The Federal Reserve moved Thursday for the first time to scale back several of the emergency lending programs it launched last fall at the height of the financial crisis.
The central bank's announcement carried political overtones because it came the same day that Fed Chairman Ben Bernanke on Capitol Hill disputed accusations that he pressured Bank of America into acquiring Merrill Lynch in a deal that ultimately cost taxpayers $20 billion.
The Fed will allow one program intended to support money market mutual funds -- which hasn't been used -- to expire Oct. 30. And it's reducing the maximum it will lend to banks under two other programs.
The Fed has pumped trillions of dollars into commercial and investment banks through an alphabet-soup of emergency programs, after struggling banks hoarded cash and refused to lend to each other and consumers.
The central bank on Thursday extended until Feb. 1, 2010, five lending programs that had been slated to expire Oct. 30 .
In addition, the Fed is buying $1.75 trillion in mortgage-backed securities, Treasury bonds and other debt in an effort to keep interest rates low. The extended programs include swap lines with more than a dozen foreign central banks that enable them to provide dollars to their financial systems in exchange for giving the Fed foreign currencies.
The Fed extended swaps with the European Central Bank, the Bank of England, the Swiss National Bank and others. The Bank of Japan will consider extending its swap during its next meeting, the Fed said.
The Fed said the moves reflect its view that "financial markets have improved in recent months, but market functioning in many areas remains impaired" and likely will be "strained for some time."
Interest rates that banks charge to lend to each other soared last winter as large institutions such as Citigroup Inc. reported mounting losses on real-estate related investments. But those rates have recently fallen to record lows.
The Fed's announcement Thursday is "a gentle backing away" from its lending to the financial sector, said Michael Feroli, senior economist at JPMorgan Chase & Co. But its lending programs "were declining on their own," he said.
The Fed said it will allow the Money Market Investor Funding Facility to expire Oct. 31. That program was part of the government's efforts last fall to prevent a run on money market mutual funds. It came after one money fund saw its share price fall below the standard $1 in the wake of Lehman Brothers' collapse in September.
The Fed facility, which was never used, was intended to reassure investors that money funds would be able to fully redeem their investments. It would have allowed the funds to sell assets to the central bank.
In addition, the Fed said it will reduce the maximum amount it will lend under the Term Auction Facility, or TAF, which provides one-month loans to banks, to $500 billion from $600 billion. The Fed has lent $337 billion under TAF, down from a peak of more than $490 billion in March.
The Term Securities Lending Facility, which allows investment banks to borrow the Fed's Treasury securities in exchange for riskier mortgage-backed securities and corporate bonds, also is being scaled down.
The maximum amount outstanding under that program will drop to $75 billion from $200 billion. The use of that program has fallen to about $16 billion from a peak of $234 billion in October.
Among the facilities that will be extended is a program that provides overnight loans to investment banks. Demand for the loans, though, has dropped to zero from nearly $150 billion last fall.
Feroli, like many economists, said the Fed faces a bigger challenge in managing its $1.75 trillion in asset purchases in a way that doesn't spur inflation later on.