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htm Fed Joins Other Banks in Measures To Inject More Funds Into Markets By GREG IP December 12, 2007 1:41 pm The Federal Reserve has joined with four other major central banks to announce a series of measures designed to inject added cash into global money markets in hopes of thawing a credit freeze that threatens their economies. The Fed said today it would create a new "term auction facility" under which it would lend at least $40 billion and potentially far more, in four separate auctions starting this week. The loans would be at rates far below the rate charged on direct loans from the Fed to banks from its so-called "discount window." But the new loans can still be secured by the same, broad variety of collateral available that banks pledge for discount window loans.
Swiss National Bank statement The European Central Bank, Bank of England, Bank of Canada and Swiss National Bank simultaneously announced parallel measures. "This is not about particular financial institutions with particular problems. It is about market functioning," said a senior Federal Reserve official who briefed reporters on condition of anonymity because of the sensitive nature of the actions. This Fed official, who spoke to reporters on a conference call, said that the adverse reaction of Wall Street on Wednesday had nothing to do with the timing of the announcement. This official said discussions with the other central banks had been going on "for a while." Wall Street investors applauded the Fed's latest effort to combat the country's worst credit crisis in nearly a decade. The Dow Jones industrial average was up by more than 200 points in early trading although it later gave back some of those gains. A day earlier the Dow had plunged 294 points as investors expressed disappointment with what they saw as a lack of urgency on the part of the central bank for dealing with a credit crunch which threatens to push the country into a recession. The Fed also said it had created reciprocal "swap" lines with the European Central Bank, for $20 billion, and the Swiss National Bank, for $4 billion. These will enable the ECB and SNB to make dollar loans to banks in their jurisdiction, in hopes of putting downward pressure on interbank dollar rates in the offshore markets, principally the London Interbank Offered Rate, or Libor, market. The inability of foreign central banks to inject funds in anything other than their own currency has been a factor creating the squeeze on bank funding in those markets. The Fed has worried that banks' growing reluctance to lend either to other financial institutions or to businesses and consumers could cause the flow of credit to dry up and drag the weak economy into recession. The new "term auction facility" overcomes the principal obstacles the Fed has faced using its two main tools for injecting liquidity. Open market operations can be used to inject cash at the federal funds rate, which is relatively cheap, but only against a limited range of collateral. The discount rate, on the other hand, is half a point higher than the federal funds rate and banks are reluctant to access it for fear of the stigma of being seen to be desperate for funds. The new loans will be auctioned off with a minimum rate linked to the expected actual federal funds rate over the duration of the loan. Since the federal funds rate is expected to decline over the next two months, when the loans will be outstanding, the loan rate could end up being close to or even below the current federal funds rate.
The ECB, SNB and Bank of Canada are all taking separate actions to tackle the squeeze on funding in their respective markets. "By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress," the Fed said. The Fed indicated that the new facility could become a permanent addition to its monetary policy toolkit. "Experience gained under this temporary program will be helpful in assessing the potential usefulness of augmenting the Federal Reserve's current monetary policy tools--open market operations and the primary credit facility--with a permanent facility for auctioning term discount window credit." The Fed "would seek public comment on any proposal for a permanent term auction facility." The announcement reflects months of preparation and study within the Fed on how to deal with the shortcomings it met in August when it lowered the discount rate in an effort to push added cash into financial markets. Nonetheless, its potential importance has grown given Wall Street's negative reaction to the quarter-point cuts the Fed announced Tuesday in the federal funds rate target and discount rate, to 425% and 475%, respectively. Blue chip stocks tumbled 2% and treasury yields plunged as investors bet the Fed would ultimately have to cut rates far more to catch up with a sinking economy. It remains unclear whether the new operation will do the trick. But the early reaction was favorable: Treasury bond prices plunged and their yields shot up in early trading, a sign that investors are abandoning the relative safety of Treasurys and preparing to bid up riskier debt. Futures markets suggested stocks would rise at the opening.
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