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) — It appears 0% is here for the foreseeable future.

A year ago, the Federal Reserve took its key overnight lending rate, the fed funds rate, down to near 0% for the first time in its history in an effort to keep the economy from falling into depression.

The cheap money meant lower rates for consumers on credit cards and home equity loans, as well as for many business loans.

The threat of a depression is widely acknowledged to have passed and most economists believe the economy has begun at least a modest recovery. But the Fed hasn’t moved the rates since, and experts don’t think they’re likely to do so for the foreseeable future, perhaps not until 2011.

Fed funds futures on the Chicago Board of Trade, which track the key rate, show investors aren’t betting on a hike anytime next year.

Part of that is because of talk from Fed officials. Fed Chairman Ben Bernanke, named Time’s Person of the Year on Wednesday, has repeated frequently that one of the problems of the Great Depression was that the Fed raised rates too quickly when the economy first showed signs of life, causing a second, much more painful downturn that extended the Depression for years.

Economists say they think the chairman and many other policymakers are willing to wait too long to raise rates rather than risk hiking too soon.

“I think they’ll leave the taps open as long as possible, until they’re absolutely certain the economy is back on track,” said Anthony Michael, head of fixed income for asset manager Aberdeen’s Singapore office.

In recent statements issued after policy-making meetings, the Fed keeps cautioning that it expects economic conditions “likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

That language is widely expected to stay in place when the central bank concludes a two-day meeting Wednesday.

But leaving rates at such levels is not without significant risks.

Low rates can sow the seeds of inflation, which can eat into workers’ earnings and squeeze budgets. It also has been blamed for the fall in the value of the dollar versus other major currencies, such as the euro, which in itself can limit Americans’ buying power.

Beyond that there are concerns that cheap rates can feed asset bubbles. Many blame the Fed’s decision to leave rates at its previous record low of 1% for 12 months from June 2003 to June 2004 as a major factor in feeding the housing bubble. The low rates caused builders to overbuild, lenders to make riskier loans seeking better returns, and consumers to use the cheap credit to buy homes they ultimately would not be able to afford.

While another housing bubble is not likely, some are now worried about bubbles in U.S. stock and bond markets, as well as in some commodities such as gold. The Standard & Poor’s 500 has gained 64% since it hit a low in March.

All those fears have prompted some in the market to argue the Fed risks falling behind the curve if it doesn’t raise rates sooner rather than later. But others dismiss those fears.

“Am I worried about the Fed being behind the curve in raising rates? At this point I want to make sure there’s a curve,” said David Wyss, chief economist for Standard & Poor’s. He said a rebound in hiring could prompt the Fed to move as early as next summer.

But others think the Fed will wait until it sees both a pickup in consumer spending and inflation warning bells.

“The consumer is not a viable spender right now and won’t be throughout most of 2010,” said Jeffrey Burchill, chief financial officer for business property insurer FM Global. “If you’re not seeing spending, it’s going to be difficult to raise rates even if there’s early signs of inflation. Similarly, if you see spending but without signs of inflation, there’s no need to raise rates.”

While economists think there’s a chance the Fed could raise rates late next year, few would be surprised to see them stay on hold all the way through 2010. A survey of 48 top economists by the National Association of Business Economics foresees rates at current levels through the first quarter of 2011.

Part of the reason is the Fed has done so much more than simply cut rates to nearly 0% in an effort to spur the economy.

It has bought more than $1 trillion in mortgages in an effort to keep rates low and spur home sales and building. It also has bought hundreds of billions of Treasurys and debt issued by mortgage finance firms Fannie Mae and Freddie Mac. And it has offered a number of other programs designed to jumpstart lending to small businesses and consumers.

Many believe the Fed will have to sell a significant portion of those assets into the market before it is ready to raise rates

“There are too many things that have to happen before the Fed is in position to (raise rates) again,” said Kevin Giddis, managing director of fixed income at investment house Morgan Keegan.

By Chris Isidore

NEW  YORK , September 30, 2008 — The New York Stock Exchange will implement new circuit-breaker collar trigger levels for fourth-quarter 2008 effective Wednesday, October 1, 2008.

Circuit-breaker points represent the thresholds at which trading is halted marketwide for single-day declines in the Dow Jones Industrial Average (DJIA).   Circuit-breaker levels are set quarterly as 10, 20 and 30-percent of the DJIA average closing values of the previous month, rounded to the nearest 50 points.

In fourth-quarter 2008, the 10, 20 and 30-percent decline levels, respectively, in the DJIA will be as follows:

Level 1 Halt
A 1,100-point drop in the DJIA before 2 p.m. will halt trading for one hour; for 30 minutes if between 2 p.m. and 2:30 p.m.; and have no effect if at 2:30 p.m. or later unless there is a level 2 halt.

Level 2 Halt
A 2,200-point drop in the DJIA before 1:00 p.m. will halt trading for two hours; for one hour if between 1:00 p.m. and 2:00 p.m.; and for the remainder of the day if at 2:00 p.m. or later.

Level 3 Halt
A 3,350-point drop will halt trading for the remainder of the day regardless of when the decline occurs.

Background:
Circuit-breakers are calculated quarterly.  The percentage levels were first implemented in April 1998 and are adjusted on the first trading day of each quarter.  In 2008, those dates are Jan. 2, April 1, July 1 and Oct. 1.

Read more about it at http://www.nyse.com/press/1222772891771.html

Citic Pacific Ltd seems to be in a bad position. An executive working at Citic seemingly violated procedures by investing in the Australian Dollar, the Euro, and the Chinese yuan without proper approval. When the dollar surged against the Australian dollar and the Euro, Citic Pacific was exposed to unlimited losses due to their investing in major Hong Kong banks using a so-called “accumulator” position.

The company would face a loss of about HK$14.7 billion based on current forex levels; however, as it intends to mark the contracts to market on Dec. 31, the actual loss could be higher or lower. Citic Pacific had already realized losses of HK$807.7 million on the forex contracts as of Friday. Citic Pacific plans to realize all of the losses this year, so they won’t affect the company’s 2009 results.

Citic Pacific had been suspended from trade in Hong Kong on Monday and is expected to fall sharply when it resumes Tuesday.