. The first is reverse repurchase agreements, or reverse repos, in which the Fed would sell securities from its portfolio with an agreement to buy them back at a slightly higher price at a later date. The second is term deposits, analogous to the certificates of deposit banks offer to customers. Third, the Treasury could sell bills and deposit the proceeds at the Fed.

Finally, the Fed could sell some of its long-term securities, including those backed by mortgages, taking more money out of the system. That strategy would carry risk given that the Fed’s ownership of such securities is helping keep mortgage rates low and support the housing market.

Mr. Bernanke’s statement was initially to be presented at a House hearing scheduled for Wednesday. After the hearing was postponed because of snow, he decided to release it anyway.

The New York Times

NEW YORK (CNNMoney.com) — Mortgage giants Fannie Mae and Freddie Mac have directed their network of servicers to halt all foreclosure and eviction proceedings between Nov. 26 2008 and Jan. 9, 2009, meant to give a recently announced rescue plan time to work.

The Streamlined Modification Program, set to launch Dec. 15, enables delinquent borrowers to get a modified mortgage that lowers payments to no more than 38% of their gross incomes.

“By delaying these foreclosure sales, the nation’s servicers will have the opportunity to work with more borrowers who could qualify for a modification under the new [program],” said Freddie Mac CEO David M. Moffett in a statement.

Freddie has told its servicers to immediately contact the 6,000 borrowers who already have auction sales or evictions scheduled for between the specified dates to tell them the sales are postponed. Fannie estimated that 10,000 of its borrowers will be affected. Borrowers facing eviction between Nov. 20 and Nov. 26 were not expected to get relief.

The foreclosure suspension affects only a small percentage of homeowners facing foreclosure over the next two months. Although Fannie and Freddie mortgages account for more than half of all mortgages, they have relatively few of the most risky subprime loans at the center of the foreclosure crisis.

“The vast majority of what’s going into foreclosure are not Fannie Freddie loans,” said Freddie Mac spokesman Brad German.

The Fannie, Freddie plan was unveiled on Nov. 11. Eligibility is determined by several factors: Homeowners must be 90 days or more late in their mortgage payments, owe at least 90% of their home’s current value, live in the home on which the mortgage was taken and have not filed for bankruptcy.

The mortgage rate could be lowered to as little as 3% for five years. After that, it would increase by 1 percentage point a year until it hits either the market rate or the original interest rate, whichever is lower.

Unlike previous federal efforts, participation by servicers is not voluntary.

Several major servicers — including Bank of America, JPMorgan Chase and Citigroup — have recently announced expansions of their foreclosure prevention efforts, which could aid nearly a million more borrowers.

Associated Press

WASHINGTON – The White House said Monday that the giant federal takeover of troubled mortgage giants Fannie Mae and Freddie Mac might have been prevented if Congress had acted on its recommendations for changing the system.

“It is exactly the kind of event we warned about and tried to prevent over the years,” White House press secretary Dana Perino said. “Remember that we have highlighted the systemic risk posed by Fannie Mae and Freddie Mac because of the very large role they play in housing markets and because of their business practices.”

She said that the White House has asked Congress “for years” to establish a strong independent regulator to oversee the institutions.

Perino also highlighted that the takeover will allow time for Congress and the next administration to determine the appropriate future role for the companies. She said their primary mission should be to increase the availibility and affordability of home mortgages.

“Whatever eventual longtime solution is decided for Fannie Mae and Freddie Mac,” Perino said, “it is crucial that there are reforms so they do not pose similar risks to our economy or the financial system again.”

President Bush said he is pleased with the action and believes “it will stabilize the markets.”

“I wouldn’t call it a bailout,” he said in an interview conducted Sunday with Fox News Channel’s Fox & Friends show, and set to air Tuesday. “I’d call it a stabilization.”

Perino said the nation’s “economy will not return to strong job growth until the housing correction is behind us.”

Perino was pressed repeatedly about how Bush — a fiscal conservative — could champion such a historic government takeover and intervention in markets.

“This is not action that we wanted to take. It’s action that we needed to take,” she replied.

Analysts were split on how much the takeover could eventually cost taxpayers although they all agreed the upfront costs will be substantial, possibly hitting $100 billion as the Treasury is called upon to bolster the capital cushions at both institutions. Perino said the administration is moving “to make sure that the taxpayers would be paid back first.”

“The goal is to prevent additional risk to the taxpayers,” she said.

July 30 (Bloomberg) — President George W. Bush signed into law legislation that helps 400,000 homeowners facing foreclosure and extends a lifeline to Fannie Mae and Freddie Mac.

Bush signed the measure at the White House shortly after 7 a.m., spokesman Tony Fratto said. Treasury Secretary Henry Paulson, Housing and Urban Development Secretary Steve Preston and Federal Housing Administration Director Brian Montgomery were among those present.

“We look forward to putting in place new authorities to improve confidence and stability in markets, and to provide better oversight for Fannie Mae and Freddie Mac,” Fratto said.

The law is aimed at stemming foreclosures and halting a free-fall in housing prices by providing federal insurance for refinanced 30-year mortgages for homeowners struggling to make their monthly payments.

The measure also is designed to restore confidence in Fannie Mae and Freddie Mac by tightening regulations and authorizing the Treasury secretary to inject capital into the two biggest U.S. providers of mortgage money.

The measure passed the Senate July 26 and the House three days earlier.

The recession in the housing market, the worst since the Depression, along with higher fuel prices and a shrinking job market, is weighing on consumers and the economy.

The White House Office of Management and Budget this week cut its February forecast for economic growth this year to 1.6 percent from 2.7 percent. The OMB said it expected the economy to expand 2.2 percent next year, compared with its earlier forecast of 3 percent growth.

Lead Lobbyist

The foreclosure-prevention measure, unveiled in March, was bolstered after Paulson sought and received temporary authority, through Dec. 31, 2009, to lend money or to buy the stock of Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac. The goal is to avert a collapse of the companies that buy or finance almost half of the $12 trillion of U.S. mortgages.

The Treasury chief, who was the lead lobbyist for the White House, persuaded Bush to back off a threatened veto over a section of the legislation that provides $3.9 billion in grants to states to buy and repair foreclosed properties. Bush said he regarded it as a bailout of lenders. Democrats said it would stabilize neighborhoods.

New Regulator

The law creates a new, independent regulator called the Federal Housing Finance Agency. It would ensure that Fannie Mae and Freddie Mac adhere to minimum capital requirements, limit the size of portfolios and oversee executive pay for the two government-sponsored enterprises.

Under the law, the FHA can now insure higher loan limits, up to $625,500 from $417,000 in high-cost areas. The law also raises the nation’s debt limit to $10.6 trillion from $9.816 trillion to accommodate the Paulson plan.

A new FHA program, a unit of the U.S. Department of Housing and Urban Development, would insure up to $300 billion in refinanced 30-year fixed loans for about 400,000 borrowers struggling with their monthly payments after loan holders agree to cut their mortgage balance.

HUD Secretary Preston expressed misgivings when asked in a Bloomberg TV interview if he was confident that money for the program would be spent effectively with no loss to the taxpayer.

“No, I’m not,” Preston said. “Roughly a third of the people who get this assistance will end up in foreclosure,” he said, citing Congress’ own estimates, “and many more, we believe, will be chronic delinquencies.”

The measure would offer $15 billion in tax breaks, including provisions offering the equivalent of interest-free loans worth up to $7,500 for first-time homebuyers. States would be able to offer an additional $11 billion in mortgage revenue bonds to refinance subprime loans.