The central bank also held interest rates steady at record lows, with a closely watched bank lending rate near zero, and again pledged to keep them there for “an extended period” to nurture an anticipated recovery.

Fed Chairman Ben Bernanke and his colleagues said the economy appeared to be “leveling out” — a considerable upgrade from their last meeting in June, when the Fed observed only that the economy’s contraction was slowing.

“We’re no longer at DEFCON 1,” said Richard Yamarone, economist at Argus Research, referring to the defense term used to indicate being under siege. “The Fed is pulling in some of its life preservers now that the economy is no longer sinking.”

The more optimistic tone lifted Wall Street. The Dow Jones industrials gained about 120 points, or 1.3 percent, to close above 9,360 — near their highest level since the market bottomed out in early March.

The Fed said it would gradually slow the pace of its program to buy $300 billion worth of Treasury securities and shut it down at the end of October, a month later than previously scheduled.

It has bought $253 billion of the securities so far. The program is designed to force interest rates down for mortgages and other consumer debt and spur Americans to spend more money.

“I think the Fed is feeling increasingly comfortable about where the economy is going,” said Mark Zandi, chief economist at Moody’s Economy.com. “For the first time in two years, the Fed is taking one step — a baby step — toward unwinding the massive stimulus.”

The Treasury-buying program’s effectiveness has been questioned on both Wall Street and Capitol Hill, with critics saying it looks like the Fed is printing money to pay for Uncle Sam’s spending binge.

As the Fed winds down the program, rates on government debt might edge higher, economists said. But the Fed appeared to feel sufficiently secure that higher rates would not jeopardize a recovery, they said.

Chris Rupkey, an economist at Bank of Tokyo-Mitsubishi, viewed it as a “vote of confidence that credit markets and the economic outlook has improved and will show even further improvement down the road.”

The Fed left unchanged another program that aims to push down mortgage rates. In that venture, the Fed is on track to buy $1.25 trillion worth of securities issued by mortgage finance companies Fannie Mae and Freddie Mac by the end of the year.

The central bank’s recent purchases have totaled about $543 billion, suggesting the Fed still has firepower in its arsenal.

The Fed left the target range for its bank lending rate at zero to 0.25 percent. And economists think it will stay there through the rest of this year. The rationale: Super-cheap lending will lead Americans to spend more, which will support the economy.

If the Fed holds rates steady, commercial banks’ prime lending rate, used as a peg for rates on home equity loans, certain credit cards and other consumer loans, will stay at about 3.25 percent, the lowest in decades.

The Fed gave its assessment after its first meeting since the economy began flashing significant signs of turning a corner. They include fewer job losses in July, slower economic contraction and stabilizing consumer spending. But dangers still lurk.

Further job losses, sluggish income growth, hits to wealth from tanking home values and still-hard-to-get credit could make Americans cautious in the months ahead, the Fed said.

The Fed expressed confidence that low rates and other aggressive action will gradually bolster the economy. Even so, economic activity probably will “remain weak for a time,” the Fed warned.

Against that backdrop, the Fed said inflation is likely to stay “subdued.” Fed policymakers predicted that idle factories and the weak employment market will make it hard for companies to jack up prices.

While unemployment dipped to 9.4 percent in July, the Fed says it’s likely to top 10 percent this year because companies are in no rush to hire.

The Fed offered no hints about the fate of another program intended to spark more lending to individuals and businesses at lower rates.

The Term Asset-Backed Securities Loan Facility, which had gotten off to a slow start in March, is slated to shut down at the end of December. And people are having trouble getting loans anyway, analysts say. More recently, the program was expanded to provide relief to the commercial real-estate market.

The Fed has been weighing whether it should end some of its economic revival programs now that signs are growing that the worst recession to hit the country since World War II is drawing to a close.

Many analysts believe the economy — which logged a mild contraction in the second quarter after a dizzying fall in the prior six months — is growing now.

“A paradigm shift is occurring at policy deliberations of the Federal Reserve,” said Sung Won Sohn, an economist at California State University, Channel Islands. “The officials are no longer worried about a severe retrenchment as they were late last year. Now, they are trying to sustain the economic recovery in motion.”

Applications for loans to buy homes, an early indicator of sales, rose slightly. Tepid interest in purchase loans does not bode well for the hard-hit U.S. housing market, which has been showing signs of stabilization.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, for the week ended August 7 decreased 3.5 percent to 499.0.

Celia Chen, senior director of housing economics at Moody’s Economy.com in West Chester, Pennsylvania, said higher interest rates on mortgages tend to depress home buying, but that demand is not as sensitive to changes in rates as it is in refinancing activity.

“Even though mortgage rates are rising, they still remain quite affordable,” she said.

“The bigger obstacle to home buying is job losses and tight qualifying conditions for borrowing,” she said.
WASHINGTON – The number of U.S. households on the verge of losing their homes rose 7 percent from June to July, as the escalating foreclosure crisis continued to outpace government efforts to limit the damage.

Foreclosure filings were up 32 percent from the same month last year, RealtyTrac Inc. said Thursday. More than 360,000 households, or one in every 355 homes, received a foreclosure-related notice, such as a notice of default or trustee’s sale. That’s the highest monthly level since the foreclosure-listing firm began publishing the data more than four years ago.

Banks repossessed more than 87,000 homes in July, up from about 79,000 homes a month earlier.

Nevada had the nation’s highest foreclosure rate for the 31st-straight month, followed by California, Arizona, Florida and Utah. Rounding out the top 10 were Idaho, Georgia, Illinois, Colorado and Oregon. Among cities, Las Vegas had the highest rate, followed by the California cities of Stockton and Modesto.

While there have been numerous recent signs that the ailing U.S. housing market is finally stabilizing after three years of plunging prices, foreclosures remain a big concern. Foreclosures are typically sold at a deep discount, hurting neighbors’ home values.

The mortgage industry has been slow to adapt to the surge in foreclosures. Many lenders have needed government prodding to get up to speed with the Obama administration’s plan to stem foreclosures.

The Treasury Department said last week that banks have extended only 400,000 offers to 2.7 million eligible borrowers who are more than two months behind on their payments. More than 235,000, or 9 percent, those borrowers have enrolled in three-month trials in which their monthly payments are reduced.

“The volume of loans that are in distress simply overwhelms” those efforts, said Rick Sharga, RealtyTrac’s senior vice president for marketing.

His firm, Paulson & Co., bought 168 million shares of Charlotte, North Carolina-based Bank of America valued at $2.2 billion as of June 30, according to a filing yesterday with the U.S. Securities and Exchange Commission. It was the biggest new purchase in the second quarter for Paulson, 53, and made him the bank’s fourth-largest owner.

“It’s ironic because he was the one that made the right call shorting subprime,” said Jerome Dodson, who oversees $2.5 billion at Parnassus Investments in San Francisco. “His timing is good but he probably won’t be as successful with this purchase as he was with betting the housing market would collapse.”

Paulson, who manages about $29 billion, last year started a hedge fund, called Paulson Recovery fund, to invest in financial firms hurt by mortgage writedowns. He boosted investments in gold companies this year to help mitigate potential inflation as governments worldwide increase spending to help their economies recover from recession. Gold has gained 7.7 percent this year.

Stefan Prelog, a spokesman for New York-based Paulson, declined to comment on the filing.

Bank Stocks

Bank of America gained 94 percent in the second quarter as concern the government would take an ownership stake eased amid signs of an improving economy. Paulson also bought 2 million shares of Goldman Sachs, the New York-based investment bank, in the period.

He ended the quarter with 7 percent of the UltraShort Financials ProShares exchange-traded fund, which is used by investors who expect bank shares to decline. The fund declined 57 percent in the quarter as the Dow Jones U.S. Financials Index rose 29 percent. Paulson’s 2 million shares were valued at $84 million on June 30.

Bank of America is the second-largest home lender, trailing Wells Fargo & Co., after acquiring Countrywide Financial Corp. last year. Countrywide lost $703.5 million in 2007 and almost collapsed under the weight of defaulting subprime mortgages.

Paulson’s filing came a day after Timothy Barakett, founder of the $5.5 billion Atticus Capital LP, said he was closing his $3.5 billion Atticus Global Fund to spend more time with his family and concentrate on philanthropic interests. Atticus bought Bank of America shares valued at $355 million in the second quarter, according to a regulatory filing on Aug. 10.

Betting on Gold

Paulson’s stake in the bank is the fund’s second-biggest holding after SPDR Gold Trust. He left unchanged his 9 percent stake in the investment fund that buys gold bullion, according to the filing.

His firm became the largest holder of Johannesburg-based gold producer AngloGold Ashanti Ltd. after buying 40 million shares to end the quarter with a 12 percent stake. Paulson also increased his stake in Johannesburg-based Gold Fields Ltd., becoming the third-largest owner of its U.S.-listed shares.

The fund reduced its stake in Market Vectors Gold Miners ETF, a fund that mirrors moves in the Amex Gold Miners Index, after selling 11 million shares. He owned a 5.3 percent stake in the fund in the second quarter valued at $227 million, down from 15 percent in the first three months of the year.

The hedge fund manager left unchanged a 4.4 percent stake in mining firm Kinross Gold Corp., according to the filing.

Paulson’s Pay

Paulson earned an estimated $2.5 billion last year, according to Institutional Investor’s Alpha Magazine. His Credit Opportunities Fund soared almost sixfold in 2007 on bets that subprime mortgages would plummet. Last year, his flagship fund returned 37 percent, compared with a loss of 19 percent for hedge funds on average.

Money managers who oversee more than $100 million in equities must file a Form 13F within 45 days of each quarter’s end to list their U.S.-traded stocks, options and convertible bonds. The filings don’t show non-U.S. securities or how much cash the firms hold.

Paulson reported holdings valued at $17.1 billion at the end of June compared with $9.3 billion at the end of the first quarter. He placed bets during the quarter on companies including Sun Microsystems Inc. and Wyeth that are takeover targets.

Paulson bought 74 million shares of Santa Clara, California-based Sun Microsystems, which is being taken over by Oracle Corp. for $7.4 billion. The new purchase was his second- largest in the second quarter, according to the filing.

The hedge fund increased its stake in Madison, New Jersey- based Wyeth, which is set to be acquired by Pfizer Inc., by buying 18 million shares of the drugmaker, according to the filing.

Paulson also increased his stake in Schering-Plough Corp. after buying 44 million shares in the Kenilworth, New Jersey- based firm. Schering-Plough agreed in March to be taken over by Merck & Co.

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net;