Central banks step in to rescue credit market

Washington
March 12, 2008

The US Federal Reserve and other central banks on Tuesday teamed up to get hundreds of billions in fresh funds to cash-starved credit markets, allowing financial firms to use home mortgages as collateral. Stocks surged and bonds fell in reaction to the move, in a sign that the financial markets saw the plan as a viable remedy to ease a crisis that has threatened world economic growth. US stocks rallied the most in six weeks with the Dow Industrials Average jumping 250-points higher at the start of trading.

In the latest effort to ease a credit contraction that has disrupted finance and rescued the world economy from a credit contraction, the Fed, Bank of Canada, Bank of England, European Central Bank and Swiss National Bank announced a series of aggressive measures to boost liquidity. The Fed will for the first time lend treasuries in exchange for debt that includes mortgage-backed securities.

The Fed said in a statement in Washington it plans to make up to $200 billion available through weekly auctions, and officials told reporters the program may be increased as needed. “This is the most significant step the Fed has taken so far,” said David Resler, chief economist at Nomura Securities International Inc. in New York. “This relieves some of the pressure” in the credit markets, he said.

The Fed said it 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. Today’s steps indicate the Fed is increasingly concerned about the investor exodus from mortgage debt, which threatens to deepen the housing contraction and the economic slowdown. While they fall short of the calls by some analysts for the Fed to make outright purchases of mortgage debt, the central bank left the door open to expanding the effort.

The measures are the latest in chairman Ben S Bernanke’s effort to alleviate increasing strains in financial markets that are curtailing credit to homeowners and companies, even after the Fed lowered its main interest rate by 2.25 percentage points. Last week, the Fed said it would make up to $200 billion available to banks in a separate initiative to help boost liquidity.

The Fed set up a new tool, the Term Securities Lending Facility, to lend Treasuries to primary dealers for 28- day periods through weekly auctions. The Fed also said it’s increasing the amount of dollars available to European central banks through swap lines. The Federal Open Market Committee authorised increasing currency swap lines with the European Central Bank and Swiss National Bank to $30 billion and $6 billion, respectively, increasing the ECB’s line by $10 billion and the Swiss line by $2 billion.

The Fed extended the swaps through September 30. The ECB announced it will lend banks in Europe up to $15 billion for 28 days and the SNB announced a similar auction of up to $6 billion. The Bank of England will offer $20 billion of three-month loans on March 18 and hold another auction on April 15. The Bank of Canada announced plans to purchase $4 billion of securities for 28 days. Treasuries slid after the announcement, with yields on 10- year notes rising to 3.60% at 10:32 am in New York, from 3.46%.

Traders removed bets on the Fed to lower its benchmark rate by a full percentage point, to 2%, by the end of the next meeting on March 18, futures showed. The contracts indicate a 60% chance of a 0.75 percentage-point reduction. The Fed’s auctions of Treasuries, which will begin March 27, may be secured by collateral including agency and private residential mortgage-backed securities, the Fed said. The central bank “will consult with primary dealers on technical design features” of the new tool. Primary dealers are a group of 20 banks and securities firms that trade Treasuries directly with the Fed Bank of New York.

The Fed action received full backing from the White House. US president George W Bush has full confidence in Federal Reserve chairman Ben Bernanke and he backed the latest steps taken to boost liquidity in financial markets, White House spokeswoman Dana Perino said on Tuesday.

“The president welcomes the steps today by the Federal Reserve and he has full confidence in Ben Bernanke at the Fed,” said Perino as Bush travelled to Tennessee for a speech on the war in Iraq. “Beyond that, I cannot comment on specifics.” Asked if Bush was informed about the steps in advance, Perino said she did not know.

Despite the positive market reaction, some analysts questioned whether the latest round of central bank efforts would have much staying power. Earlier efforts by the Fed and its counterparts were successful in reviving markets for a short time, only to see them unravel again when the next bout of credit turmoil emerged.

“This Fed action is good for a day or two,” said Michael Cheah, senior portfolio manager at AIG SunAmerica Asset Management in Jersey City, New Jersey. “There are three problems in the market. One is the price of money, then liquidity and counterparty risk. The Fed can do all it can in the first two areas by trying to reduce Fed funds and the price of money. However, these moves are not going to mitigate the counterparty risk,” he said.

In essence, banks have lost faith in each other after seven months of market unrest, making them reluctant to lend money to one another and driving up borrowing costs for the consumers and companies that power the world economy. The US central bank said the purpose of its latest action was to “promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally.”

[Source: The Economic Times]