The Federal Reserve has warned of significant risks to the already weak US
economy and launched a new plan to lower long-term borrowing costs and bolster the battered housing market.

The US central bank said it would sell $400 billion of short-term Treasury bonds to buy the same amount of longer-term US government debt, its latest attempt to kickstart growth that slowed to a crawl over the first half of the year.

Apparently spooked by the central bank's dismal outlook for the economy, US stocks sold off. The Standard & Poor's 500 index closed down nearly 3 percent.

Prices for long-term government debt rose, pushing yields lower -- a sign the measures were more aggressive than some investors had expected. The yield on the benchmark 10-year note dropped as low as 1.856 percent, the lowest in more than 60 years.   

'Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated,' the Fed said in a statement after a two-day meeting. 'There are significant downside risks to the economic outlook, including strains in global financial markets.'    

In offering a fresh approach to spur the economy and lower unemployment, the Fed ignored top Republicans on Capitol Hill who had pressed the central bank to refrain from action.

In addition to rebalancing its portfolio, the Fed intensified its efforts to shore up the housing market by pledging to reinvest proceeds from maturing housing-related debt it holds back into the mortgage market.

Analysts said the Fed's actions might not have a great impact, even if they did lower long-term interest rates. 'The cost of borrowing simply isn't the problem,' said Paul Ashworth, an economist at Capital Economics in Toronto.
'Businesses don't have the confidence to invest and half of all mortgage borrowers don't have the home equity needed to refinance at lower rates.'    

Still, faced with a lofty 9.1 percent jobless rate and an escalating sovereign debt crisis in Europe, Fed officials felt they needed to do what they could to try to breathe more life into the sluggish US recovery.   

The economy grew at less than a 1 percent annual rate over the first half of the year and analysts have warned of a heightened risk of recession.

With Fed chairman Ben Bernanke reluctant to stay on the sidelines, his activism has become a punching bag for politicians as an election year nears. Top Republican lawmakers wrote to Bernanke this week urging the central bank to resist further economic interventions, echoing criticism voiced by Republican presidential candidates.   

The portfolio retooling plan stops short of an outright expansion of the Fed's holdings -- sometimes referred to as quantitative easing -- of the type that has drawn harsh criticism domestically and internationally for sowing the seeds of inflation and debasing the dollar.

Some analysts however expect the move will be one in a series of steps the Fed takes to help the economy. The Fed could cut the rate it pays banks for reserves parked at the central bank, which might free up lending, or promise not to raise rates until unemployment drops to a certain level. - Reuters