More than half the collateral backing cash advances made by the U.S. Federal Reserve to U.S. banks is in the form of loans, not securities, the Federal Reserve Bank of New York told The Financial Times.

Economists and analysts had speculated that banks would post only complex housing-related securities -- including mortgage-backed securities -- that they could not refinance elsewhere.

That has not been the case. The Federal Reserve Bank of New York told FT that since the credit crisis began, banks had continued to provide a wide variety of assets as collateral -- including U.S. Treasuries, other government and agency-backed securities, and private-label mortgage-backed securities.

The U.S. Federal Reserve said that despite inflation concerns, "relatively low" interest rates may be needed "for some time," the central bank announced Wednesday in the minutes from its most-recent meeting. At the same time, however, the Fed raised its inflation projections for 2008.

"Several participants noted that the risks of a downturn in the economy were significant,'' the Fed said in minutes of the January 9 and 21 conference calls and the January 29-30 policy meeting last month. "Many participants were concerned that the drop in equity prices, coupled with the ongoing decline in house prices, implied reductions in household wealth that would likely damp consumer spending.''

Last week, in Congressional testimony U.S. Federal Reserve Chairman Ben Bernanke indicated that the Fed will lower rates further if financial conditions and the availability of credit deteriorate.

Also in the minutes, the Fed termed the inflation statistics since the end of the year, "disappointing." The Fed now expects 2008 core inflation of 2.0-2.2%, up from the previous 1.7-1.9% estimate.

Further, the Fed lowered its 2008 U.S. GDP outlook to 1.3-2.0% from the earlier 1.8-2.5%.

The Fed may have to lower interest rates again because previous cuts have failed to lower borrowing costs for many corporations and households, Bloomberg News reported Wednesday.

Despite 125 basis points of rate reductions by the Fed over a nine day span in January 2008, companies are paying more to borrow now than before the cuts, data compiled by Merrill Lynch (NYSE: MER) indicated, Bloomberg News reported.

Further, banks have been forced to abandon loan sales, student loan enterprises have had to postpone auctions, and even major municipalities have had to increase the interest rate they offer on bonds to attract investors reluctant to take on additional debt instruments amid subprime asset defaults and constrained credit market conditions. Economist David H. Wang told BloggingStocks Wednesday in a normal market the Fed's rate cuts would have lowered short-term borrowing costs and enhanced liquidity. It has not happened, which all but guarantees another rate cut by the Fed on March 18.

"We're definitely going to need another shot [interest rate cut]," Wang said. "The only question now is whether the Fed goes 25 basis points or 50. Credit market conditions are way too constrained. It's one thing to have a bond deal on a young company deferred or priced differently on risk factors, but this business of Sallie Mae's auctions failing to generating interest is just a ridiculous situation, frankly. It shows just how irrational the market has become, short-term."

As the saying goes, what if you invited everyone to a party and no one showed up?

That's a little like how the U.S. Federal Reserve feels right now. The Fed has lowered benchmark, short-term interest rates substantially - - including 125 basis points of reduction in January 2008 alone - - but so far, banks, stung by subprime losses, have been reluctant to ramp-up lending, CNBC.com reported Monday.

Patience advised

Still, economist David H. Wang took issue with those arguing that the Fed's rate cuts and ongoing term auction facility that haven't worked or weren't needed.

Concerning rate cuts, Wang told BloggingStocks Monday that the banking sector had to work through "a period of loan fright" - - an irrational fear of risk - - that is, in his view, the additive inverse of "the total neglect of risk" that characterized the earlier housing boom.

"Banks need some time to improve their balance sheets. Some may accomplish this through job cuts and by operational cut-back. Many will accomplish this through curtailed lending and tighter lending standards, at least for a short period of time," Wang said. "But in time, lending to businesses and individuals will resume its normal pace."

'Gradualism' vs. shock therapy

Second, the Fed's term auction facility - - which U.S. Federal Reserve Chairman Ben Bernanke has said will remain in operation "for as long as necessary" - - is working. "The term auction facility is doing exactly what it's supposed to do... it's providing short-term loans to banks who need it, who don't want to borrow from the discount window and who can't get the money from other banks who are afraid to lend," Wang said. "And in the process, bank operations are maintained, even as they slowly and gradually digest subprime defaults and related asset write-offs."

And that last point may be the key to understanding the outlook for a resumption of normal lending conditions, he said. Given the size of likely, problematic subprime loans - - some have put the figure at $500 billion - - and the preference for gradualism, it may be two quarters or more before normal lending conditions resume. Further, the correct place to look for the start of increased lending is not the stock market's level, but commercial activity: orders for new equipment, business expansion plans, and job growth / new hiring announcements.

And while some economists argue that it would be better if the financial services sector wrote-off problem loans quicker - - i.e. 'the sooner the better for economy,' Wang does not agree.

"Shock therapy may have worked in Poland's transition from a communist centrally-planned economy to a free-market economy but we're dealing with a magnitude difference in money here," Wang said with chuckle. "The Fed's goal here is to enable banks to gradually work the bad loans out the system, while maintaining the conditions for sustainable economic growth and not causing runaway inflation. And so far, that strategy is working, in my interpretation."

The U.S. economy could be growing faster before the inauguration of the new U.S. president. Bloomberg News reported Monday.

The forecast is based on the rise in the 5-year U.S. Treasury yield from its lowest level relative to the 2- and 10-year notes since 2001. The last two times that occurred, during the 1990 and 2001 recessions, the economy started to expand within nine months.

Famous last words

Economist David H. Wang agreed that the indicator has accurately predicted previous recoveries. "It's been an accurate indicator, famous last words," Wang told BloggingStocks Monday.

However, Wang cautioned that the nation's public officials, corporate America and individuals can't overlook, or neglect to prepare for, what's in-between.

The compelling question, following the U.S. Federal Reserve's 125-basis-point cut in short-term interest rates in 8 days, is whether the Fed has done enough.

"Probably not," economist David H. Wang told BloggingStocks Thursday. "But they've done all they can do, politically and practically, until the next meeting in five or so weeks."

By practically, Wang means that barring another market plunge or a capitulation day, the Fed is not prepared to lower rates before its next meeting. The Fed is already facing criticism that it responded earlier not to economic conditions, but to Wall Street's demands -- perpetual demands in the view of some -- for interest rate cuts. In this climate it would take an extraordinary event to secure another Fed emergency cut, he said.

By politically, Wang means the Fed is, similarly, facing criticism that its current easing policy will increase inflation pressure. "Some in Washington believe in inflation will accelerate so much that by year's end the Fed may be forced to raise rates. And I grant you, it's not a baseless concern," Wang said.

Federal Reserve Bank of Philadelphia President Charles Plosser indicated that further interest rate reductions may be needed to stimulate the U.S. economy, should economic growth become "substantially weaker" than already projected, Bloomberg News reported Tuesday.

"A substantially weaker outlook than expected, particularly if that weakness is projected to be more prolonged than anticipated, may require further adjustments to policy,'' Plosser said in a speech in Gladwyne, Pennsylvania, adding that he already expects several ``sluggish'' quarters of growth, Bloomberg News reported.

However, Plosser also told Reuters that he's "concerned that developments on the inflation front will make the Fed's policy decisions more difficult in 2008."

The Fed's preferred measure of consumer prices has risen 2.2% on a November 2006-November 2007 basis, or at a rate above the Fed's comfort zone, leading many economists to argue that the Fed may not be as stimulative as it typically would be at this stage of the economic cycle. The Fed may also continue to use non-interest rate policy options to encourage economic activity, these economists say.

The U.S. Federal Reserve announced that $16.5 billion of its first $20 billion in loans under its term auction facility went to institutions in the New York district [subscription required], an area that includes the headquarters of some of the nation's largest banks, The Wall Street Journal reported on Friday. The Fed doesn't disclose loan sizes or borrowers' identities.

Meanwhile, the Fed's Dallas district reported loans of $1.4 billion, while the St. Louis district reported loans of $1 billion.

Earlier this fall, the Fed established the term auction facility as an alternative short-term loan operation because banks were reluctant to access the Fed's traditional short-term window, the discount window. Banks became reluctant to borrow from the discount window because of the stigma attached: doing so can telegraph distress to other banks.

Fed Analysis: So far, the Fed's effort, along with the effort of the European Central Bank and other major central banks, to provide short-term loans to banks appears to be working. Both overnight and two-week liquidity has improved, as measured by yield spreads and transaction conditions. A later announcement by the Fed to maintain the term auction facility "for as long as necessary" further calmed the markets. Still, investors/readers should keep in mind that the housing correction / credit quality issue is young: given the plethora of at-risk subprime loans and related assets, more default declarations are undoubtedly ahead in 2008.

The U.S. Federal Reserve said it will conduct biweekly emergency auctions of loans "for as long as necessary" as part of a coordinated effort among the world's major central banks to provide liquidity to head off a potential, future credit crunch, the Fed announced Friday in a statement.

The Fed said: "The Federal Reserve intends to conduct biweekly Term Auction Facility (TAF) auctions for as long as necessary to address elevated pressures in short-term funding markets. The Board of Governors will announce the sizes of the January 14 and January 28 TAF auctions at noon on January 4."

To date, the Fed, in conjunction with the European Central Bank, has loaned more than $40 billion in 35-day loans in two auctions at interest rates of 4.65% and 4.67% per auction, respectively, Bloomberg News reported Friday.