Treasury, Fed act to boost lending

NEW YORK(CNNMoney.com) – The Federal Reserve and Treasury Department on Tuesday unveiled hundreds of billions more in money they are pumping into the struggling U.S. economy to try to jump start lending by the nation’s banks for mortgages and consumer debt.

The Federal Reserve Bank of New York will lend up to $200 billion to holders of securities backed by consumer debt, such as credit card debt.

The statement from Treasury said that while roughly $240 billion of those kinds of securities were issued by the nation’s financial institutions in 2007, the issuance of those securities essentially came to a halt in October.

Treasury will allocate $20 billion to back that lending by the New York Fed.

Plans to pump money into the consumer debt market was signaled last week by Treasury Secretary Henry Paulson. He discussed the state of the $700 billion bailout of the nation’s banks and Wall Street at a press conference, although the details of the plan were not available at that time.

„Today, the illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards. This is creating a heavy burden on the American people and reducing the number of jobs in our economy,“ said Paulson at that time.

But the Treasury, which has been reluctant to tap into the $700 billion already approved by Congress to help financial institutions, was reluctant to make a major commitment of those funds to this new effort. Thus it allocated only $20 billion, or the same amount it invested in troubled banking giant Citigroup (C, Fortune 500) in a move announced Sunday.

So it was left to the Federal Reserve of New York, which is headed by Timothy Geithner, the man nominated by President-elect Obama to take Paulson’s place, to come up with the funds to try to restart consumer lending.

The moves came as the Commerce Department announced that gross domestic product, the broad measure of the nation’s economy, fell by 0.5% in the third quarter, the biggest drop in economic activity in seven years. Economists believe that the economy is likely to continue to shrink in the current quarter and into early next year.

In addition, the Federal Reserve, the nation’s central bank, announced it will purchase up to $500 billion in mortgage backed securities that have been backed by Fannie Mae (FNM, Fortune 500), Freddie Mac (FRE, Fortune 500), and Ginnie Mae, the three government-sponsored mortgage finance firms set up to promote home ownership. It will also buy another $100 billion in direct debt issued by those firms.

„This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally,“ said the statement from the Fed.

The financial crisis has frozen lending markets, making it nearly impossible for consumers and businesses to borrow money.

Treasury originally had planned to use the $700 billion bailout to buy troubled mortgage assets. But it has shifted gears and focused mostly on injecting capital into banks.

The last capital injection into Citigroup was part of a broader rescue package under which Treasury and another U.S. agency, the Federal Deposit Insurance Corp., announced it would guarantee losses on more than $300 billion of Citi’s troubled assets.

But once again, Treasury is not using the $700 billion in bailout funds for that guarantee, as it tries to keep those funds available for future capital needs by the nation’s financial institutions.