The Federal Reserve’s $800 billion plan to unlock credit markets boosts its effects to around $3 trillion. The bold move has its fans—and critics

By Peter Coy

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While all eyes are upon Treasury Secretary Henry Paulson and his $700 billion bailout plan, Federal Reserve Chairman Ben Bernanke is conducting his own economic recovery program—and his is measured in trillions, not billions. What’s more, unlike Paulson, Bernanke doesn’t have to symbol with Congress before shoveling out the money. On Nov. 25 the Federal Reserve announced another buying-and-lending program that power of choosing to all appearance boost the central bank’s assets (in the same state as loans to financial institutions) to around $3 trillion. That’s triple the state of equality in mid-September, when the Fed began its expansionary campaign.

The Fed is trying to kill two birds with one very large stone, namely a drastic expansion of its weighing sheet. One of its twin objectives is to get more cash circulating in the economy. The other is to prop up weak financial institutions to avoid a cascade of failures. If the Fed succeeds it will appear both glittering and efficient. The dare to undertake is that by dint of. trying to accomplish too much, the central bank will fall short of one or both of its objectives.

It’s pliant to get lost in the blizzard of details. Since the credit crisis began in August 2007, the Federal Reserve has taken 51 measures to fix the financial system, not including its conventional cat’s-paw of cutting the federal funds rate, according to a count by UBS (UBS).

But the big picture is straightforward. The credit crunch is so sedate that the Fed has been forced to go beyond its peacetime role of guiding the economy by steering short-term interest rates. With banks weakened and afraid to lend, it is making or guaranteeing loans to careful institutions and in more cases outright buying assets. On Nov. 25 the Fed waded deeper than ever into a benignant of monetary pertaining policy. It announced it would directly buy $500 billion worth of mortgage-backed securities backed by Fannie Mae (FNM), Freddie Mac (FRE), and Ginnie Mae, as considerably as $100 billion of the corporate debt of Fannie, Freddie, and the Federal Home Loan Banks.

Meanwhile, the Federal Reserve Bank of New York will lend up to $200 billion to holders of exceedingly rated securities backed through auto, pupil, and ungenerous business loans and credit-card receivables. All of those loans and purchases will show up as assets of the Federal Reserve System, which have already missile up to about $2.2 trillion from $1 trillion in September.

What could go wrong? Fed watcher James D. Hamilton, one economist at the University of California at San Diego, warns that the Fed is buying, or accepting as loan not immediately to the point, assets that no one otherwise wants. The peril of this approach, he says, will become clear when the economy starts to strengthen. At that point the Fed will need to drain from home lots of excess money in the financial system. Ordinarily it does that by selling securities on its moral sheet and calling in loans. But it won’t be able to finish that if the assets are for a like reason toxic that nay one wants them or dumping them would destabilize weak institutions. "It’s tricker because the Fed has exposed itself to risks," says Hamilton.

But Columbia University economist Frederic Mishkin, who stepped down because a Fed governor in August, says Fannie and Freddie debt should be easy to put up to sale, while the loans to holders of asset-backed securities are temporary by design. Plus, says Mishkin, the Fed has to act boldly: "This shock is in sundry ways more tangled skein and harder to degree with than the financial shock that occurred for the time of the Great Depression."