March 12 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke's latest attempt to alleviate seized-up credit markets marks his most direct effort yet to repair the mortgage meltdown that poses the biggest threat to the economy.

The Fed pledged yesterday to lend, in return for mortgage debt, $200 billion of Treasuries to the securities firms that trade directly with the central bank. Officials told reporters later that the program may escalate from there as the central bank seeks to break the logjam in the home-loan market.

The step goes beyond past initiatives because the Fed can now inject liquidity without flooding the banking system with cash. Bernanke and his colleagues are trying to halt a cycle in which the losses on mortgage investments cause banks to cut their lending, sending the economy into a deeper contraction.

``It is a strong attempt to stabilize a crisis,'' Henry Kaufman, president of Henry Kaufman & Co. in New York and the former chief economist at Salomon Brothers Inc., said in a Bloomberg Radio interview. ``It is a further recognition that this credit crisis is deeper and wider, and has been exceedingly opaque, in contrast to earlier credit crises.''

Investors' unwillingness to hold mortgage-backed bonds amid record home foreclosures sent premiums on even Fannie Mae and Freddie Mac guaranteed assets to the highest in 22 years this month. The two government-chartered companies are the biggest sources of U.S. housing finance.

Evening Call

The Fed decided to act when the crisis spread beyond the securities backed by subprime loans, officials said on condition of anonymity. Policy makers gathered by conference call the evening of March 10 and voted to set up the new lending tool, spokeswoman Michelle Smith said in Washington.

``They see residential mortgage securities markets as the linchpin,'' said Stephen Stanley, chief economist at RBS Greenwich Capital Markets Inc., who used to work at the Richmond Fed bank. ``If they can get that normalized, it might resolve some of the other problems.''

Economists at Goldman Sachs Group Inc. and Nomura International Plc questioned how successful the new initiative would prove in easing the credit squeeze. It doesn't improve the solvency of some institutions or encourage looser lending standards, they wrote in reports today.

``We are not convinced that yesterday's move will solve all the multiple challenges facing credit markets and the financial system,'' said Fiona Lake, an economist at Goldman Sachs in London.

Market Reaction

Stocks climbed the most in five years and Treasuries slid after the Fed's announcement. The extra yield investors demand to buy mortgage-backed bonds guaranteed by Fannie Mae instead of 10-year Treasuries narrowed to 2.11 percentage points yesterday, from 2.28 percentage points the day before. The spread has still widened from 1.38 percentage point two months ago.

The spread was at 2.07 percentage points today. The dollar also retreated amid concern credit strains will continue. The U.S. currency fell to a record low of $1.5504 per euro.

Under the new Term Securities Lending Facility, the Fed will lend Treasuries for 28-day periods in return for debt including AAA rated mortgage securities sold by Fannie Mae, Freddie Mac and by banks. The weekly auctions begin March 27.

More Flexible

Bernanke, 54, has enacted a series of measures to repair the strains in credit markets that erupted in August. Unlike the newest tool, the past steps added cash to the banking system, which affects the Fed's benchmark interest rate. The central bank had to withdraw the funds through operations with securities dealers to keep the rate from falling below the target.

By contrast, the TSLF injects liquidity by lending Treasuries, which doesn't affect the federal funds rate. That leaves the Fed free to address the mortgage crisis directly without concern about adding more cash to the system than it wants. The Fed has about $713 billion of Treasuries.

Direct purchases of mortgage-backed assets, as advocated by some analysts and investors, would affect the price of the securities, going against the Fed's aims, officials said yesterday. They said the goal is to get the market back to regular trading conditions rather than to target a level for spreads.

Discounted Values

Fed officials said they will work with the primary dealers, a group of 20 firms including Goldman Sachs and Merrill Lynch & Co., on setting discounts from face value of the mortgage securities submitted to the Fed.

``The innovation is essentially permitting the primary dealers to swap their illiquid assets for Treasuries,'' said Robert Eisenbeis, former head of research at the Atlanta Fed and chief monetary economist at Cumberland Advisors Inc. ``Clearly, this is an attempt to break the logjam.''

Bernanke's first step in August was to reduce the charge on direct Fed loans to banks. He acknowledged later that the effort failed to reduce the ``stigma'' surrounding borrowing at the so- called discount window.

The Fed in December introduced the Term Auction Facility, where it lends cash to banks in exchange for a variety of collateral. The central bank last week increased the size of its planned TAF auctions to $100 billion this month from a previously announced $60 billion.

Officials also aim to make $100 billion available through repurchase agreements, where the Fed loans cash to the primary dealers in return for assets including mortgage debt.

Policy makers are ``trying to break into the adverse feedback loop'' they have warned about, said John Ryding, chief U.S. economist at Bear Stearns Cos. in New York. The market for mortgage-backed debt is ``far and away the most important'' in the credit crisis, he said.

Fed Governor Frederic Mishkin cautioned March 4 about the risk of ``an adverse feedback loop whereby financial disruptions cause investment and consumer spending to decline,'' which in turn prompts an even deeper credit rout.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: March 12, 2008 10:23 EDT